The fastest growing segment of the financial services industry was the one hardest hit by MF Global’s suspicious demise and overt fraud at Peregrine Financial Group (PFG).
The managed futures industry, which had grown from $14 billion under management in 1991 to over $329 billion to end 2012, was a shining star of the new economy. Offering the unique ability to zig when other investments zagged, the lack of correlation and performance during crisis were key points of attraction. This attraction came to a screeching halt with the MF Global and PFG criminal incidents. Not only were investors getting acquainted with the asset class shocked to learn their accounts were looted of assets, but more troubling criminal behavior appeared the cause - casting a shadow over all participants.
“There is a severe loss of trust, a loss of confidence. There is incredible anger and frustration. Things need to change,” said Diane Mix Birnberg, president of Horizon Cash Management. Her firm just released a study, The Aftermath of MF Global and Peregrine Financial Group Meltdowns: A Crisis of Trust, showing that a whopping 91% of respondents believed there was a breakdown in audit procedures.
The study themes that emerged included:
The laws and rules that govern the industry need to have ‘teeth’ â€“ and those involved in fraud and theft need to be punished.
Customer segregated funds must either be kept completely out of the FCM and/or be verified in real-time by regulators.
A strong and rare female voice inside a Type A male dominated industry, Ms Birnberg’s firm, Horizon Cash Management, has become the top cash management firm for participants in the managed futures industry. Starting in the 1970s as a secretary in a stock brokerage firm in Atlanta, where “women generally didn’t think about career aspirations,” she later joined Lehman Brothers in the bond business. After moving to New York City to work on Wall Street, she was recruited in 1980 by investors to operate a cash management firm in the futures industry and in 1991 founded Horizon Cash Management, which currently has $2 billion under management.
In MF Global “there was very little institutional leadership (from exchanges, regulators and major firms),” she said. “This resulted in rumor, innuendo and ultimately a lack of trust. The void in leadership is terrifying.”
Looking back on the MF Global and PFG disasters, Ms. Birnberg has the experience of witnessing 10 FCM implosions. “In every FCM implosion it has negatively touched the CTA / CPO segment of the industry.”
“Think about a plane crash,” she said. “When it happens? Key issues and facts are addressed by the airline, the FAA and even the US president. Information is available regarding what happened, why it happened and steps being taken to address the problem.”
With MF Global a plane crashed and there was silence.
This is the first part of a two part article.
Mark Melin is author of three books and taught a managed futures course for Northwestern University’s Executive Education program. To read additional blog posts visit www.UncorrelatedInvestments.com (requires free registration).
The voluntary return of $546 million in MF Global customer assets, the subject of hard fought 2 Â˝ year battle, was not motivated solely by the kindness of JP Morgan.Â Rather, it could be considered fruit from a likely hard investigation now gearing up if not already under way.Â This investigation, declared “dead” many times over in leaks to the press from official sources, has heated up, asÂ first discussed here.
The return of illegally transferred MF Global customerÂ assetsÂ was always a key bone of contention.Â JP Morgan had summarily dismissed regulatory and public pressure to return customer assets, so the question is: why submit to authority now?
In 2012 the National Futures Association (NFA) went so far as to send the bank a public letter, which was generally brushed aside as were numerous verbal requests and mounting public pressure from groups such as the Commodity Customer Collation and its leaders James Koutoulas and John Roe.Â This significant pressure was dismissed, yet an attempt by bankruptcy trustee James Giddens was successful. Â The fact this occurred at this moment in time is not aÂ coincidence.
Speculation is JP Morganâ€™s normally dismissive attitude towards government regulators might have changed in the face of what is expected to be a no holds bar CFTC / DoJ criminal investigation.Â In other words, the specter of government actually asserting itself and allowing career investigators to do their jobs unimpeded is enough motivation for JP Morgan to return what are documented to be illegally transferred customer assets.
But perhaps more important to the future, a real investigation could also be motivation for JP Morgan to provide critical testimony regarding the criminal activity of MF Global executives, including that of Jon Corzine.
The need for deterrence that derives from a Jon Corzine conviction is more important because the future that matters most.Â Since 2008, when financial crimes that damaged the US financial system were was documented not to be investigated by DoJâ€™s former assistant attorney general in charge of criminal investigations Lanny Breuer, Wall Street crime has imploded in its brazen disregard.Â MF Global is one example, but the case of HSBC laundering money for terrorist organizations and drug cartels â€“ after being warned on several occasions not to do so â€“ is a sign of complete disrespect and a breakdown of law and order on Wall Street. Â Â When the full story is known, Mr. Corzineâ€™s disrespect for the US financial system and its cogs of justice will likely stand as the turning point in a long battle.
