In many ways, Wednesday’s House Financial Services subcommittee hearing on the eighth largest bankruptcy in US history was as much about what was not said than what was said.
Much attention was focused on MF Global assistant treasurer Edith O’Brien and her widely anticipated move of declining to answer questions during the hearing. Ms O’Brien has been at the center of questions surrounding her role in questionable money transfers of nearly $1 billion during the final days of MF Global’s existence. Speculation is Ms O’Brien received instructions from top officers at MF Global to transfer the money, a charge which has been denied by the executives, who generally claim either to not be aware of “where the money went” or claim they did not provide specific instructions to dip into customer segregated funds. A handful of money transfers were sent to the likes of JP Morgan and related MF Global overseas brokerage units in the final days of the firm’s existence. The staggering size of the money transfers makes it impossible for such transfers to have occurred without dipping into customer segregated funds, as the reported $1.6 billion “missing” from MF Global far exceeds the company’s net worth at the time.
While O’Brien was up-front about not answering questions, the remaining panelists might have just taken “the fifth” because their responses often didn’t answer questions.
In a contest for the most absurd answer of the hearing, MF Global chief financial officer Henri Steenkamp may be the winner. When asked about the historic money transfers in the final week of existence, Mr. Steenkamp claimed he was unaware of fund transfers due to his “global role” and he was engaged in “other serious matters” that apparently took his attention away from the draining of $1.6 billion in assets from the firm.
While the transfers were initially painted by quotes in news reports as due to “chaos” and implications were made that money vanished due to clerical errors, questions remain as to how $1.6 billion in cash – an amount in excess of MF Global’s total liquidation value at the time – could have escaped the notice of top executives. In fact, testimony highlighted how the bankruptcy trustee clearly identified October 26 as the date the segregated funds short fall was officially identified, while in testimony Mr. Steenkamp claimed learning of the transfers several days later.
“The height of absurdity is thinking that $1.6 billion simply vanished without the CFO’s knowledge,” noted Stanley Haar, who runs a managed futures hedge fund and has been a leader in bringing the MF Global issue to the attention of Congress.
When asked an obvious question regarding the role of creditor’s bankruptcy trustee Louis Freeh and his stated motivation to deliver assets to creditors as opposed to customers, Steenkamp answered with “I’m not an expert in bankruptcy.” Mr. Freeh is effectively Mr. Steenkamp’s employer and has authorized bonuses be paid to MF Global executives such as Steenkamp who have remained at the firm while it is being liquidated.
If Mr. Steenkamp was consistent in one area, it was avoidance of questions – and this drew the ire of Committee Chairman Randy Neugebauer, who flatly questioned Mr. Steenkamp’s honesty. At one point Congressmen queried Mr. Steenkamp regarding relatively arcane details of his college life, which he remembered. Then the Congressman proceeded in asking why the CFO of a financial firm couldn’t remember details regarding what were likely the most significant money transfers in MF Global’s 224 year history.
Ferber Confirms Investigators Finally Questioning Top Executives
While MF Global chief legal officer Laurie Ferber was generally evasive, one interesting piece of information to emerge is that investigators are beginning to question the firm’s top executives. Unlike MF Global’s back office, which had been questioned by executives early in the process, Ms. Ferber acknowledged that she will be questioned for the first time in April – close to six months after the fact. Mr. Steenkamp confirmed that he has not spoken to investigators, although his lawyers have answered questions. MF Global’s chief financial officer for North America, Christine Serwinski, who worked in the Chicago back office, confirmed in testimony she had been previously questioned twice by investigators. “I’m shocked,” said Congressman William Posey, speaking of the fact investigators have not interviewed MF Global’s top executives until long after the potential crime had occurred.
Ferber also made statements confirming that Mr. Corzine was involved in MF Global’s questionable money transfers to JP Morgan and she acknowledged she was responsible for compliance and disclosure to regulators. One issue in the MF Global case is that proper disclosure of segregated account balances was not made to regulators during the final week of the firm’s life.
Finger Pointing to Steenkamp, Serwinski, O’Brien
During a rare moment of candor, at one point Mr Steenkamp was asked who would have authority over money transfers and he apparently pointed a finger at Ms Serwinski, who proceeded to point the finger at an absent Ms. O’Brien. When Ms Serwinski was asked if she would have approved the wire transfer in question had she been in the office, she said she would not have approved the transfer.
Committee Treats JP Morgan to Soft Questions
Among other panelists was JP Morgan, which played a number of reported conflicting roles as MF Global’s primary lender, provided clearing services and was custodian of certain MF Global customer funds. Questions that might point more specifically to JP Morgan’s intimate knowledge that such money transfers took place from customer funds were left alone in the testimony.
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Mark Melin is author of three books, including HIgh Performance Managed Futures.He taught managed futures at Northwestern University in Chicago and has consulted for a variety of futures exchanges, hedge funds and professional traders. He can be reached at: markhmelin(at)yahoo.com
Contents Copyright (C) 2012 Mark H. Melin all rights reserved.
(What follows is the authors individual speculation. Written by Mark Melin with Bob English. To download a PDF version of this article, visit http://www.go2managedfutures.com/Vaporized.pdf)
Sometimes you wonder if we’re living in an alternate universe.
Recent news reports that cite un-named sources and indicate the MF Global criminal case has “gone cold” are curious. In fact, these news reports are even more bizarre than previous reports claiming MF Global client funds have simply “vaporized.” A pattern of behavior and reporting appears to be emerging that supports one overall goal: push the MF Global story under the radar, avoiding serious investigation and keep the inner workings and questionable circumstances surrounding a historic event out of public view and understanding. This, in turn, paves the way for MF Global creditors to legally swoop in on what rightfully belongs to the customers.
The “vaporized” and “case gone cold” news reports all convey a common underlying message: no one is responsible for what is now estimated as the loss of $1.6 billion taken from customer segregated accounts. There was no criminal activity. The message seems to instruct people to “mind their own business, keep quiet and just ignore what is the 8th largest bankruptcy in US history, a scandal tainted with fraud allegations that involves a man who is arguably the most politically connected Wall Street insider to ever walk among the backroom corridors of Washington DC.” Yet, by not officially using the “f” word (fraud), regulators, trustees, prosecutors and the rest of the panoply of public “protectors” make it more likely that the recipients, such as JP Morgan, of hundreds of millions in transfers of customer money in MF Global’s final days will simply get to keep it. The core integrity of the commodity markets has been destroyed and an “industry of investor protections” with an exemplary regulatory record for protecting customer funds, now demands a rewrite.
This is the story we are supposed not to discuss? Is it really too complicated for mere mortals to understand?
Explaining a Complex Story with a Simple Analogy
One critical goal among those on the side of JP Morgan and other creditors is that they are attempting to confuse the issue, so it helps to start with a simple analogy of what occurred.
Imagine for a moment that MF Global was your bank. One day you woke up and discovered that the account holding your college savings was gone. Poof! The money in your retirement accounts and related checking accounts had just been “vaporized.” You go to ask the bank where you money is and you are locked out of the bank while strangers who are not depositors are allowed to enter and take assets from the bank, including the contents of the “safe” deposit boxes. You finally hear from the bank and the authorities, who essentially say that while they can see all the transactions of the bank over the last month, for some reason, there is just no longer any trace of the money, and no explanation of what happened. The funds just “vaporized.” And after a few weeks of minimal information dribbles, you hear the search has gone cold. You are told the money disappeared in a chaotic tsunami of transactions and there is no evidence of any criminal actions. But, if money happens to get found, you might get some of it. Oh, and the contents of your safe deposit box are going to be auctioned off, with only a portion of the funds returned to you (this was the fate of the unlucky souls who held gold and silver bars on deposit in their own name with MF Global). That’s all…talk to you later. Good bye and good luck.
How would you react? Would the notion that your money “vaporized” elicit outrage?
Welcome to the MF Global case, one that is currently being swept into the tangle of questionable bankruptcy litigation and under the media rug.
In Criminal Investigations, Shouldn’t The Witnesses to a Crime And Suspects Be Interviewed Before a Case “Goes Cold”
In the case of MF Global, claims of customer “seg funds” being “vaporized” and the “case going cold” are made without investigators interrogating the primary suspect and individual in charge, former MF Global and Goldman Sachs President, New Jersey Senator & Governor, Jon Corzine. As the New York Times reported last week, “…authorities have yet to interview key witnesses — including a person who is believed to have transferred client funds in the firm’s final days.” Yet around the same time, Reuters reports: “Criminal Probe Trial going cold at MF Global.”
