Reuters Breakingviews Assistant Editors Richard Beales and Jeffrey Goldfarb and columnist Agnes Crane discuss why, despite JPMorgan’s noteworthy third-quarter results, it’s too soon for bank boss Jamie Dimon to get too confident. (more…)
Archive for the ‘Hubris’ Category
“One thing I am sure of is that it’ll be great theatre,” I wrote at the end of Tuesday’s blog ahead of Jamie Dimon’s Senate banking committee hearing on Wednesday. It promises to be a fascinating showpiece event, I said, that should see a fulsome display of Senatorial emotion ranging from the ABC of anger, bewilderment and confusion through to disgust, puzzlement and indignation.
How wrong was I? I watched the entire sorry affair and it was the dullest, most pointless two hours I’ve spent in a long, long time. In the event, the Senate committee pussyfooted around a man they were clearly in awe of and proceeded to develop a weak and disinterested line of questioning and took everything Dimon said at face value.
If we got an ABC of any emotion from the committee of blasĂ©, grandstanding blowhards, it was apathy, boredom and crass obsequiousness.
I’d resisted the temptation to mention previously that the committee is peppered with Senators for whom JP Morgan is a top political contributor, and who have aides who had lobbied on JPM’s behalf. But after viewing the sorry episode, it was clearly much more of an issue than I had thought. I wouldn’t have been surprised if one of the supposed interrogators had carried in a chaise lounge for Dimon while the rest served him Martinis and canapĂ©s.
There was no new information presented to the hearing, which didn’t just cover the credit derivatives losses as billed. Dimon was asked his opinion of the Volcker Rule, the Dodd-Frank Act, the role of regulators, his view of regulation, how much capital banks should ideally hold (8%, he reckons), whether smaller banks were more at risk from greater regulation, whether banks that are too big to fail are also too big to manage and too big to regulate; he was even taken to task over the length of time it took the bank to return monies in the MF Global saga.
In fact, the hearing covered the waterfront in broad generalities that only served to divert attention from its principal focus. (On the TBTF issue, he proffered that one of the downsides of size was a tendency towards greed, arrogance, hubris and lack of attention to detail. Cute comeback!) There were nuances of the right line of questioning throughout the hearing but no real conviction and no follow-through on material points. For Dimon, the hearing was a walk in the park.
Mind you, he did the mea culpa thing very well. He admitted he was aware of the CIO trading strategy but was quick to say he didn’t personally approve it. In fact, he was extremely careful not to take any specific blame for the credit derivatives losses, which he happily laid at the feet of the CIO traders, the CIO risk committee, the group’s risk managers and CIO management, all of whom he said, let a lot of people down. Their actions, he said, are “something I can’t publicly defend”. He acknowledged the chain of command didn’t work and blamed the risk function for not imposing more granular limits on the traders.
He repeated many times what we already knew: that rather than reducing existing positions in order to bring risk limits that had been triggered back over the line, they embarked on a larger, more complex strategy that created new and larger risks. Traders didn’t have the requisite understanding, he said; and they should have gotten more scrutiny â from himself as well as the wider risk functions. He pointed out that an extensive review is underway that is being overseen by an independent board.
About the tempest in a teapot comment, he admitted “I was dead wrong” but he deflected responsibility immediately and directly by saying that he had spoken to Ina Drew (former CIO head), to the CFO and the risk officers, all of whom, he said, assured him they thought the problems that had come to light in the CIO were small and isolated. With regard to regulators, Dimon said the bank was very “open kimono” (Ughh!) but said that in the particular case of the synthetic credit portfolio, the regulator had initially been misinformed because management had been misinformed.
He didn’t really respond satisfactorily to questions about when regulators were informed about changes to the CIO’s risk models and whether changes to VaR tolerances were undertaken to mask the true extent of risk being undertaken by CIO traders or to incentivise them to take on more risk. He did say the CIO had requested an update to its models in order to be compliant with the new Basel capital rules, and that the new models the CIO adopted were approved by the independent model review group.
He said the first error management made in the affair was complacency and over-confidence because the CIO had done so well in the previous year. He blamed the CIO risk committee for not being independent enough and not challenging developments in the synthetic credit portfolio. The portfolio, he said, should have had more scrutiny and more granular risk limits right from the start.