Is this real?Â Is the investigation a serious point where the rule of law might actually apply to once exempt Wall Street players?Â We donâ€™t know for certain at this point, but one key tell is going to be the type of charges filed against MF Global executives.Â If RICO charges are used, this will send the powerful message that a cop is in fact back on the beat.
Mark Melin is author of three books and taught a course on managed futures for Northwestern University’s Executive Education program. Â To read more of his blog posts, click here (requires free registration). Â Contents Copyright (C) 2013 Mark Melin.
NEW YORK (Reuters)â€”Morgan Stanley plans to slash 1,600 jobs in what may be just the beginning of a new round of layoffs at large investment banks, this time driven by a deeper reassessment of Wall Street businesses in the face of new regulations and capital standards.
Morgan Stanley, the sixth largest U.S. bank by assets, plans to begin letting go of the employees, many of whom work in its securities unit, starting this week, two people familiar with the matter said on Wednesday [Jan. 9].
A third person who has been involved with plans to cut staff at Morgan Stanley and other large banks said that Morgan Stanley’s cuts had been in the works for months, and that more are expected in the future.
Large global investment banks have been cutting staff for the better part of five years, when the financial crisis pegged to the U.S. housing market began to seize up markets. Firms previously focused their job cuts on areas where activity had screeched to a halt, such as securitization of mortgages, or that were explicitly banned by new regulations, such as proprietary trading.
But banks are now making strategic decisions about businesses in grey areas where management teams do not see major profit potential, or realize that their individual banks are not competitive, the third source said.
“It’s hard to look at yourself in the mirror, and say: ‘I’m not good at this,’” said the source. But now that management teams are coming to those realizations, he said, they are beginning to make strategic decisions to exit businesses and cut more staff.
So far, the most prominent example of a bank making that kind of a tough decision is Swiss bank UBS AG, which said in October that it would exit bond trading altogether and eliminate 10,000 jobs.
Morgan Stanley has said it will not give up on the fixed income, currency and commodities trading business, known as “FICC” in Wall Street circles. The firm has said it wants to boost market share in FICC by two percentage points.
But Morgan Stanley is aiming to exit more complex realms of bond trading that require more capital under new regulations. The latest staff reductions will affect 6 percent of the institutional securities unit’s workforce, which includes the bank’s FICC business. The cuts will target salespeople, traders and investment bankers, the sources said. Support staff who work in areas such as technology will also be affected, the sources said.
Although all staff levels will be affected, the likely targets will be more senior employees who take in the biggest paychecks, and about half of the cuts will come from the United States, one of the sources said.
The cuts are also notable because, unlike its chief rival Goldman Sachs Group Inc., which culls the bottom 5 percent of its workforce each year to improve performance, Morgan Stanley does not have such a staff reduction program.
Some analysts have questioned Morgan Stanley’s plans to gain market share in the bond trading business.
JPMorgan analyst Kian Abouhossein â€” who earlier said that Morgan Stanley should give up that goal â€” expects Wall Street banks to report a 10 percent decline in revenue for the fourth quarter, compared with the previous period.
Bernstein Research analyst Brad Hintz, a former Morgan Stanley treasurer, said in a report on Wednesday that layoffs are expected in capital-intensive areas of Morgan Stanley’s fixed-income trading business, such as asset-backed securitization, synthetic products, structured credit and correlation trading.
“Investors continue to wonder how Morgan Stanley’s fixed income business will be able to generate steady returns and beat its cost of capital without massive changes to its business model,” Mr. Hintz said.
Restructuring Wall Street
Morgan Stanley Chief Executive James Gorman has pledged to cut costs, and said in July that he planned to reduce overall staff 7 percent in 2012. The new job cuts are in addition to that plan, the sources said, and come just a week after Colm Kelleher took over as the sole president of the securities unit on Jan. 1.
The cuts represent less than 3 percent of Morgan Stanley’s entire estimated workforce at year-end, following other staff reductions in 2012.
“This continues the steady drumbeat of negative news from banks,” said Greg Cresci, a Wall Street recruiter with New York-based Odyssey Search Partners. “It’s hard to tell where the bottom is, given how many banks have made similar announcements.”
Altogether, U.S. financial firms announced plans to reduce payrolls by 38,135 jobs last year, in addition to 63,624 job cuts that were detailed in 2011, according to employment consulting firm Challenger, Gray & Christmas.
“We are seeing a redrawing and restructuring of the industry,” said John Challenger, CEO of the firm. “The map continues to be redrawn in terms of regulation, who the competitors are, and the resources banks are willing to commit to the investment banking business.”
In addition to earlier job cuts at Morgan Stanley and UBS, Goldman Sachs cut 700 jobs during the first nine months of 2012 as part of a plan to reduce annual expenses by $1.9 billion.
