(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 8^th 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 17^th 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 8^th 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:

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

From the moment CMEGroup Chairman Duffy released the bombshell that a senior MF Global employee had implicated Mr. Corzine, claiming falsification of documents and challenging the MF Global CEO’s sworn Congressional testimony, focus has been on those likely most knowledgeable of the situation: the back office employees.

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.”

According to the aforementioned February 6 status report filed in Court by Trustee Giddens, MF Global had a bad habit of dipping into customer funds during the day only to reconcile by the close of business.  Mr. Giddens states (emphasis ours):

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


####

Article written by Mark Melin http://www.Twitter.com/markmelin with Bob English www.economicpolicyjournal.com with thanks to others who contributed.

In this third issue of the Uncorrelated Investments Show, hosted by Mark Melin, players in the MF Global saga tell their stories.

First up is Stanley Haar, whose efforts in Congress have been gaining traction towards ultimate investigation into MF Global wrong doing. Haar discusses his personal experience when he first learned of the MF Global issue and then discusses his discretionary agricultural trading method at a high level.

After this Melin goes to a presentation given by James Koutoulas, founder of the Commodity Customer Collation, and his experiences protecting MF Global investors. Note in this presentation how essentially no one came to the aid of investors in early court procedures.

Watch the first two installments of the show here and here.

And one more from Jim Rogers’ Reuters Insider interview last week with Axel Threlfall. In this installment, Rogers argues that stocks could well go even higher due to central bank stimulus, but he refuses to buy into it.

“Well I have plenty of ways that I’m participating,” Rogers says. “As we’ve discussed before, I own a lot of commodities. If things are going to be good, commodities are going to do extremely well and are doing extremely well because of the shortages that are existing. So I’m playing and I own some currencies. I’m there. There’s more than one way to skin a cat, Axel, and I’m skinning it in my own way.”

JPM has MF Global’s missing funds?

The mystery of the MF Global bankruptcy continues to be the location of the missing funds. Chris Whalen, senior managing director of Tangent Capital Partners, says the raiding of customer accounts at MF Global to make a margin payment to JPMorgan ruins customer trust in the broker-dealer relationship.

“Look, it’s very basic. In our industry, we have a legal responsibility to safeguard customer funds,” Whalen says. “It appears that the individual accounts of the commodity customers of MF Global were raided and they took those funds and made a margin payment to JPMorgan to try and save the business. Everybody in our business who works for a broker-dealer should be getting really angry about this because no customer is gonna trust an independent dealer to act as custodian for their securities; that’s gonna be over, between Madoff and this.”

Since the Oct. 31 bankruptcy of brokerage MF Global, about 72 percent of frozen customer funds have been returned, according to a recent update.

MF Global kept an estimated $5.9 billion in U.S. customer segregated funds, according to James Giddens, the trustee overseeing MF Global’s bankruptcy. Giddens secured about $5.3 billion for transfer. Of that amount, he has paid out $3.83 billion to customers via three bulk transfers that took place in November and December, he said in a January presentation.

Here’s a breakdown of the transfers:

FIRST BULK TRANSFER: 10,202 accounts totaling $1.52 billion

The first transfer of funds began on Nov. 3, a day after a U.S. bankruptcy judge approved Giddens’ request to transfer accounts to futures merchants.

The funds transferred included accounts containing open U.S. commodity contracts and a percentage of the associated collateral used for margining as of Oct. 31.

Initially, the CME Group, the exchange which cleared most of MF Global’s trading business, expected that client accounts would be transferred to one of six futures commission merchants (FCMs).

These included: ABN Amro Chicago Clearing, ADM Investor Services, Dorman Trading, INTL FCStone, R.J. O’Brien, and/or Rosenthal Collins Group.

Eventually, that group was broadened to include an additional five merchants: Macquarie Futures USA, Vision Financial Markets, Newedge USA, BNP Paribas and Penson Futures.

SECOND BULK TRANSFER: 15,148 accounts totaling $477 million

The second bulk transfer occurred in late November. The transfers involved accounts containing only cash or cash equivalents on the day MF Global filed for bankruptcy.

The same 11 futures merchants that participated in the first bulk transfer participated in the second transfer.

In addition, PFGBEST participated in this transfer and received its first accounts on Nov. 23.

THIRD BULK TRANSFER: 27,905 accounts totaling $1.83 billion

The third bulk transfer occurred in December, after it was approved by the bankruptcy court on Dec. 9.

The transfer included MF Global’s former retail commodities customers with U.S. futures positions, Giddens said in a press release at the time.

ESTIMATED SEGREGATED FUND SHORTFALL: $1.2 BILLION

Throughout the bulk transfer process, Giddens has maintained that there is an “apparent significant shortfall” in MF Global’s customer segregated funds.

Some of this money could be sitting in foreign depositories as well as in the United States.

Reporting by Cezary Podkul

Follow Reuters Legal on Twitter: @ReutersLegal
Visit Thomson Reuters News & Insight for more.

John Kemp is a Reuters market analyst. The views expressed are his own.