He did accept that it would have been hard for the risk committee to have captured potential problems in the CIO’s synthetic credit portfolio, particularly if they hadn’t been picked up by management. And he pointed out that the original intent of the synthetic credit trading strategy was sound. “What it morphed into I can’t defend,” he said, even though the people doing it thought they would benefit the company in a crisis. The synthetic credit bets, he said, “morphed into something I can’t justify; they were too risky for our company.”
While he is clearly against the Volcker Rule, he did acknowledge that had it been in place, it might have prevented what the strategy morphed into. (Yes ‘morph’ was an oft-used word).
He explained the positions were intended to make a little money in the normal course of business but that in the event of a credit crisis, they would reduce group risk by making more money. He wouldn’t be drawn on making distinctions between hedging and proprietary trading but did say the synthetic credit ‘hedge’ was intended to improve the safety and soundness of the group.
The CIO, he said, was set up to invest money and earn income but pointed to its conservative stance: of the US$350bn in assets managed by the CIO, the average rating is AA Plus; the average maturity is three years and the average yield 2.7%. The CIO, he said is very conservative, and is sitting on US$7bn-$8bn of unrealised gains.
He rejected any notion that compensation played a part in incentivising risk-taking in the CIO. When the board finishes it review, Dimon said, “we will take proper corrective action”, he said, and it’s likely there’ll be clawbacks. Asked what he had learned from the problem, he said: “no matter how competent you are, you should never get complacent”. Cute.
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 â an amount in excess of MF Global’s total liquidation value at the time â 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 â 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 â 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.
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.
Janet Tavakoli, president of Tavakoli Structured Finance Inc., spoke with Lauren Lyster on her “Capital Account” program about too-big-to-fail banks, the financial oligarchy and how MF Global fits into the web of derivatives-inspired meth lab of shadow liquidity and off-balance sheet risk.
MF Global “sort of epitomizes a lot of the issues that occurred that led to our financial crisis,” Tavakoli says. “The fact that this can happen after the financial crisis, after Dodd-Frank, after Sarbanes-Oxley, just shows you how lax and hypocritical we’re being in the United States about financial regulation âŠ and the world is watching.”
Tavakoli is the author of several books, including the recently published The New Robber Barons: How Bankers Created an International Oligarchy.
(What follows is the authors individual speculation. Â Written by Mark Melin with Bob English. Â To download a PDF version of this article, visitÂ http://www.go2managedfutures.com/Vaporized.pdf)
Sometimes you wonder if weâre living in an alternate universe.
Recent news reports that cite un-named sources and indicate the MF Global criminal case has âgone coldâ are curious.Â In fact, these news reports are even more bizarre than previous reports claiming MF Global client funds have simply âvaporized.âÂ 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.Â This, in turn, paves the way for MF Global creditors to legally swoop in on what rightfully belongs to the customers.
The âvaporizedâ and âcase gone coldâ 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.Â There was no criminal activity.Â The message seems to instruct people to âmind 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.âÂ Â 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.Â The core integrity of the commodity markets has been destroyed and an âindustry of investor protectionsâ 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 âvaporized.â 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 âvaporized.âÂ And after a few weeks of minimal information dribbles, you hear the search has gone cold.Â You are told the money disappeared in a chaotic tsunami of transactions and there is no evidence of any criminal actions.Â But, if money happens to get found, you might get some of it.Â 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).Â Thatâs all…talk to you later. Good bye and good luck.
How would you react? Would the notion that your money âvaporizedâ 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, Shouldnât The Witnesses to a Crime And Suspects Be Interviewed Before a Case âGoes Coldâ
In the case of MF Global, claims of customer âseg fundsâ being âvaporizedâ and the âcase going coldâ 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.Â Â As the New York Times reported last week, ââŠauthorities have yet to interview key witnesses â including a person who is believed to have transferred client funds in the firmâs final days.âÂ Yet around the same time, Reuters reports:Â âCriminal Probe Trial going cold at MF Global.â
One would, of course, think a âcase gone coldâ proclamation is made only after investigators have finished examining all evidence, and only after questioning the primary suspect and all witnesses. Â Thatâs not the case â investigators claim they havenât finished reviewing documents, but they are pretty sure the âcase is cold.â 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.Â Why would a US Trustee, under the authority of the Department of Justice, withhold anything needed for the investigation? (Many questions regarding Mr. Freehâs 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 toÂ accept and then âvaporizeâ from its collective mind?
The âvaporized propaganda campaignâ 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. Â Thatâs the goal. In fact, it’s impressive how âMr. Vaporizedâ has managed to keep this case out of the news so well.