One would, of course, think a “case gone cold” proclamation is made only after investigators have finished examining all evidence, and only after questioning the primary suspect and all witnesses. That’s not the case – investigators claim they haven’t finished reviewing documents, but they are pretty sure the “case is cold.” Further, and as an aside, Mr. Freeh, trustee for MF Global Holdings has agreed to release documents from October 17th going forward, but nothing from before that date. Why would a US Trustee, under the authority of the Department of Justice, withhold anything needed for the investigation? (Many questions regarding Mr. Freeh’s appointment as trustee, and who recommended that appointment, are not being addressed in this document.)
Is this the information the financial services industry is asked to accept and then “vaporize” from its collective mind?
The “vaporized propaganda campaign” is a well-coordinated effort intended to confuse, divert and distract from the truth surrounding the crime of taking over a billion of customer funds. That’s the goal. In fact, it’s impressive how “Mr. Vaporized” has managed to keep this case out of the news so well.
How “Vaporized” and “Mr. Vaporized” Entered the Picture
On January 24, 2012 a jarring news leak, first reported by Wall Street Journal reporters Scott Patterson and Aaron Lucchetti, was said to come from sources close to judicial proceedings. The report made the now famous claim that MF Global customer funds had simply “vaporized.” After months of rapt attention to the question of “where’s the money,” those in the media still paying attention were now told the money just simply disappeared without a trace! Poof!
After initial, and inaccurate speculation, a potential source for the leak emerged and was summarily dubbed “Mr. Vaporized.” It is the author’s speculation that “Mr. Vaporized” is none other than Kent Jarrell, the third party media management consultant hired by customer trustee James Giddens. When reached for comment Mr. Jarrell responded “I have no idea where that word ‘vaporized’ originated from and I don’t know what you are talking about.”
Mr. Jarrell is a highly connected Washington DC media operative, who works for APCO Worldwide, a marketing, brand management and public relations firm with significant experience in “community relations” and strategic media planning. Mr. Jarrell is director of APCO’s Washington, D.C.-based litigation communication practice. The firm’s web site states “He advises CEOs, general counsels and boards of directors on preparation for unfolding material events.” And that, “He currently …advises the trustee in the liquidation of Lehman Brothers Inc.” Attorney James Giddens is also the Lehman Brothers Liquidation Trustee, a case in which $160 million was said to have been billed by trustees in legal fees.
Mr. Jarrell’s role in MF Global has been limited to communications regarding the liquidation and bankruptcy, as well as controlling the message and public expectations. Early in the process, Mr. Jarrell relayed a message through the media to MF Global clients that they should be prepared to “share” the MF Global proceeds with creditors such as JP Morgan. The message further stated that customers would only receive on a pro rata basis what is “identified by the trustee as available for distribution.” Further, that “The trustee then would be unlikely to find much value within the estate to pay back commodities customers, unless he can locate the missing cash,” noted a Reuters article.
In previous cases where futures brokers failed, the customer accounts were either transferred to another broker prior to a bankruptcy filing or the customers were afforded priority protection above all other claims in the bankruptcy process, in accordance with the Commodity Exchange Act. (That customers are not first is only so because of the curious way in which the bankruptcy and liquidation were structured by the regulators and MF Global execs in the first place. The parent holdings company filed under Chapter 11, generally used for reorganizations—not liquidations—and the broker unit was forced into a SIPA liquidation by the Securities and Exchange Commission. This decision has been a highly debated topic, as the 99% of accounts that were futures customers were afforded no insurance under SIPA and no protections from bankruptcy that fall under the Commodity Exchange Act. All in all, another MF Global mystery.)
On October 31, 2011, the day of the filings (or, perhaps even before), MF Global and its regulators may have planned such a structure to put customers on the same footing as creditors. Whatever went on in those closed door meetings, these reports of a new set of rules came as yet another shock to futures industry participants.
How Stupid Do They Think We Are?
Rules of propaganda teach us that if you repeat something long enough, no matter how absurd, it will eventually be believed. Multiple sources and narratives have parroted the thematic evolution: there was an unknown amount of missing money, which became money that had somehow disappeared, and finally an investigation gone cold, setting the stage for customers to expect less than 100% of their money back.
In an article dated January 30, 2012, The Wall Street Journal reported “a ‘significant amount’ of the money could have ‘vaporized’ as a result of chaotic trading at MF Global during the week before the company’s Oct. 31 bankruptcy filing, said a person close to the investigation.” It is interesting to note the phrase “a person close to the investigation” might indicate someone associated with court proceedings or grand jury proceedings.
Is anyone so stupid to believe that customer funds held in a segregated account could simply “vaporize?” Yet sources quoted in the Wall Street Journal seem to believe that could be possible. The assertion was widely questioned by those with knowledge of the situation, including CFTC commissioner Bart Chilton and US Congressman Bill Posey.
Judging by reactions of expert industry participants on Twitter, the medium de jour for exchange among professionals in the futures industry, the outrageous stunt of the “vaporized” claim was met with shock and disbelief. Knowledgeable industry participants understand there are special documentation requirements for 4-D and 30.7 customer funds and strict regulations that must be followed to move funds in such accounts. Further, the brokers are subject to daily reporting requirements which, combined with the traditionally sacrosanct nature of segregated account protections, relentlessly drilled into industry participants, makes “mistakes” in this realm highly unlikely.
These claims of back office “mistakes” stand beside a less reported note. In sworn Congressional testimony CMEGroup Chairman Terry Duffy was clear. Just before the bankruptcy, critical documents given to regulators by MF Global had been falsified. Mr. Corzine’s sworn testimony had been called into question by an MF Global employee – an employee now potentially being prevented from talking, a story that needs to be told to prosecutors. Not only has potential fraud been publically disclosed, but a web of fraud may lie underneath the 8th largest bankruptcy in US history. But, as the propaganda campaign goes: Ignore MF Global. No fraud investigation required here.
With informed participants now detecting that an obvious agenda was in play by the media sources close to the bankruptcy, the question becomes: why the focus on back office “mistakes” rather than investigate fraud?
Why Avoiding a Fraud Investigation Is So Critical: The Safe Harbor
If fraud is investigated in a bankruptcy it is much easier for illicit money transfers to be “clawed back” in Court through preference actions by the trustee. Thus, in the case of MF Global, if $1.2 billion was wired out of MF Global to JPMorgan the week before the bankruptcy, this money could be safely returned to client segregated accounts. If fraud is not investigated, if illicit money transfers will be allowed to move out of MF Global into JP Morgan, then JP Morgan keeps the money.
Speaking on Bloomberg Law, a web-based video program, editor at large Bill Rochelle was clear: “Here is (why fraud) is an important point in the bankruptcy process,” Rochelle continued. “Congress passed what is known as a ‘safe harbor.’ What it says is the in a bankruptcy if money was paid in a stock transaction or if it was paid as margin, (MF Global account holders) can’t get it back. The only way you can get money back in a case like that if (the money) disappeared as a result of actual fraud. This report that the trustee was filing to me doesn’t sound like he (the trustee) is making a case for actual fraud, but rather (they are making a case for classical incompetence – and that may not be enough to get the money back,” which is a key point. Legal sources independent of Mr. Rochelle say if fraud is involved in a bankruptcy case, MF Global customer rights could be enhanced.
Trustee Giddens Softens Up MF Global Customers to Take it on the Chin
On February 6, 2012, James W. Giddens, the MF Global broker unit Liquidation Trustee, who is statutorily tasked with obtaining as much recovery as possible for customers, released a preliminary status report. In it, he sets the tone for ensuing media stories, toeing the “chaos and confusion” theme.
In various places, the report implies a degree of certainty about the flow of funds in MF Global’s final days, such as, “The Trustee’s investigators have now traced a majority of the cash transactions, totaling more than $105 billion, made in and out of MFGI in the last week before bankruptcy and are completing the process of tracing the remaining transactions.” And, “The Trustee has identified most of the parties that were the immediate recipients of transfers from MFGI during the final days and weeks of operation.”
Interspersed with these glimmers of hope, though, are statements about the reign of chaos, such as, “For three months the Trustee’s investigative team has worked to understand what happened during the final days of MF Global when cash and related securities movements were not always accurately and promptly recorded due to the chaotic situation and the complexity of the transactions.” And, “The company’s computer systems and employees had difficulty keeping up with the unprecedented volume of transactions [in the final week]. A number of transactions were recorded erroneously or not at all.”