E.U. sanctions on Iran’s oil exports and fears about disrupted supply lines may not have made bullish oil analysts more confident since the start of the year, but they have forced bears with below price average forecasts to scale back their estimate of downside risk.

Seven analysts have made significant changes to their forecasts for average Brent crude prices in 2012 in January compared with December, according to an analysis of the latest oil price poll published by Reuters.

Six analysts raised the predictions by $5 per barrel or more, while one cut their forecast by $8. Every one of the analysts raising their forecasts this month had previously been significantly below the median in the December poll, while the lone analyst to cut their prediction had been significantly above average.

The result is that forecast clustering has intensified. The standard deviation among institutions surveyed in November and January was around $9.25, falling to $7.50 in the January poll.

Pressure to stick close to the consensus remains fierce, but so far it is analysts with the more bearish forecasts who have been forced to come into line, while bulls stick with their earlier numbers.

Forecast clustering to this degree looks incongruous. The average change in annual Brent futures price from one year to the next since 1990 has been 23 percent. Market forecasts are converging on $107 in 2012, which is less than 4 percent away from the $111 average in 2011. So much price stability from one year to the next would be unusual.

Clustering may be an inevitable consequence of competitive pressure on analysts (it’s better to be wrong in company than on your own), as well as the unusual lack of volatility in oil markets at present and range-bound trading inside a tight $105-115 band which has not seriously been challenged since summer 2011.

In the absence of a dominant narrative, most analysts seem as uncertain about when and which way prices will break as the rest of the market, and are therefore predicting no change.

You’ve gotten it from everywhere else- the hot shot managers, institutional titans and talking heads on CNBC have all weighed in on where they think 2012 will take investors. Now, it’s our turn in what has become our most read newsletter – the annual Attain Capital look back/peer forward – the 2012 Managed Futures Outlook and 2011 Review. We may be a few weeks late to the party, but the wait was worth it, as the added time meant more data and more interesting conclusions overall.

If 2008 was the managed futures party year, 2009 was the “hangover”, where the big drop in volatility following the historic 2008 volatility caused managed futures losses, and 2010 the “rebound” year, where managed futures avoided putting in back to back losing years. 2011 can best be described as “a whole lot of nothing.” There were ups, there were downs, and managed futures programs tried to capitalize on both side of these moves. But in the end, none of the moves extended far enough for managed futures to profit substantially from, leaving gains here, losses there, and so on. In short, a whole lot of nothing.

What trading atmosphere generated these results? Can we expect more of the same in 2012, or will the tides turn? To find out our take on what is in store for Managed Futures in the new year, click through.

To read more Managed Futures research pieces, visit Attain’s Managed Futures Newsletter archive and our Managed Futures Blog.

DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex.  Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts.

The mention of asset class performance is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.) , and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices:  such as survivorship and self reporting biases, and instant history.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.

Copyright © 2011 Attain Capital Management, licensed Managed Futures, Trading System & Commodity Brokers. All Rights Reserved. Reprinted with permission.

(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.

To read the full article click here.

Mark H. Melin is currently writing his fourth book on uncorrelated investing.  He is previous author / editor of three books, including High 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.

Jim Rogers says despite his doubts over the European Union, the euro currency is oversold. Rogers says he may actually add more of the currency to his portfolio while shorting European stocks.

“I own the euro,” Rogers says. “I was most delighted to see 
 in the press that there’s a huge short position. All the hedge funds are now short, short the euro. I was actually thinking about selling some of my euros, but now I’m thinking about buying more euros.”

John Kemp is a Reuters market analyst. The views expressed are his own.

Commodity markets are becoming more efficient at processing information about current supply/demand conditions and expectations about the future. But in the process, excess returns captured by investors for assuming price risk are vanishing.

The poor performance of first-generation passive commodity indices since 2005 is well known as the extra money allocated to the asset class has eroded roll returns. But there is some evidence returns on second- and third-generation indices with dynamic rolls and commodity allocations are also starting to evaporate as more money chases them.

“Commodity markets are coming of age,” according to a recent research note by Citigroup. “Simple strategies to make money in commodities are no longer likely to yield good returns.

“Our guess is that this is down to the massively increased investment in the asset class in recent years, which has driven returns lower,” according to the bank’s global strategy team.

Citigroup based its conclusions on a dynamic strategy of filtering a set of commodity futures for roll returns and then again for momentum before buying the five with the best roll and momentum and selling the five worst (”Global Macro Strategy - Commodity markets are becoming ever more efficient”, Jan. 3).

According to the Citi strategists, “returns in the April to December 2008 period were 40 percent, in the 2009 calendar year were 22 percent, in 2010 were 9.5 percent and in 2011 were 5.4 percent. Every year, the return seems to halve.”

Back-Testing and Achievable Returns

The Citi findings are intuitively plausible. They are also consistent with the observed changes in commodity prices and futures curves since investing in the asset class started to become popular in 2005.