How Â âVaporizedâ and âMr. Vaporizedâ 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.Â The report made the now famous claim that MF Global customer funds had simply âvaporized.â After months of rapt attention to the question of âwhereâs the money,â 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 âMr. Vaporized.â 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.Â When reached for comment Mr. Jarrell responded âI have no idea where that word ‘vaporized’ originated from and I don’t know what you are talking about.â
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 âcommunity relationsâ and strategic media planning.Â Mr. Jarrell is director of APCOâs Washington, D.C.-based litigation communication practice.Â The firm’s web site states âHe advises CEOs, general counsels and boards of directors on preparation for unfolding material events.â Â And that, âHe currently âŠadvises the trustee in the liquidation of Lehman Brothers Inc.â 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. Jarrellâs 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 âshareâ the MF Global proceeds with creditors such as JP Morgan.Â The message further stated that customers would only receive on a pro rata basis what is “identified by the trustee as available for distribution.âÂ Further, that âThe trustee then would be unlikely to find much value within the estate to pay back commodities customers, unless he can locate the missing cash,â 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.Â Â (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.Â Â The parent holdings company filed under Chapter 11, generally used for reorganizationsânot liquidationsâand the broker unit was forced into a SIPA liquidation by the Securities and Exchange Commission.Â 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.Â 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. Â Â 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.Â 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 âa âsignificant amountâ of the money could have âvaporizedâ 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.â It is interesting to note the phrase âa 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 âvaporize?âÂ Â 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 âvaporizedâ claim was met with shock and disbelief.Â Â 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.Â Â 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 âmistakesâ in this realm highly unlikely.
These claims of back office âmistakesâ stand beside a less reported note. In sworn Congressional testimony CMEGroup Chairman Terry Duffy was clear.Â Just before the bankruptcy, critical documents given to regulators by MF Global had been falsified.Â Â Mr. Corzineâs sworn testimony had been called into question by an MF Global employee â an employee now potentially being prevented from talking, a story that needs to be told to prosecutors.Â Not only has potential fraud been publically disclosed, but a web of fraud may lie underneath the 8th largest bankruptcy in US history.Â But, as the propaganda campaign goes: Ignore MF Global.Â 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 âmistakesâ 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 âclawed backâ in Court through preference actions by the trustee.Â 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.Â 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: âHere is (why fraud) is an important point in the bankruptcy process,â Rochelle continued.Â âCongress passed what is known as a âsafe harbor.âÂ Â 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) canât get it back.Â The only way you can get money back in a case like that if (the money) disappeared as a result of actual fraud.Â This report that the trustee was filing to me doesnât sound like he (the trustee) is making a case for actual fraud, but rather (they are making a case for classical incompetence â and that may not be enough to get the money back,â which is a key point.Â 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.Â In it, he sets the tone for ensuing media stories, toeing the “chaos and confusion” theme.Â Â Â
In various places, the report implies a degree of certainty about the flow of funds in MF Global’s final days, such as, “The Trusteeâs 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.”Â 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 Trusteeâs 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.”Â And, “The companyâs 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.Â But the pattern of deception over truth would eventually persist, apparently taking a cue from Trustee Giddens’ early report about the back office.Â Bloombergâs Bill Rochelle noted the trusteeâs report characterized MF Global management as simply having âlost control of the backroom.Â The left hand didnât know what the right hand was doing.Â They were not recording transactions.Â 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 werenât able to.â
This characterization of MF Global back office behavior is noteworthy and requires critical examination.Â Would back office testimony contradict these statements?Â 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.Â We may never know, because investigators have determined the case âis coldâ before any investigation into what industry professionals consider highly unusual behavior for any firm regardless of the level of âchaos.â
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 Â for any serious charges due to âplenty of âchaosâ at MF Global in its waning days, but âno evidence of fraud,ââ 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).Â The excuse, or in legalese, âsafe harborâ, 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 âand 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.â The February 10 report was similar in context and tone, noting an investigation was ongoing but that investigation was stalling.Â Â 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 peopleâs 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.Â Â Â This news was cheered by many industry participants, as the potential for justice finally appeared to arrive.Â 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 âcase had gone cold.â
In an article titled âDoubtful Signs of a Criminal Case Against MF Globalâ on February 28,Â New York Times reporters Azam Ahmed and Ben Protess notedÂ âFederal authorities are struggling to find evidence to support a criminal case stemming from the collapse of MF Global.â
Frustration Boils Over, Limited Options For Industry Participants