But, where subject and medium converge is in Trustee Giddens’ confusing representation of cash movements at the broker unit during the month of October, 2011:
Figure 1: Actual chart provided by Trustee to "simplify" MF Global money transfer. Could straight lines have been drawn between various parties?
Mainstream Media Starts to Find the Scent
It seemed that certain mainstream and alternative business journalists had begun to take an interest in the unusual circumstances of the case. But the pattern of deception over truth would eventually persist, apparently taking a cue from Trustee Giddens’ early report about the back office. Bloomberg’s Bill Rochelle noted the trustee’s report characterized MF Global management as simply having “lost control of the backroom. The left hand didn’t know what the right hand was doing. They were not recording transactions. They (MF Global back office) ordinarily sometimes took out customer money but replaced it by the end of the day, but as the company was collapsing they weren’t able to.”
This characterization of MF Global back office behavior is noteworthy and requires critical examination. Would back office testimony contradict these statements? In fact, one familiar with MF Global operations and futures industry auditing procedures might express surprise at what was characterized as routine violations in back office behavior. We may never know, because investigators have determined the case “is cold” before any investigation into what industry professionals consider highly unusual behavior for any firm regardless of the level of “chaos.”
On February 9, Reuters reporters Nick Brown and Grant McCool reported that an investigation of some sort was taking place, but again downplayed the possibility for any serious charges due to “plenty of ‘chaos’ at MF Global in its waning days, but ‘no evidence of fraud,’” the article noted, quoting sources close to the investigation.
Unfortunately for MF Global customers, sweeping changes in the Federal Bankruptcy Code enacted in 2005 grant special super-priority status to derivatives in bankruptcy (including loans structured as repos) and prevent last minute margin transfers from being clawed back, except in the case of fraud (which everyone in charge refuses to discuss). The excuse, or in legalese, “safe harbor”, was again roundly questioned by many leading industry professionals, including R. Christopher Whalen, when he appeared on CNBC with Rick Santelli and in an article he penned at Zero Hedge titled “MF Global: Where’s the Cash — Part II.”
The February 9 Reuters article went on to note “and keeping with the message pattern identified, people familiar with the situation said some executives and employees who, in the normal course of an investigation would have been interviewed by authorities at this stage, have not been asked to provide their version of events.” The February 10 report was similar in context and tone, noting an investigation was ongoing but that investigation was stalling. This is a pattern that had developed, as increasingly pessimistic news concerning the potential for discovering the perpetrators was also accompanied by a dash of hope to add seasoning to the bad taste the investigation was leaving in people’s mouth.
Jubilation Over Justice Is Quickly Dampened
Fast forward to February 28, 2012. This is when solid news reports of a Chicago federal grand jury investigation surfaced in the CMEGroup annual report, which noted the exchange had received a subpoena. This news was cheered by many industry participants, as the potential for justice finally appeared to arrive. Just as quickly as the ray of hope of grand jury news reports were made public, another leak to the press emerged to dampen expectations that an investigation might yield results, again highlighting how the “case had gone cold.”
In an article titled “Doubtful Signs of a Criminal Case Against MF Global” on February 28, New York Times reporters Azam Ahmed and Ben Protess noted “Federal authorities are struggling to find evidence to support a criminal case stemming from the collapse of MF Global.”
Frustration Boils Over, Limited Options For Industry Participants
By now, growing discontentment from select industry participants with the investigation could be characterized as hostile. Questions were being logically asked as to how it can be that a investigation was growing “cold” without interrogation of the primary suspect or interviewing potential witnesses to the crime. Attempting to get their message heard with limited options, visible outrage occurred on Twitter, and a small group of industry participants, speaking behind the scenes, considered the motivation behind the press leaks. A strategy appears to have emerged, with the goal to dampen expectations for any serious criminal charges and keep confidential key documents and testimony regarding what transpired before and after the historic bankruptcy. Such suspicions grew with the next set of press leaks. Leaks apparently designed to discredit the more vulnerable.
Back Office Workers Defamed, Unable to Defend Themselves
Back office employees are typically trained to follow specific processes for managing customer capital, processes which are confirmed and audited on a regular basis by the broker’s regulator. These processes are stressed tested, as the threat of real life chaos is considered a constant in the lives of many back office employees, particularly one as experienced and highly respected as Edith O’Brien, an MF Global treasurer. It was these back office employees who likely executed what became, knowingly or not, the raid on customer segregated funds that may hold the key to understanding what really occurred. If these individuals on the front lines were to provide testimony and documentation, it could unlock the key to understanding what transpired and potentially allow justice to prevail.
Unfortunately, the first news to emerge regarding back office employees didn’t focus on their cooperation with the court. Instead, leaked reports focused on information possibly designed to defame the employees and paint a picture of lax back office behavior, which in turn supports the “vaporized” themes. These leaks were also reported to come from those close to the court room proceedings and criminal investigation. Based on the documentation type, speculation favors that the documents were leaked by someone close to the liquidation trustee (Giddens) or bankruptcy trustee (Freeh), with a more distant possibility being law enforcement investigators.
How does the defamation of employees critical to the flow of funds work?
In an article published in both the Wall Street Journal and on the Fins Finance web site titled “Building Chaos at MF Global,” among the first reports to emerge regarding the MF Global back office focused on key employees and called them out by name. The article noted that these two key employees were away at a ball room dancing competition in Las Vegas–a situation that might be laughable were it not so serious. But this is yet only another distraction from the core issues.
The fact that two key employees, one, the MF Global North American finance chief, the second, the head of margins, would be away “ballroom dancing” when the company was under historic stress raises questions. This curiosity is compounded when one considers that many at MF Global and inside the futures industry understood the firm may have been spiraling into bankruptcy during that very time. In fact, senior management had prepared a “break the glass” document weeks before in early October that specifically identified a scenario under which the segregated customer funds account might go in the red. Given this obvious crisis situation, of which senior management appeared acutely aware, why would management allow two key employees in finance and margins, potential customer safeguards, to be away at a time when they were known to be needed most? It just does not add up.
All futures brokers are required to design and enforce internal controls and procedures that will protect customer funds under all circumstances. These internal controls must be attested to by the firm’s senior officers and must be audited at least annually (in the case of MF Global, this was done by PricewaterhouseCoopers). Who authorized these key employees to take time off in those critical days? What would be the motivation for top management to allow key back office personal to take off when, as Mr. Corzine even testified to Congress, they knew capital had to be rapidly raised and massive financial gaps had to be filled? Were the firm’s internal controls and procedures followed? Either way, the media ought to be questioning those who were responsible for designing and implementing those procedures, not putting out red herring stories that conjure images of a National Lampoon movie.
The source of these leaks ridiculing the two financial officers came from “internal emails, documents and people familiar with the matter.” Who could this source be? Simple knowledge of the case reminds us that the two trustees and FBI investigators had access to the documents in question.
More Strange Leaks, Wall Street Journal Headline: “Fast and Furious at MF Global”
The Wall Street Journal headline of March 1, 2012 may be appropriately titled, as it refers to another scandal at the Federal Bureau of Investigation, this one involving gun running to a Mexican drug cartel and a potential cover-up.
The article noted that “At 4:53 p.m. five days before MF Global Holdings Ltd. collapsed, an employee in its Chicago office asked a co-worker to move $165 million from one of the securities firm’s bank accounts to another.” The approval was reportedly granted by email a mere minute later, and funds were transferred to an MF Global account at JP Morgan. This raises a sea of questions:
First, the issue for customer segregated funds would have emanated from a transfer of funds from the futures brokerage unit into the securities brokerage unit. The fact that it would be a securities to securities account transaction would fall under a different regulatory structure and likely not involve the theft of MF Global segregated funds. MF Global had a paltry 318 securities accounts compared with over 38,000 active futures accounts. Having said that, let’s assume the transfer was from a CFTC regulated futures account to an SEC regulated securities account.
That an end of day money transfer of $165 million out of a segregated account in the futures brokerage unit into the securities unit, approved in mere seconds, is almost surreal. It could be speculated the speed at which this approval came might have indicated advance knowledge of the issue. Conversely, if approvals of this magnitude are routinely granted this quickly, the issue of proper design and implementation of internal controls and procedures is brought into play.
To understand the significance of the approval, legal conditions are required between the bank depository and the FCM identifying the special segregated account status. Further, what are known as 4-D and 30.7 account titles clearly identify the special nature of the customer segregated account. Regulations that govern these special accounts cannot be violated–not on an end of day basis or even intraday, according to sworn Congressional testimony by CFTC General Counsel Dan Merkovitz. Did the transfer paperwork specify the 4-D or 30.7 account title? With these rigid requirements, speculation among industry participants is that the move to transfer money out of a customer segregated account would not happen by “accident” in a moment of “chaos.”