Citigroup Inc. announced plans last month to cut 11,000 jobs, including some in investment banking and trading, to save $1.1 billion in annual expenses. Credit Suisse Group AG is also cutting securities jobs to reach an annual cost-savings target of 1 billion Swiss francs ($1.1 billion), while Bank of America Corp. is in the process of cutting 30,000 jobs across the firm in a plan unveiled in 2011 to save $5 billion in annual expenses.
Morgan Stanley shares fell 0.2 percent to close at $19.62 on Wednesday. Its shares are up 15 percent over the past 52 weeks, part of a broad rally in financial stocks.
Reuters Breakingviews Assistant Editors Richard Beales and Jeffrey Goldfarb and columnist Agnes Crane discuss why, despite JPMorgan’s noteworthy third-quarter results, it’s too soon for bank boss Jamie Dimon to get too confident. (more…)
“One thing I am sure of is that it’ll be great theatre,” I wrote at the end of Tuesday’s blog ahead of Jamie Dimon’s Senate banking committee hearing on Wednesday. It promises to be a fascinating showpiece event, I said, that should see a fulsome display of Senatorial emotion ranging from the ABC of anger, bewilderment and confusion through to disgust, puzzlement and indignation.
How wrong was I? I watched the entire sorry affair and it was the dullest, most pointless two hours I’ve spent in a long, long time. In the event, the Senate committee pussyfooted around a man they were clearly in awe of and proceeded to develop a weak and disinterested line of questioning and took everything Dimon said at face value.
There was no new information presented to the hearing, which didn’t just cover the credit derivatives losses as billed. Dimon was asked his opinion of the Volcker Rule, the Dodd-Frank Act, the role of regulators, his view of regulation, how much capital banks should ideally hold (8%, he reckons), whether smaller banks were more at risk from greater regulation, whether banks that are too big to fail are also too big to manage and too big to regulate; he was even taken to task over the length of time it took the bank to return monies in the MF Global saga.
In fact, the hearing covered the waterfront in broad generalities that only served to divert attention from its principal focus. (On the TBTF issue, he proffered that one of the downsides of size was a tendency towards greed, arrogance, hubris and lack of attention to detail. Cute comeback!) There were nuances of the right line of questioning throughout the hearing but no real conviction and no follow-through on material points. For Dimon, the hearing was a walk in the park.
Mind you, he did the mea culpa thing very well. He admitted he was aware of the CIO trading strategy but was quick to say he didn’t personally approve it. In fact, he was extremely careful not to take any specific blame for the credit derivatives losses, which he happily laid at the feet of the CIO traders, the CIO risk committee, the group’s risk managers and CIO management, all of whom he said, let a lot of people down. Their actions, he said, are “something I can’t publicly defend”. He acknowledged the chain of command didn’t work and blamed the risk function for not imposing more granular limits on the traders.
He repeated many times what we already knew: that rather than reducing existing positions in order to bring risk limits that had been triggered back over the line, they embarked on a larger, more complex strategy that created new and larger risks. Traders didn’t have the requisite understanding, he said; and they should have gotten more scrutiny â€“ from himself as well as the wider risk functions. He pointed out that an extensive review is underway that is being overseen by an independent board.
About the tempest in a teapot comment, he admitted “I was dead wrong” but he deflected responsibility immediately and directly by saying that he had spoken to Ina Drew (former CIO head), to the CFO and the risk officers, all of whom, he said, assured him they thought the problems that had come to light in the CIO were small and isolated. With regard to regulators, Dimon said the bank was very “open kimono” (Ughh!) but said that in the particular case of the synthetic credit portfolio, the regulator had initially been misinformed because management had been misinformed.
He didn’t really respond satisfactorily to questions about when regulators were informed about changes to the CIO’s risk models and whether changes to VaR tolerances were undertaken to mask the true extent of risk being undertaken by CIO traders or to incentivise them to take on more risk. He did say the CIO had requested an update to its models in order to be compliant with the new Basel capital rules, and that the new models the CIO adopted were approved by the independent model review group.
He said the first error management made in the affair was complacency and over-confidence because the CIO had done so well in the previous year. He blamed the CIO risk committee for not being independent enough and not challenging developments in the synthetic credit portfolio. The portfolio, he said, should have had more scrutiny and more granular risk limits right from the start.
He did accept that it would have been hard for the risk committee to have captured potential problems in the CIO’s synthetic credit portfolio, particularly if they hadn’t been picked up by management. And he pointed out that the original intent of the synthetic credit trading strategy was sound. “What it morphed into I can’t defend,” he said, even though the people doing it thought they would benefit the company in a crisis. The synthetic credit bets, he said, “morphed into something I can’t justify; they were too risky for our company.”