Charts 1 and 2 show long-run returns on a diversified first-generation index (the GSCI Light Energy Index) and two dynamic indices that could be considered second- or third-generation products (the SummerHaven Dynamic Commodity Index and the Deutsche Bank Liquid Commodity Index Mean Reversion Enhanced strategy)

Chart 1

Chart 2

Since the 1990s, dynamic strategies have vastly outperformed passive allocations. Chart 3 shows the degree of outperformance persisted in the early years of the commodity investment boom (2005-2008). But as Chart 4 illustrates, outperformance has vanished since the beginning of 2009. Dynamic strategies have been no more successful in delivering excess returns than their passive counterparts in the last three years.

Chart 3

Chart 4

Dynamic indices are suffering the classic back-testing problem. Index creators mined data on past futures prices to select the strategy that maximizes returns. But once investors started to implement the resulting strategies, the pricing anomalies that were the source of the historic returns vanished.
No one was actually implementing dynamic index strategies in the 1990s, when the back-fitted index data show impressive gains. In the mid-2000s, only a very small amount of money was tracking these strategies; most investors were still using passive approaches.

Once returns on passive indices started to disappoint from 2008, and significant amounts of money were allocated to dynamic strategies or hedge funds, returns on dynamic strategies promptly collapsed. Once a significant number of investors tried to exploit market inefficiencies, the inefficiencies disappeared.

Risk Premiums and Market Efficiency

The academic literature is divided about the theoretical nature of expected returns to investors in commodity futures. Some treatments emphasize the concept of hedging pressure (more producers than consumers seeking to hedge their price risk) resulting in “normal backwardation”. Others focus on the idea of a risk premium investors capture from hedgers. In practice, there is little difference. All approaches suggest hedgers (on net) must pay a premium to investors to encourage them to assume unwanted price risk.

In their famous paper on “Facts and Fantasies about Commodity Futures”, published in 2004-2005, Gary Gorton and Geert Rouwenhorst characterized the excess return over bonds as a “risk premium”. They found that an investment in a fully collateralized equal-weighted basket of commodity futures between 1959 and 2004 provided about the same return as equities.

But their study seems to have suffered from its own back-testing problem (or fallen victim to its own success). For most of the period Gorton and Rouwenhorst studied, commodity markets were small and illiquid, with only a relatively small volume of investment. Returns to investors were correspondingly high. But once the asset class became popular, more investors were chasing the same source of returns, liquidity increased and premiums shrank.

Increased market efficiency is expected. But we need to be careful what we mean. Efficiency means less persistence and predictability in both outright prices and term structure (roll returns), which is what has undercut both the first-generation and second/third-generation products.

It does not mean markets are infallible at predicting the future or even that they are terribly rational in how they react to news in the short term. Markets are social communities, not mathematical models. As John Maynard Keynes understood (but many of his successors appear to have forgotten), markets are voting machines, not weighing machines.

Faster Price Dynamics

Most participants at the recent OPEC-IEA International Energy Forum in Vienna, Austria, agreed oil (and other commodity) prices could be driven by speculation in the short term, over-reacting to developments with mini-bubbles and crashes, but were firmly anchored by fundamentals in the long term.

No one was able to define what was meant by short term and long term. Presumably the short term is reflexively defined as the period when prices are driven by speculative factors, while the long term is whatever time period over which fundamentals prevail.

But if oil and other commodities do suffer from price anomalies in the short term, the short term may be getting shorter. Certainly there is statistical evidence that markets are becoming more forward-looking, such as in studies by economists at the U.S. Commodity Futures Trading Commission. They also appear to discount future changes in supply and demand more quickly than before.

As a result, it is becoming harder to make confident predictions (even dubiously accurate ones) about what will happen to prices or curve structures.

Even most big commodity trading firms, the supposed experts, deny taking “directional” views on prices, arguing they have no better than a 50:50 chance of being right, and insist they are fully hedged and focus instead on curve structure and location/grade premiums.

In oil, “few traders are venturing firm price predictions due to the large tail risks” on both sides of the market at present, according to my colleague Javier Blas at the Financial Times (”Traders fear tail risks in commodities”, Jan. 3).

While some analysts believe risks are currently tilted towards the upside, on balance, and are unusually large, the implied volatility surface for WTI and Brent options shows a more even distribution.

Oil and other commodity markets are becoming increasingly integrated with equities and other assets, as well each other, as they move faster than ever before to incorporate economic developments. Oil and gas markets are moving aggressively to price medium-term supply shifts as well as short-term political risks.

The last few years have seen a sterile (and inconclusive) debate between commentators who believe commodity markets are efficient and driven purely by fundamentals, and those who believe price moves are exaggerated and driven mostly by speculative froth. Like most divisions in economics, it mirrors views about whether markets should be more tightly regulated or not.

But recent research and Citi’s analysis suggests a middle way between these theological extremes. It suggests that commodity markets remain imperfect and inefficient, subject to strange enthusiasms and frenzies, but the massive influx of investment in recent years may actually have made them less inefficient than before.

Unfortunately, improved efficiency may actually be to the detriment of many investors, who have successfully traded away many of the anomalies on which their strategies depended.