The investigation to date has found that transactions regularly moved between accounts and that funds believed to be in excess of segregation requirements in the commodities segregated accounts were used to fund other daily activities of MF Global. In the past, such transfers were in amounts of less than $50 million, but as liquidity demands increased and could not be met from internal sources, much larger amounts were used, apparently with the assumption that funds would be restored by the end of the day. By Wednesday, October 26th, as the result of increasing demands for funds or collateral throughout MF Global, funds did not return as anticipated.
Recognize that some may interpret this statement as an admission that fraud regularly occurred at MF Global. The unambiguous statement by the customer’s trustee clearly states that the provisions of the Commodity Exchange Act (CEA) designed to protect customer funds were likely routinely violated, and knowingly so . Yet, neither he nor anyone else in the know can so much as hint at fraud?
In the report, Mr. Giddens falls back on the chaos angle, stating, “As these withdrawals occurred, a lack of intraday accounting visibility existed, caused in part by the volume of transactions being executed…” One has to read between the lines here, because based on Giddens’ prior disclosures, the primary cause of the lack of accounting visibility was the habitual violation of CEA regulations, but this is not mentioned–only the sheer “volume of transactions.”
One of Several Smoking Guns Being Ignored?
Back to the WSJ article, in what might be construed by some as covering tracks, it then quotes the back office staff as saying they noticed a mistake and then tried to reverse it. If this were a crime, the mastermind might be saying right now, here’s what you tell them: “Oops, we just transferred $165 million from customer segregated funds to JP Morgan. I hate it when that happens. And because this case is a SIPA/Chapter 11 bankruptcy, we can engineer the process so that fraud is not investigated from the start and MF Global customers have no claw back rights. The money stays at JP Morgan.” And, as was reported in the press early in the bankruptcy, customers will have to be happy with sharing whatever might be recovered from the estate.
“Midlevel finance officials usually couldn’t move such funds without direction from more senior officials,” the article continues. This is the essential point. It is the author’s speculation that at some point there was likely an order from one of the big three in MF Global – Mr. Corzine, COO Bradley Abelow and/or CFO Henri Steenkamp. Given the $6.3 billion trade in risky sovereign debt was known as the “Corzine trade,” the risk allocation of the trade that put the customer broker unit on the hook for all losses could be characterized as “his brainchild.” Further, in all likelihood it was Mr. Corzine who had key trade management relationships with JP Morgan, and it might be assumed he had awareness of $165 million being sent to the firm. Any mid level investigator might rightfully conclude that Mr. Corzine’s knowledge of the money transfer was highly likely, if not based on his actual instruction.
At the very least, MF Global’s internal controls were sorely lacking in design and implementation, and anyone who signed off on them, including Mr. Corzine and PricewaterhouseCoopers, may eventually have to answer for these alleged transgressions.
The article further revealed interesting developments at J.P. Morgan:
“JP Morgan also has been questioned about the $165 million transfer, according to a person familiar with the matter. Four days before MF Global filed for bankruptcy protection, the company’s brokerage unit borrowed the same amount using a secured credit facility led by J.P. Morgan. The loan was paid back the next day, this person said. It couldn’t be determined if the loan and transfer were related.”
These types of relationships and apparent cozy transfer of money between two entities highly related to the process warrant clear explanation before calling the case cold. However, such explanation might be rather difficult given the fact that neither MF Global senior management nor key people in the back office have been questioned by investigators.
But that is only if fraud is investigated. Remember, in the MF Global case there is not even the apparent suspicion of fraud. No reason for any serious investigation into this story.
To quote the classic movie Wizard of Oz: “Ignore the man behind the Curtin.” Ignore MF Global everyone. There isn’t a story here…
Is your friendly neighborhood hedge fund prepared for March 30?
That’s the deadline to register with the Securities and Exchange Commission. This change in regulation—brought forth by the Dodd-Frank legislation—requires large hedge funds to provide the SEC with details about their risk management, trading, and disciplinary records. According to CNBC, this could mean that the $15 billion Moore Capital Management will transform itself into a smaller type of fund that would focus on its founder’s investments, instead of those from outside investors.
This is not the positive news hedge fund managers were hoping to get in 2012. But it’s not unexpected. They’ve been preparing for the Dodd-Frank invasion for some time, which is why Moore Capital Management and other hedge funds are considering a transformation. Many are expected to disappear entirely, while others could face harsh penalties for violating rules that were (up until now) completely ignored.
Interestingly, the SEC did allow for a few exemptions under the Dodd-Frank Act:
- Advisers solely to venture capital funds.
- Advisers solely to private funds with less than $150 million in assets under management in the U.S.
- Certain foreign advisers without a place of business in the U.S.
But considering the fact that most major hedge funds do not meet the criteria above, it’s not surprising to hear that many are fearful of the future.
“It’s trying,” Brad Alford, a money manager who invests in Moore Capital Management (among other hedge funds), told CNBC, expressing his disappointment. “The years that we needed hedge funds to perform the most—in 2008 and 2011—they failed us miserably.”
With hedge funds failing to live up to expectations, and with the impending regulation threatening to forever change the industry, guys like Alford might be tempted to leave the investment community for a more substantial job on Wall Street.
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First Business’ Bill Moller talks with Janet Tavakoli, president of Tavakoli Structured Finance, about her new book, The New Robber Barons, a compilation of articles and other pieces she wrote about the global financial crisis.
“What we’ve learned from this crisis is that when you throw trillions of dollars on the table, nobody tells the truth and everyone plays for keeps,” Tavakoli says.
(Note: This is the first of three articles that details questionable, behind the scenes meetings and special treatment that negatively impacted investor protections. This first article details a critical meeting where core investor protections were jeopardized. The second article details tampering of critical MF Global documents at the SEC. The third article provides names, dates and topics of critical meetings that took place between government regulators and Mr. Corzine that likely influenced the outcome of regulatory action.)
In Closed Door Meeting Preceding Bankruptcy Filing, JP Morgan and Goldman Sachs Granted Superiority over MF Global Segregated Accounts
Move Jeopardized Integrity of Futures Markets while Top CFTC Officials Acted As Idle Bystander
(Chicago) It seems ironic that after all is said and done, it was a hasty conference call between government regulators on October 31, 2011 that sealed the fate of MF Global segregated account protections – and plaaced in jeopardy the integrity of the futures markets.
A key legal protection providing security to the account segregation process appears to have been given away in a closed door meeting between the Commodity Futures Exchange Commission (CFTC) and Securities and Exchange Commission (SEC). Early in the MF Global bankruptcy process, before even the first court filing, decisions were made that resulted in weakening the core integrity of the futures markets at its most fundamental level.
It was here a little discussed legal technicality usurped the common bankruptcy code, which has very specific language in it protecting MF Global segregated account holders. The common bankruptcy code has the iron clad protections for segregated accounts built in. It is upon this very foundation that the integrity of the futures markets and its “segregated account comes before all else” claim rests.
This core protection was given away in a closed door meeting between the SEC and CFTC. This article provides details of the closed door meeting, including meeting participants and the profound impact the meeting has on the very integrity of the futures markets.
In this meeting, which is said to have taken place via conference call early on the morning of October 31, an SEC official made the discretionary decision to engage in what is known as a SIPA liquidation process written for the securities industry. While it may seem absurd, this liquidation process wasn’t designed or written for a futures brokerage, which has very unique needs in a liquidation. But here is where the technical detail becomes the devil:
In a SIPA liquidation creditors are afforded legal superiority over segregated accounts.
Mark H. Melin is currently writing his fourth book on uncorrelated investing. He is previous author / editor of three books, includingHigh Performance Managed Futures (Wiley, 2010) and an adjunct instructor in managed futures at Northwestern University. He can be reached at markhmelin (at) gmail.com
Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors. Past performance is not indicative of future results.
The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.
Commodity Customer Coalition founder James Koutoulas is requesting that MF Global bankruptcy Judge Martin Glenn investigate three potential legal issues that are said to have occurred in transferring of MF Global assets. The key issues include the fact that JP Morgan was able to purchase MF Global bonds at a discount without any open bidding process and the assets were apparently sold without disclosure to or approval from the U.S. bankruptcy court or trustees. The third issue centers on JP Morgan seeking special favors from the Federal Reserve to receive priority treatment over investor segregated fund accounts.