By now, growing discontentment from select industry participants with the investigation could be characterized as hostile.Â Questions were being logically asked as to how it can be that a investigation was growing âcoldâ without interrogation of the primary suspect or interviewing potential witnesses to the crime.Â Â 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.Â Â 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.Â Â 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 CEOâs 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.Â 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 OâBrien, an MF Global treasurer.Â Â 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.Â 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 didnât focus on their cooperation with the court.Â 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 âvaporizedâ themes.Â 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 âBuilding Chaos at MF Global,â among the first reports to emerge regarding the MF Global back office focused on key employees and called them out by name.Â 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.Â 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 âballroom dancingâ when the company was under historic stress raises questions.Â 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.Â In fact, senior management had prepared a âbreak the glassâ document weeks before in early October that specifically identified a scenario under which the segregated customer funds account might go in the red.Â 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? Â 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.Â 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).Â 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?Â Â Â Â Were the firm’s internal controls and procedures followed?Â 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 âinternal emails, documents and people familiar with the matter.â Â Who could this source be?Â 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: âFast and Furious at MF Globalâ
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 âAt 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.âÂ The approval was reportedly granted by email a mere minute later, and funds were transferred to an MF Global account at JP Morgan.Â 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.Â 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.Â MF Global had a paltry 318 securities accounts compared with over 38,000 active futures accounts.Â Having said that, letâs 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.Â It could be speculated the speed at which this approval came might have indicated advance knowledge of the issue.Â 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.Â Further, what are known as 4-D and 30.7 account titles clearly identify the special nature of the customer segregated account.Â 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?Â 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 âaccidentâ in a moment of âchaos.â
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.Â 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.Â The unambiguous statement by the customerâs trustee clearly states that the provisions of the Commodity Exchange Act (CEA) designed to protect customer funds were likely routinely violated, and knowingly so .Â 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…”Â 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.Â If this were a crime, the mastermind might be saying right now, hereâs what you tell them: âOops, we just transferred $165 million from customer segregated funds to JP Morgan.Â I hate it when that happens.Â 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.Â The money stays at JP Morgan.âÂ 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.
âMidlevel finance officials usually couldnât move such funds without direction from more senior officials,â the article continues.Â This is the essential point.Â It is the authorâs speculation that at some point there was likely an order from one of the big three in MF Global â Mr. Corzine, COO Bradley Abelow and/or CFO Henri Steenkamp.Â Given the $6.3 billion trade in risky sovereign debt was known as the âCorzine trade,â the risk allocation of the trade that put the customer broker unit on the hook for all losses could be characterized as âhis brainchild.âÂ 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.Â Any mid level investigator might rightfully conclude that Mr. Corzineâs 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:
âJP 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.â
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.Â 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.Â Remember, in the MF Global case there is not even the apparent suspicion of fraud.Â No reason for any serious investigation into this story.
To quote the classic movie Wizard of Oz: âIgnore the man behind the Curtin.âÂ Ignore MF Global everyone.Â There isnât a story hereâŠ
Entire contents Copyright (C) 2012 Mark H. Melin
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.
The New Robber Barons is available via Amazon.com.
Sold Out: How A Private Meeting Between Regulators Gave Away MF Global Segregated Account ProtectionsWednesday, January 18th, 2012
(Note: This is the first of three articles that details questionable, behind the scenes meetings and special treatment that negatively impacted investor protections.Â This first article details a critical meeting where core investor protections were jeopardized.Â The second article details tampering of critical MF Global documents at the SEC.Â 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 â 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).Â 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.Â 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 âsegregated account comes before all elseâ 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.Â While it may seem absurd, this liquidation process wasnât designed or written for a futures brokerage, which has very unique needs in a liquidation.Â 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. Â 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. Â 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. Â 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 inÂ transferringÂ of MF Global assets. Â 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. Â The third issue centers on JP Morgan seeking special favors from the Federal Reserve to receive priority treatment over investorÂ segregatedÂ fund accounts.
The first such non-transparent movement of assets occurred when JP Morgan is said to have purchased MF Globalâs 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. Â No one is going to complain about JP Morgan generating profit. Â 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. Â This sale could be subject to clawback provisions, legal experts speculate. Â (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. Â 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. Â âWho gave JP Morgan permission to purchase those bonds at a discount without open bidding?â
The second questionable movement of assets is said to have occurred when JP Morgan purchased MF Globalâs stake in the London Metals Exchange (LME) without proper disclosure. Â The event wasÂ widelyÂ reported at a basic level on November 28, 2011. Â 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.
