MF Global Inc. filed the eighth-largest U.S. bankruptcy on Monday October 31, 2011. MF Global would ultimately report the shortfall in customer accounts at $891,465,650 as of close of business Friday, October 28, 2011. The SIPA Trustee for MF Global indicates that the total shortfall may be as large as $1.6 billion.
On June 4, 2011, James Giddens, the SIPA (Securities Investor Protection Act) Trustee for MF Global, issued a detailed 275 page report that provides enormous detail of what happened. The Trustee plainly states that civil claims exist against a number of MF Global’s senior executives and officers. If the Trustee’s report is correct, it would be hard to imagine why the reported conduct would not also generate criminal indictments, since they include both (i) intentional taking of customer moneys to cover unrelated cash shortfalls, and (ii) material misrepresentations (termed “errors” by those involved) to regulators regarding the status of the customer accounts.
Jon Corzine was the CEO of MF Global at the time of its failure, having been put in that position in March 2010. Prior to his role at MF Global, Mr. Corzine was exceptionally well connected. He was the former CEO of Goldman Sachs, served as the Governor of New Jersey from 2006 to 2010 (was defeated for reelection by current Republican governor Chris Christie) and served five years of a six-year U.S. Senate term representing New Jersey before being elected Governor.
Corzine was subpoenaed by the Committee on Agriculture of the House of Representatives on December 8, 2011 regarding missing money from MF Global client accounts. Corzine’s testimony included the following denials:
“Obviously on the forefront of everyone’s mind – including mine – are the varying reports that customer accounts have not been reconciled. I was stunned when I was told on Sunday, October 30, 2011, that MF Global could not account for many hundreds of millions of dollars of client money….
I simply do not know where the money is, or why the accounts have not been reconciled to date. … I do not know, for example, whether there were operational errors at MF Global or elsewhere, or whether banks and counterparties have held onto funds that should rightfully have been returned to MF Global.”
The Trustee’s report tells a much different story. The Trustees report takes dozens of pages to describe a day-by-day account of the transfers that were made, and the reporting of such transfers to executive management. There can be little doubt that Mr. Corzine was not as clueless about the transfers as indicated by the above quote.
MF Global’s liquidity challenges were the motivation for taking customer moneys, which the Trustee describes as follows:
“MF Global’s investment in sovereign debt peaked at nearly $7 billion (net) in October 2011, and still stood at nearly $6 billion as of the bankruptcy filing date. As early as May 2010, the Chief Risk Officer at the time, Michael Roseman, began expressing concerns regarding liquidity risk of the RTM portfolio, which reportedly led to his termination in January of 2011. As the Board and management were aware, the exposure from this portfolio was the equivalent of 14% of MF Global’s assets as of September 30, 2011, and was more than four-and-a-half times MF Global’s total equity, a level that was orders of magnitude greater than the relative exposure at other, larger financial institutions.”
MF Global’s cash challenges were openly discussed and analyzed before the public announcements were made that started the liquidity crunch. The Trustee described this as follows:
“Liquidity concerns prompted an Audit and Risk Committee request in early September 2011 for an analysis of the potential impact on MF Global of a significant financial disaster such as a downgrade. After surveying business heads and operational personnel, in mid- October 2011, MF Global Risk, Finance and Treasury personnel prepared a “Stress Scenario Analysis – Downgrade: Potential Impact on MF Global” presentation … This analysis captures in one place most of the liquidity stresses at MF Global in its final weeks of business. It shows that management conscientiously (if belatedly) examined the likely sources of losses and demands for funding, but seriously underestimated both the speed and extent of demands on liquidity. It is significant that the total of this underestimate is in the range of $600 million to $1 billion dollars, approximating in magnitude the customer funds released from segregation and not returned in MFGI’s final days of operation. [Emphasis added]
The simultaneous occurrence of a customer “run on the bank” and unwinds of repo counterparty and proprietary positions within a three-day timeframe overwhelmed the Firm. The mitigating factors were also overly optimistic. The speed at which events transpired was beyond management’s predictions – the worst-case scenario played out in the span of only a few days. Reality unfolded vastly more quickly than the assumptions and timing laid out in the presentation, which anticipated that MF Global had sufficient liquidity to survive a “severe stress event” for at least one month.”
In other words, MF Global management knew that a cash flow problem might likely occur, but they underestimated the magnitude of the problem. They incorrectly thought that they could weather the storm by borrowing customer cash to cover the shortfall. When the problem came faster, and got larger than could be hidden, the bankruptcy filing occurred.
Initial speculation about the causes of cash shortages was entirely incorrect. Instead, the cash shortage was triggered by the risks that the Stress Scenario anticipated, which the Trustee describes as follows:
“Before a transfer was made on the morning of October 31 … the shortfall resulting from transfers from the FCM [futures commission merchants] amounted to approximately $900 million. Contrary to some public reports, the shortfall of customer property at MFGI was not caused by direct investment of customer funds in sovereign debt or even by losses on proprietary investments such as the sovereign debt. Rather, as detailed below, the actions of management and other employees, along with lack of sufficient monitoring and systems, resulted in FCM customer property being used during the liquidity crisis to fund the extraordinary liquidity drains elsewhere in the business, including margin calls on the European sovereign debt positions. …
Had customer funds been properly protected, the customer property in Customer Accounts should have been largely if not completely unaffected by the liquidity crisis at MF Global. Instead, these funds were used to fund MF Global’s liquidity needs in at least the latter part of the week of October 24.”
MF Global is remarkable because it involves a public company and a CEO with a solid reputation. To the extent that those involved claim that their actions were legal, regulatory changes are certain.
Fulcrum Inquiry performs forensic accounting and investigations.