The first such non-transparent movement of assets occurred when JP Morgan is said to have purchased MF Global’s Sovereign Debt at a significant discount without an open bidding process, paying $0.89 and later selling that debt to investor George Soros for $0.95. No one is going to complain about JP Morgan generating profit. However, purchasing assets of a bankrupt firm without an open bidding process or disclosure to the bankruptcy court and trustees is where JP Morgan may be in trouble, according to Mr. Koutoulas. This sale could be subject to clawback provisions, legal experts speculate. (On December 9, 2011 The Wall Street Journal reported the fact that bonds were moved to KPMG London office, which was the bankruptcy administrator, but at the time the article did not discuss sale details or approval through the bankruptcy process. See “Corzine’s Loss May Be Soros’s Gain” by Gregory Zuckerman and Dana Cimilluca.)
The key issue is that such transfers is the bonds were purchased at a discount without open bidding and the process was not disclosed to or authorized by the U.S. Bankruptcy Court, according to Mr. Koutoulas. “Who gave JP Morgan permission to purchase those bonds at a discount without open bidding?”
The second questionable movement of assets is said to have occurred when JP Morgan purchased MF Global’s stake in the London Metals Exchange (LME) without proper disclosure. The event was widely reported at a basic level on November 28, 2011. The larger issue, however, appears to center on the fact that such a transaction was not approved by the U.S. bankruptcy court and trustee.
“Was this disclosed in court?” Mr. Koutoulas rhetorically asked. “No. Was their trustee approval? No.”
The third issue occurred in congressional testimony Thursday, December 15, 2011 where it was discovered JP Morgan asked the Federal Reserve to write a letter claiming that the segregated funds should not be categorized as client money.
“How many letters like this have they asked for in the past? I want all the statistics regarding the number and content of letters,” Koutoulas questioned. “JP Morgan wanted a ‘get out of jail free card’ from the Fed. Guess what? That doesn’t fly with me.”
“Their hubris is so severe. They think we don’t know the industry, like we are Occupy Wall Street radicals or something and don’t have a clue or message,” Mr. Koutoulas said, noting that the CCC is comprised of experienced industry participants who understand the financial services industry from the inside.
Mr. Koutoulas seeks to solve the problem with JP Morgan without dragging the issue through court. In speaking to JP Morgan, Mr. Koutoulas said “Listen, you are buying vulture MF Global claims at $0.86 ½ on the dollar. Why don’t you pay a fair price of $0.97 ½ take the customers out of the bankruptcy and we will indemnify you from any class actions resulting from this.” A vulture claim occurs when an MF Global claimant such as a farmer or small business person is in desperate need of cash and sells their claim to someone such as JP Morgan, who purchases the claim at a lower rate than the value at maturity. In this example if JP Morgan purchased the claim at $0.87 and all clients were eventually “made good” JP Morgan would receive the par value of $1.00. With the MF Global bankruptcy proceedings apparently moving along much quicker than expected, JP Morgan stands to potentially make a quick 13% return on such vulture claims.
Mr. Koutoulas reports that JP Morgan would not even discuss the issues. “I can see that you disagree with me,” said Mr. Koutoulas, whose organization represents over 7,000 MF Global clients, mostly professional investors. “They won’t even meet with me and talk with me.”
Mr. Koutoulas is currently working Pro Bono and many of the lawyers are working at a highly discounted rates and requested that industry participants donate to help . “I need professional litigators and bankruptcy attorneys backing me up,” said Northwestern Law School grad Koutoulas who also operates Typhon Capital Management, which is an NFA-registered Commodity Trading Advisor and Commodity Pool Operator. ”We’ve had an outpouring of lawyers who want to help,” Mr. Koutoulas said, sitting with a young Yale Law School grad as we spoke.
In calling on MF Global presiding bankruptcy Judge Glenn to investigate these issues, Mr. Koutoulas is rallying the futures industry to boycott use of JP Morgan. “Call your FCM and if they are using JP Morgan say ‘We won’t do business with you if you work with JP Morgan,’” he said, requesting that industry participants get on Twitter and follow the #BoycottJPM hash tag.
For additional information on the Commodity Customer Coalition visit www.CommodityCustomerCoalition.org and on Twitter use hash tag #boycottJPM
Mark H. Melin is author / editor of three books, includingHigh Performance Managed Futures (Wiley, 2010) [http://amzn.to/vyonBA] and was an adjunct instructor in managed futures at Northwestern University. Follow him on Twitter @MarkMelin or visit www.Go2ManagedFutures.com for additional information.
Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors. Past performance is not indicative of future results.
The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.
While no one person can speak for a diverse industry, it might not be true to generalize the futures and options industry hates Jon Corzine. Many, including myself, don’t personally know the man.
What is known is that an industry has been brought to the brink and a serious test of its backbone is underway. Many of our business associates and friends have been dramatically impacted by actions from someone known as an arrogant individual used to getting his way most of the time, a man who demonstrated a complete disregard for MF Global and the industry in which it operated.
Not only did Mr. Corzine expect special treatment, he was surprised when he didn’t get it. Here is a man that is said to have engineered the toppling of a CFTC regulator in 1998 over the issue of transparency. This lack of transparency and disregard for regulators are career trait many practitioners in the futures and options industry couldn’t get away with. Why should a man who brought an industry to its brink and had a history of complete disregard for regulators and transparency be given special treatment?
As such, it’s time for the tough questions to be asked because we are getting close to the point where if this were regulators would descend on a mid-sized FCM or IB with the force of a predator drone attacking a domestic terrorist. (Mr. Corzine, to clarify in the previous sentence “IB” stands for “Introducing Broker,” not “Investment Banker.”)
Here are key points that have emerged since his compelling testimony:
As Futures Magazine’s Dan Collins aptly noted in an article after Corzine’s initial testimony, the most significant information to come out of the testimony didn’t come from the “lawyered up” Corzine statements, but rather from the Chicago Mercantile Exchange (CME). The CME essentially established what had previously been undisclosed by Mr. Corzine: Funds were improperly transferred at 2:00 AM Monday morning.
The question is: who is responsible for that transfer? To think that Mr. Corzine or the top two or three officials at the top of MF Global were not aware of the transfer of $1.2 billion out of customer segregated funds might be similar to belief in the tooth fairy.
When the transfer occurred, how could it be that those “pushing the button” not be aware they were violating CFTC fund segregation rules? Or perhaps with a history of ignoring regulation, those “pushing the button” might have assumed they would be accorded special treatment.
Are regulators expected to prevent such an action, or is their role simply to recognize how the regulation works and then enforce strict rules?
These questions should be answered in the context of a larger picture being painted. Here is what likely happened, pointing to the questions to which Mr. Corzine should be responsible to answer.
(Note: what follows is highly speculative and opinionated)
In the chaos of the early-morning realization liquidity was gone, a decision was made to move segregated funds. In almost any imaginable case inside an FCM, the only ones with access and authority to move such a large amount of capital at 2 AM was a high level official. At minimum, such activity would likely have been reported to top officials at MF Global early Monday morning as mid-level and high-level officials would have been alerted to the transfer through even the most basic FCM security process. MF Global was not a “basic” FCM and had a more detailed process in place, leading to a question: Why did it take so long for this activity to get reported?
And here is where another inconsistency appears:
Upon entering the brokerage, it was said the “account records were a mess.” Really? Is this disorganization consistent or did it occur only after the transfer of capital out of segregated funds? Based on subjective observations, those close to the industry might find such disorganization inconsistent. Does the disorganization of critical account documents point to attempts to hide the paper trail that was clearly present at MF Global before funds were missing?
But perhaps most inconsistent are Mr. Corzine’s own statements.
“In testimony on Capitol Hill on Thursday, Mr. Corzine only added to the mystery. He said that transferring customer funds was ‘a complex process’ and, asked who could execute such a transfer, said ‘I wouldn’t know probably who that person is.’”
In this testimony Corzine is making two potentially inaccurate statements.
First, he claims the process is “complex.” Ok, taking this at face value “complex” likely implies a number of people associated with such a transfer and a process that would also trigger alarm bells. When were the alarms reported to regulators?
But more to the point, is the process really that complex for Mr. Corzine or his top deputies? In all likelihood there were potentially a handful of those within the FCM that had the ability to authorize a large capital transfer out of segregated funds, including Mr. Corzine. In many cases moving such capital out of segregated funds cannot be authorized by one individual, but might require a counter-signature.