âWas this disclosed in court?â Mr. Koutoulas rhetorically asked. Â âNo.Â Was their trustee approval?Â No.â
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.
âHow many letters like this have they asked for in the past? Â I want all the statistics regarding the number and content of letters,â Koutoulas questioned.Â âJP Morgan wanted a âget out of jail free cardâ from the Fed.Â Guess what?Â That doesnât fly with me.â
âTheir hubris is so severe.Â They think we donât know the industry, like we are Occupy Wall StreetÂ radicalsÂ or something and donât have a clue or message,â 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.Â In speaking to JP Morgan, Mr. Koutoulas said âListen, you are buying vulture MF Global claims at $0.86 Âœ on the dollar. Â Â Why donât you pay a fair price of $0.97 Âœ take the customers out of the bankruptcy and we will indemnify you from any class actions resulting from this.âÂ 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. Â 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. Â 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.Â âI can see that you disagree with me,â said Mr. Koutoulas, whose organization represents over 7,000 MF Global clients, mostly professional investors.Â âThey wonât even meet with me and talk with me.â
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 .Â âI need professional litigators and bankruptcy attorneys backing me up,â said Northwestern Law School grad Koutoulas who also operates Typhon Capital Management, which is an NFA-registered Commodity Trading Advisor and Commodity Pool Operator. Â ”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 GlobalÂ presiding bankruptcyÂ Judge Glenn to investigate these issues, Mr. Koutoulas is rallying the futures industry to boycott use of JP Morgan.Â âCall your FCM and if they are using JP Morgan say âWe wonât do business with you if you work with JP Morgan,ââ 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
For a related radio interview: http://bit.ly/vGsnh2
Mark H. Melin is author / editor of three books, including High Performance Managed Futures (Wiley, 2010) [http://amzn.to/vyonBA] and was an adjunct instructor in managed futures at Northwestern University. Â 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. Â 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.
Someone asked a pointed question this weekend:
âDoes the futures industry hate Jon Corzine?â
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.Â Many, including myself, donât 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.Â 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 didnât get it.Â Here is a man that is said to have engineered the toppling of a CFTC regulator in 1998 over the issue of transparency.Â This lack of transparency and disregard for regulators are career trait many practitioners in the futures and options industry couldnât get away with.Â 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, itâs 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 âIBâ stands for âIntroducing Broker,â not âInvestment Banker.â)
Here are key points that have emerged since his compelling testimony:
As Futures Magazineâs Dan Collins aptly noted in an article after Corzineâs initial testimony, the most significant information to come out of the testimony didnât come from the âlawyered upâ Corzine statements, but rather from the Chicago Mercantile Exchange (CME).Â The CME essentially established what had previously been undisclosed by Mr. Corzine:Â Funds were improperly transferred at 2:00 AM Monday morning.
The question is: who is responsible for that transfer?Â 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 âpushing the buttonâ not be aware they were violating CFTC fund segregation rules? Â 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.Â 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.Â 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.Â 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.Â MF Global was not a âbasicâ FCM and had a more detailed process in place, leading to a question:Â 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 âaccount records were a mess.â Â Really?Â Is this disorganization consistent or did it occur only after the transfer of capital out of segregated funds? Â Â Based on subjective observations, those close to the industry might find such disorganization inconsistent.Â 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. Corzineâs own statements.
âIn testimony on Capitol Hill on Thursday, Mr. Corzine only added to the mystery. He said that transferring customer funds was âa complex processâ and, asked who could execute such a transfer, said âI wouldnât know probably who that person is.ââ
In this testimony Corzine is making two potentially inaccurate statements.
First, he claims the process is âcomplex.âÂ Ok, taking this at face value âcomplexâ likely implies a number of people associated with such a transfer and a process that would also trigger alarm bells.Â 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?Â 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.Â 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 doesnât know the people or the process?Â 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.Â Most certainly at that point if Mr. Corzine were un-involved he would have investigated the people and the process.Â 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 doesnât know the people or process involved in transferring $1.2 billion out of segregated funds seems entirely inconsistent. Â But then the only real consistency in this story might be the specialÂ treatmentÂ Mr. Corzine typically received.
Mark H. Melin is author / editor of three books, including High Performance Managed Futures (Wiley, 2010) and was an adjunct instructor in managed futures at Northwestern University. Â 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. Â 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.