While he is clearly against the Volcker Rule, he did acknowledge that had it been in place, it might have prevented what the strategy morphed into. (Yes ‘morph’ was an oft-used word).
He explained the positions were intended to make a little money in the normal course of business but that in the event of a credit crisis, they would reduce group risk by making more money. He wouldn’t be drawn on making distinctions between hedging and proprietary trading but did say the synthetic credit ‘hedge’ was intended to improve the safety and soundness of the group.
The CIO, he said, was set up to invest money and earn income but pointed to its conservative stance: of the US$350bn in assets managed by the CIO, the average rating is AA Plus; the average maturity is three years and the average yield 2.7%. The CIO, he said is very conservative, and is sitting on US$7bn-$8bn of unrealised gains.
He rejected any notion that compensation played a part in incentivising risk-taking in the CIO. When the board finishes it review, Dimon said, “we will take proper corrective action”, he said, and it’s likely there’ll be clawbacks. Asked what he had learned from the problem, he said: “no matter how competent you are, you should never get complacent”. Cute.
Felix Salmon, finance blogger at Reuters, and Matt Taibbi, contributing editor at Rolling Stone, analyze developments relating to JPMorgan’s $2 billion trading loss with “Viewpoint” host Eliot Spitzer. Taibbi and Salmon agree JPMorgan’s risk-taking has broad implications.
“They get all of these deposits in, they’re a utility bank and it is their job and their duty in return for that implicit government backstop to take those deposits and lend them out into the economy and what do they do instead? They take the $360 billion and put it in a hedge fund in London,” Salmon says.
Ahead of Tuesday’s Senate Banking Committee hearing on MF Global, we present the April 20 installment of Capital Account with Lauren Lyster, featuring futures industry veteran guest, Mark Melin. Ms. Lyster pulls no punches in the opener:
Has the case really gone cold? Or, are those who are in charge of the investigation, the “regulators” and the trustees, simply spraying teflon on every piece of sticky evidence that could lead to criminal prosecutions–and, ultimately–the recovery of stolen customer money?
We wish that MF Global were just a one-off affair–a bad apple, if you will. Unfortunately, it seems more likely to us that this is another milestone in the history of what we see as criminality, which has swept through the financial services industry, like some sort of Medieval Black Plague–the Black Death for capital formation. It seems the only time people are held accountable anymore, is when they commit crimes that affect the super-rich.
Bernie Madoff is a prime example…Madoff is securely behind bars, but Jon “Teflon Don” Corzine is busy ordering carmel-Frappuchinos at the local Starbucks as he goes to shop for office space in New York…bothered only by the low din of discontent emanating from the blogosphere (and shows like this, Capital Account). What a nuiscance we must be to the new God-fellas of Wall Street…
Why was the MF Global back office cleared out with three top personnel allowed to leave, just as the firm was exeriencing its most serious liquidity (ahem solvency) crisis in its soon-to-be-terminated existence?
Why were C-level executives, far from being sequestered by investigators and being placed in an information silo, allowed to run the company for six weeks (prior to Mr. Freeh being installed as Trustee of the Holdings company)?
Why did Lois Freeh wait until early March to have MF Global Holdings USA declare bankruptcy, the very entity that retained the few remaining executives and employees and may have been cash-rich?
Why did Federal criminal investigators fail to so much as question Mr. Corzine nearly six months after the crime?
Why were the final days characterized as so “chaotic” when a properly programmed iPhone or Android smart phone (sorry, RIMM) should have been able to handle what amounts to maybe a few dozen megabytes of transfer instructions?
Even Chuck Grassley, the sponsor of the now-widely criticized 2005 bankruptcy reform act, has stated, “The bankruptcy laws are written to ensure that company executives who were involved in the demise of a company because of fraud or mismanagement shouldn’t be eligible for bonuses,” Mr. Grassley said.
More broadly, MF Global customers have an absolute right to clawback of questionable margin payments and asset transfers from the broker unit that occurred in the weeks leading up to the firm’s demise because there was a clear pattern of intent to deceive investors and customers alike–from manipulating regulators and the regulatory process to changing business practices in the final wee–all of which ensured that customers would be last in line for the remaining morsels of the MF Global carcass. (And, as we have pointed out since early November, 2011, the very nature of the Corzine Trade from Day One was such that all the risk was put in the customer brokerage house, while profits were diverted to an offshore business unit).
“Fraud” is the operative word here. There is no dispute that the Commodity Exchange Act (sic, the law) has been broken, but until fraud is investigated, customers are at the mercy of a very fuzzy and opaque legal process.
It’s time for Congress to put pressure on those in charge of this investigation and oversight to break their own glass of silence and dare them to utter the magic “F” word.
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