Is Mr. Corzine seriously claiming that he doesn’t know the people or the process? One can only imagine the day after the transfer of segregated funds was discovered, Mr. Corzine and top brokerage firm executives were notified of the transfer by the internal fraud alarm system. Most certainly at that point if Mr. Corzine were un-involved he would have investigated the people and the process. Remember, this is an individual who the New York Times noted in an article had a keen insight for remembering names.
Mr. Corzine expecting Congress and regulators to believe he doesn’t know the people or process involved in transferring $1.2 billion out of segregated funds seems entirely inconsistent. But then the only real consistency in this story might be the special treatment Mr. Corzine typically received.
Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors. Past performance is not indicative of future results.
The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.
With all eyes focused on Jon Corzine’s testimony relative to MF Global Thursday, perhaps it might be time to consider that MF Global might only be one act to consider in this multi-act and often undisclosed tragedy.
The whispered story of private citizen Corzine’s toppling of a regulator at the Commodity Futures Trading Commission (CFTC) is something to which light should be shown. In fact, the battle that took place in the late 90s between then CFTC Chairwoman Brooksley Born and then Goldman Sachs Chairman Jon Corzine, who is said to have directed lobbying efforts and the Washington D.C. “Working Group” to dispense with the “irascible” Ms. Born. This is a story that has dramatically impacted society, leaving a scare of undisclosed leverage that can even be seen in today’s debt crisis.
What surprises me most about this story is the fact that it has generally remained untold. Hopefully at Mr. Corzine’s congressional hearing tomorrow tough questions, listed at the end of this article, will bring forth additional details regarding the actions of Mr. Corzine and the Working Group.
Mr. Corzine’s tale really should be told by considering a pattern of behavior where the Goldman superstar ignored advice of risk managers and arrogantly rolled over regulators, literally toppling those who dare question his methods of non-transparent leverage management. Contrast this to Ms. Born’s efforts to simply make the leverage transparent and traded on an open, regulated exchange and consider what was left in the wake: the explosion of Long Term Capital Management, the Enron debacle, the deceptively wrapped mortgage credit default swaps that imploded in 2008, and the fireworks display to end Mr. Corzine’s career, MF Global.
To the determent of society, Mr. Corzine has utilized undisclosed leverage throughout his career in a way that is yet to be properly recorded. Ms. Born’s story is simply one her trying to enforce basic derivatives management practices vs Mr. Corzine’s “new school” attitude that bended or broke rules that the U.S. citizen simply didn’t think applied to him or his colleagues at Goldman Sachs. If you think it was a fair fight between a principled regulator with old school derivatives management philosophy and a Wall Street oligarchy, I have a trading floor to sell you.
This article addresses how powerful private enterprise forces controlling the levers of financial engineering literally ran through regulators on their quest to impose their unsustainable methods of leverage management on society.
Mr. Corzine’s Rolling of Brooksley Born
Brooksley Born was a demure lawyer, well known and highly respected in the derivatives industry during an era of time when derivatives industry experience mattered at the top of the Commodity Futures Trading Commission (CFTC). Upon taking over at the CFTC on August 26, 1996, life-long derivatives industry executive Ms. Born likely never though her career would abruptly end less than three years later, forced from office by the powerful financial services lobby.
Ms. Born discovered an issue that might similarly catch the attention of many in the derivatives industry if they were in her shoes. She discovered massive undisclosed leverage in mortgage derivatives over the counter trading and wanted such potentially toxic assets to transparently disclose their contents and be traded on a regulated exchange. Logical enough. The regulator then dispatched Michael Greenberg, head of the divisions of trading and markets, to simply prepare a list of questions to be answered about the over the counter market. The document asked questions and raised issues regarding previous industry fraud, potential default and market collapse and the growth of the OTC industry. This internal CFTC document was titled the “Concept Release” [link:http://www.cftc.gov/opa/press98/opamntn.htm] and was designed to be nothing more than a thought piece. Little did Ms. Born recognize that freedom of thought might get her in trouble with the financial oligarchy.
“I thought asking questions couldn’t hurt,” Ms. Born was later quoted as saying. “I was shocked at the strong negative reaction to merely asking questions about a market.”
The Concept Release was said to be shock to the system in both New York and Washington D.C. It was at this point private citizen Corzine is said to have called the “Working Group” into action, an elite club of financial engineers who determined the future of the world economy. Operated at a high level by the likes of Robert Rubin with Alan Greenspan and Larry Summers at his side, the group was said to have a second layer of devotees with tentacles that spread throughout all major economic levers of power in Washington D.C. In response to the Concept Release, Working Group leader Robert Rubin called an emergency meeting of group participants to muster support for silencing Ms. Born.
Concept Release now public, it was the summer of 1998 and Born started testifying before Congress. She simply told the truth about transparency and unregulated derivatives – and the financial oligarchy really became uncomfortable. Ms. Born warned about how mortgage derivatives traded in unregulated over-the-counter markets lacked transparency and could explode upon the economic landscape. Such heretical talk enraged the working group.
Silencing the Principled Regulator Because She Requested Transparency
The orders to the working group were clear: silence the regulator who is requesting transparency and OTC derivatives trading on open markets. The Working Group’s first tactic was arm twisting. Ms. Born was first called before Goldman alumni Robert Rubin, who flatly told Ms. Born her agency lacked the authority to regulate derivatives, a move that had some in the derivatives circles shaking their heads in disbelief of Rubin’s remarks. This didn’t stop Ms. Born, so the working group turned to the next man on the enforcer list, who happened to be then SEC chairman Arthur Levitt. Mr. Levitt’s attempts at persuasion were similarly unsuccessful. Thus, the third hitter up to bat was Alan Greenspan. In published reports, Mr. Greenspan’s face was said to have turned red during the meeting as she told Ms. Born of dire consequences if mortgage derivatives were made transparent. Ms. Born held her ground, and the phone lines between D.C. and New York were ablaze with talk of “teaching Ms. Born a lesson.”
With the Working Group’s favored behind the scenes leverage tactics experiencing surprise rare defeat, they turned to overt pressure through Congress. Later that year Born received her rebut from Congress, the censure of her powers. She later resigned from office effective June 1, 1999 and Mr. Corzine had drawn the blood of his first federal regulator.
One note about the financial oligarchy is that while members may be individually brilliant, the notion that thought on issues can be independent isn’t always valued. The group mind think at the time was that non-transparent leverage was positive for the economy (or at least there was sufficient profitability in the deceptive mortgage derivative products to make it positive). Thus, any attempts to shine light on proper derivatives management were outed.
This shouldn’t have been a big issue; “old school” derivatives management dictated that proper leverage management was transparent and traded on open exchanges. Unfortunately for society, this is when Born ran into the “new school” of derivatives management, one that didn’t feel any need for transparency, eschewed disclosure into the actual leveraged components and thought trading on regulated exchanges was a burdensome detail. In short, Ms. Born was introduced to Mr. Corzine’s philosophy. It was this moment, newly minted CFTC chairwoman Brooksley Born fought an unexpected a battle between “old school” commodities management and a powerful new school that would soon silence the demure regulator – and any future regulator that dared challenge the Wall Street power base.
With a history of rolling over regulation, Mr. Corzine’s behavior with MF Global should come as no surprise, but the financial oligarchy he lead has not always come out on top.
Wall Street Doesn’t Get Its Way All the Time – Just Most of the Time
To be clear, there have been rare successes when the derivatives industry has faced off with equity interests. One highly visible example took place when German futures exchange, Eurex, looked to take control futures on the U.S. yield curve in the early 2000’s. This effort of off-shore control of futures trading on interest rates, backed by Goldman Sachs, was one of the rare points when the commodity industry successfully fought off Goldman’s powerful Wall Street force.
In this instance, the whispered story that emerged years after the event was one of the financial services industry and Washington D.C. saying NO to Goldman Sachs. At the time of this fight, Goldman wasn’t the current omnipresent force it is now.
Significant preparation for the fight with Eurex was said to take place, but a generally calm approach was taken by those at the top of the CBOT. In stories that have emerged long since the event occurred, the real battlefield was said to take place at a dinner in Washington D.C. and private meetings in New York. In Washington D.C. a simple argument was said to be made: U.S. control of futures on the yield curve could one day prove to be strategically critical at some future point. Fast forward to 2011, with a debt crisis swirling around, this derivatives industry warning could be viewed as accurate. In this case, influential forces in Washington recognized the logical argument regarding national interest. This was also a time when the omni-potent force of Goldman Sachs did not prevail, to the surprise of some. After successful meetings in D.C., the New York meetings were said to have a different tone.
The D.C. argument was said to be different than the equity industry argument. In stories that have emerged years after the events took place, CBOT officials were said to gather the major Wall Street players with the exception of Goldman Sachs, of course. The core argument was made that it simply wasn’t appropriate for Goldman Sachs to have such omnipresent control over the U.S. futures markets and the financial industry at large. Such accurate and prophetic words, as the battle was won but the war was lost.
In short, the battle over the U.S. yield curve was won by the U.S. futures exchanges, racking up a rare loss for Goldman Sachs. But ironically the omni-present control by one financial services firm continues. With Goldman Sachs now the un-disputed heavyweight champion in financial circles in both New York and Washington D.C., it is ironic that their leader, the man who as a private citizen helped draw first blood from a regulator, was now in front of Congress after a reign of terror through the halls of MF Global.
Betting on a Bailout and Benefiting from “Working Group” Connections
Upon taking over at MF Global, Mr. Corzine was said to show little if any interest in the industry in which his firm operated. The derivatives markets and its old school methods of leverage management were of little concern, even less concern than were regulators. Perhaps it is for this reason when the CFTC gave MF Global a warning regarding toxic sovereign debt over a year before the firm declared bankruptcy, that warning could have been so easily ignored by Mr. Corzine along with warnings form MF Global internal risk managers. Instead, Mr. Corzine is said to have relied on inside whispers from contacts in Washington D.C. U.S. Treasury Secretary Timothy Geithner is said to have re-assured Mr. Corzine that European bonds would not be allowed to drift into default. In other words, Mr. Corzine could ignore the warnings of regulators so as to rely on another government bailout to support his adventures in sovereign debt. The rest, as they say, is history.
With this as a backdrop, perhaps it is time to get answers to important questions on the record.
Questions that Congress should Ask Mr. Corzine
Mr. Corzine, you were warned on the risk in your positions on several occasions. First, you violated an old school risk management principal to diversify risk away from one significant economic headwind. That diversification technique might not be as “sexy” as concentration of risk towards positive economic outcomes, but it tends to work well in a variety of market circumstances. Here is the big question: How many times were you warned the risk in your sovereign debt position was too much exposure in one direction? Who were the people that warned you regarding sovereign debt and when did those warnings take place? Did the CFTC provide MF Global a specific warning regarding sovereign debt? Why was that warning ignored?
When U.S. Treasury Secretary and former Working Group member Timothy Geithner visited Wall Street this year, what was the focus of conversations? Did Mr. Geithner assure you that governments in Europe wouldn’t be “allowed” to collapse? How did reliance on a government bailout impact your decision relative to highly leveraged investments in sovereign debt?
Mr. Corzine, describe your relationship with regulators and regulation in general. Specifically, what discussions did you have with a “Working Group” in Washington D.C. regarding the deposition of Brooksley Born as CFTC Chairwoman? The first tier of Working Group participants has been placed in the public domain. Will you name the second tier of the Working Group and disclose their current positions in the U.S. Government?
Mr. Corzine, the American public finds itself in debt crisis that as early as this summer many in the public didn’t really recognize. It seems to me that the level of leverage and methods to manage this leverage have pretty much been undisclosed. I would like your recollection of how undisclosed leverage was defended in 1998 during fights with CFTC Chairwoman Brooksley Born, and then more appropriately how undisclosed leverage led to the downfall of MF Global? Can you tie together your involvement in the following and specifically touch on how undisclosed leverage was a factor in the demise of Long Term Capital Management, the mortgage / credit crisis of 2008 and your current situation at MF Global?
Mr. Corzine, if you can reflect on the past 15 years of your career, a period of time when one Wall Street financial services firm with one groupthink mentality clearly dominates financial decision making in governments across the world, can you assess the impact undisclosed leverage might have on society’s future?
Mark H. Melin is author / editor of three books, includingHigh Performance Managed Futures (Wiley, 2010) and was an adjunct instructor in managed futures at Northwestern University. Follow him on Twitter @MarkMelin.
Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors. Past performance is not indicative of future results.
The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.
To say the MF Global situation is a mess may be the understatement of the century. What began as an excuse to extol the segregated account’s safeguards against an FCM stock slide as MF Global shares lost 70% of their value in a week rapidly morphed into a full-fledged industry disaster as bankruptcy papers were filed and executives acknowledged a shortfall in those previously sacrosanct accounts.
This admission, in conjunction with the bankruptcy, has caused over $5 Billion of customer funds held by MF Global to be frozen, unable to be accessed or transferred out. Right on cue, the lawyers have begun to circle, with employees, bondholders, and the customers themselves filing claims for their piece of the $40 Billion in Assets MF Global reportedly had on hand.
What was a very small probability just two weeks ago now looks to be a near certainty – that over 150,000 futures industry customers who held accounts at MF Global will have their money locked up for anywhere between several months to several years. Before a single penny can be distributed, a legal team charging $1,000 an hour will have to go line by line through books that have been described by regulators as a “disaster,” making the potential (and incentive) for a speedy turnaround non-existent. Even then, once the books have been closed on the accounting side, the legal battle royale begins, and if the Sentinel case is any indication, we’ll be waiting for quite a while to run through all the cases,
My firm, Attain Capital, uncomfortable with the direction MF Global was taking, moved all of its accounts from MF Global 2.5 years ago. Even with that foresight, we have had clients close their accounts in the MF Global aftermath because they are worried about the safety of their segregated funds, while many others heatedly question what the industry is going to do to make sure this never happens again.
While the lawyers fight with JP Morgan over who should get what money (how would you feel about being a taxpayer who bailed out the big banks only to have them get priority over your money in bankruptcy?), the rest of the industry needs to be talking about how to salvage our collective business.
Many of you may be feeling lucky you didn’t have exposure to MF Global, or even enjoying an uptick in business because of the MF Global accounts being transferred to you, and that’s understandable. However, that joy becomes short-lived as one realizes that this mess threatens the continued growth of not only your firm, but our entire industry. Brokers, CTAs, service providers, technology companies, and more will all go out of business because of this – some immediately because they won’t get their most recent payments due from MF Global, and others over the next several months as their business falls due to their client base’s inability to access the funds held at MF Global that they need to trade.
But the biggest threat is to the future. It’s that large investor who would have happily opened a futures account just a month ago, but now chooses not to because he is unsure what would happen to his funds should a bankruptcy occur at his broker of choice.
How do we make sure that such an investor regains confidence in the industry, and chooses to go ahead with that investment? The hollow emails by FCM presidents and owners to their clients saying they care is simply not enough; actual solutions and fixes to the problems which allowed the MF Global mess to happen need to be enacted.
The industry needs to change to protect that which was formerly held most dear – the segregated account. Here is what we propose:
Create a coalition to make all the MF Global customers whole, immediately.
There are billions of dollars of profits between the exchanges, brokerage firms which just received free business from the MF Global demise, and others in the industry. Someone (ahem… CME) needs to step up and create a coalition of these industry giants and pony up the money to make each and every one of the MF Global accounts whole, immediately.
If the government didn’t think that MF Global was too big to fail, the industry surely needs to. Do you think the CME put forth their $250 million guarantee or $50 million recovery fund out of the kindness of their hearts? No- they are worried about volumes, and rightfully so. With about $5 Billion worth of customers now unable to trade, the sooner those customers can pump those funds back into the markets, the better for the CME’s bottom line.
How is this supposed to work? We’re not saying this coalition needs to pony up the money and never get repaid. We’re saying they should step in and cover the money until the bankruptcy runs its course and the funds are released. Why can’t the industry put together a fund which covers the customer segregated funds, and in exchange for making the customer whole, the customer signs over any claim they had to their money in bankruptcy court to the fund?
Think of it more as fronting the money. After all, nearly all agree that it is just 10% or so of the money which is missing. At worst, the fund would be out the $600 million in missing segregated funds (and that’s only if the trustee is unable to get any of the $41 Billion in MF Global assets to cover that shortfall). The problem here is less about there being no money than it is about the money being frozen up.
The industry simply can’t afford to wait for the bankruptcy to run its course. Every moment of inaction that passes is a moment without those funds coursing through the industry’s veins. Consider that MF Global reported in its Q2 financials that it cleared 575 million contracts over the three months that ended June 30th, 2011. If the exchanges are getting $0.25 per contract, without taking action, that’s about $575 million in lost revenues per year. If the brokers who just received the accounts could get $0.25 per contract on the business moved to them, that’s $575 million in new revenue for them (assuming those accounts can get back trading).
There is plenty of money to go around, especially in the name of saving what has been the cornerstone of this industry since its inception- the sanctity of the segregated account. Hell, Attain will even pony up our share. Without taking this step, there is little any of us can do to help our clients feel secure. Industry participants will likely be worried about setting a precedent, but that is, in fact, the whole point. We need to be able to point to this time in our industry’s history and say, “Yes, it was ugly, but the industry stepped in and made the accounts whole.”
If you’re still not on board, why not backstop the coalition fund with a rule granting the ability to increase NFA fees from the current $0.02 per trade to $0.03 to cover any shortfall the fund has to cover? And as a final brushstroke, how about making the coalition member’s investments in the fund count 100% towards their net capital computations, treating it like cash in the bank?
The choice is a known cost in a temporary, defined and shared burden or an unknown cost in an inequitable and unquantifiable loss of business in the long run. How’s that for risk calculation?
Preventative Measures
While this may put out the fires in the short-term, at the end of the day, there’s still much more work to be done. It’s not enough to simply react; we need to be proactive about preventing this from ever occurring again. How? We’re glad you asked.
1. Extend SIPC protection to futures investors.When it came to light that the SIPC was rapidly moving to ensure that all claims to the assets of MF Global were resolved, the initial reaction of many industry participants was to breathe a sigh of relief. However, as many soon found out, SIPC protection is currently only offered to securities customers- meaning only those trading stocks and bonds would be covered, and not our beloved exchange traded futures investors. In our minds, there is zero reason why investors in traditional asset classes should be afforded such protection while investors in the alternative space are not.
As such, we propose that regulations governing the SIPC be amended to ensure protection of futures clients’ holdings as well, with guarantees on the individual account level (the sub-account of the customer segregated account on the FCM’s books) and not just the main overall account level containing all of the customer funds.
The CME and ICE should cut 10% off their marketing budget and put that to lobbying Congress for this protection. This isn’t 1970, when stocks and bonds were the only game in town. If the world turns to the CME to manage risk, the CME needs to turn to Congress to lower the risk of managing that risk.
2. Amend CFTC rule 1-25 to limit segregated funds investment to US Treasuries only.One of the issues that’s gotten a lot of press since the shortfall in funds at MF Global went public is the idea that Corzine might have used those funds to finance his European bets. There’s no proof of this yet, but the concept alone rattled many. The general belief was that FCMs could not, under any circumstances, touch segregated funds.
That’s not true. Under 1-25, FCMs are allowed to gain interest on excess segregated funds through specific investments under explicitly outlined circumstances. There are three limitations that really matter here: preservation of capital, preservation of liquidity, and adherence to risk standards.
Under the rule, FCMs can invest in 6 different vehicles (U.S. treasuries, state bonds, government agencies, commercial paper, corporate notes or bonds, sovereign debt, and money market mutual funds), but, with the exception of U.S. Treasuries or money markets, these vehicles have to have the highest rating possible from one of the NRSROs- or, official ratings agencies. This means that, technically speaking, the allegations flying around that FCMs may legally use segregated funds to invest in high-risk junk bonds are utterly incorrect. That being said, we’re still not satisfied with the requirements.
If we learned anything from 2008, it is that ratings agencies were doling out the highest ratings possible on toxic mortgage-backed securities right up to the point that things blew up. In fact, the rating agencies even downgraded MF Global…wait for it…. after they went bankrupt. Our trust in their ability to assess risk adequately enough to ensure the preservation of segregated client funds is nil. As such, our recommendation is that 1-25 be amended to prohibit investment of segregated account funds in anything but U.S. Treasuries. While a statement issued today by CFTC Commissioner Scott O’Malia pointed out that we do not know the root cause of the missing funds, and that it’s possible the missing funds have nothing to do with investments permitted under 1-25, in our minds, this changes nothing; this rule needs to be altered regardless of the MF Global investigation’s conclusions.
3. Establish regulation under which language must be added to all creditor agreements for any registered FCM in which those creditors agree to the assignment of the customer segregated accounts as the primary lien holder on all assets of the company. Under current provisions, segregated accounts are given what is, in our minds, inadequate protection during the bankruptcy process. True, their accounts cannot be tapped to meet outstanding financial obligations of the bankrupted FCM, but there’s also no guarantee of those funds being made whole in the event of a shortfall, nor protection from a too big to fail bank like JP Morgan sending in armies of attorneys arguing that their claim should take precedence over the customers. While clients may, after a pro-rata distribution, file a claim with the Trustee in an attempt to get their missing money back, it appears that there are back door methods for big creditors like JP Morgan Chase and those who held MF Global bonds to get in front of the customers in the claims process. As TheStreet summarized:
“The group of customers, led by James Koutalas, chief executive of a Chicago-based commodities trading firm, are taking issue with a lien and other protections offered to JPMorgan in exchange for a $8 million loan the bank extended to MF on the first day of its bankruptcy, according to the report. That would allow JPMorgan the right to some assets over other creditors.”
In our minds, segregated account holders should absolutely come first in the claims process. Unlike the creditors and bold holders, who knowingly accepted the risk of default when they handed over their money, MF Global clients were paying MF Global to hold their funds- not lose them. With this in mind, we believe that the law must designate segregated accounts as the primary creditor if an FCM goes belly up, ensuring that, should there be a shortfall in client segregated funds, available assets of the bankrupt FCM will be tapped to make those accounts whole before any other creditor gets their day in court.
You can be sure that the big creditors would take an immediate and very big interest in insuring that any FCM they lend money to has the adequate procedures and safeguards in place to protect customer funds knowing that they are second in line behind said customer funds. If you can’t rely on morality to protect the funds, rely on greed and the invisible hand of those who would stand to lose money should the customer segregated funds be breached.
4. Establish regulation outlining standard operating procedures in the wake of an FCM bankruptcy. Part of the reason that the MF Global situation has been so chaotic was the result of poor planning. Positions were stuck in limbo. There was no infrastructure for facilitating an orderly transfer of accounts, which led to an ad-hoc distribution among arbitrarily selected FCMs without the transfer of legal documents- including those necessary for a CTA to trade on behalf of a client. Without any stipulations regarding timeframe, the process was drawn out to the detriment of all parties involved. Add to that a failure to effectively communicate what was going on to the clients involved, and it’s no wonder the situation turned into the nightmare it did.
In the wake of both the Refco and Sentinel scandals, one would think that remedies would already have been put into place for such administrative Bermuda Triangles, but unfortunately, that did not occur. In order to prevent such a disorderly dissemination from occurring again, we suggest that new regulations be developed; outlining exactly what is to happen in the event of an FCM going bankrupt. The old plan seemed to be, wait for a suitor to step up and take on all of the accounts. That clearly worked out wonderfully this time around. Coming up with standard operating procedures outlining the immediate impact on open positions, where the client funds are to be transferred to and within what timeframe, and so forth would help avoid the confusion we’ve seen to date.
A Call to Action
We are not about to claim that we have all the answers. Have we researched these subjects? Yes. Have we consulted with others in the industry? Absolutely. Does that mean that the solutions proposed here are perfect? NO.
But someone needs to start the dialog. The CME has made a nice first step with its $250 million guarantee to the trustee. The efforts of Koutoulas and Roe to provide a voice for the clients in the bankruptcy proceedings are certainly admirable. But at the end of the day, we all know that there is a long road ahead of us. Laws need to be changed and rules rewritten. The industry needs to step up and reclaim its image. At the end of the day, perception is all that matters. If this situation is not resolved effectively, every CTA, FCM, CPO, Commodity Broker, Introducing Broker and Exchange will lose a sizable amount of business. There’s no getting around it. People aren’t going to invest in something where they don’t feel secure.
Make no mistake- these are extraordinary times we face, and they require an extraordinary communal effort to be survived. Despite the challenges on the horizon, we have no doubt that, in one way or another, this industry will rise to the occasion. Because as important as it may be to understand what’s transpired and what’s at risk here, what comes next matters even more.
Goldman Sachs and Morgan Stanley reportedly are considering ending mark-to-market accounting for some loan commitments, a practice which Reuters Breakingviews editors say puts them at a competitive disadvantage.
The story originally appeared in The Wall Street Journalthis morning.
“It’s a little bit overblown,” Breakingviews columnist Antony Currie says of the reporting on the change. “It’s not the entire portfolio. It’s actually a very small amount they’re considering changing, and that is the loan commitments they make to investment grade companies.” (more…)
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