(What follows is the authors individual speculation. Written by Mark Melin with Bob English. To download a PDF version of this article, visit http://www.go2managedfutures.com/Vaporized.pdf)
Sometimes you wonder if we’re living in an alternate universe.
Recent news reports that cite un-named sources and indicate the MF Global criminal case has “gone cold” are curious. In fact, these news reports are even more bizarre than previous reports claiming MF Global client funds have simply “vaporized.” A pattern of behavior and reporting appears to be emerging that supports one overall goal: push the MF Global story under the radar, avoiding serious investigation and keep the inner workings and questionable circumstances surrounding a historic event out of public view and understanding. This, in turn, paves the way for MF Global creditors to legally swoop in on what rightfully belongs to the customers.
The “vaporized” and “case gone cold” news reports all convey a common underlying message: no one is responsible for what is now estimated as the loss of $1.6 billion taken from customer segregated accounts. There was no criminal activity. The message seems to instruct people to “mind their own business, keep quiet and just ignore what is the 8th largest bankruptcy in US history, a scandal tainted with fraud allegations that involves a man who is arguably the most politically connected Wall Street insider to ever walk among the backroom corridors of Washington DC.” Yet, by not officially using the “f” word (fraud), regulators, trustees, prosecutors and the rest of the panoply of public “protectors” make it more likely that the recipients, such as JP Morgan, of hundreds of millions in transfers of customer money in MF Global’s final days will simply get to keep it. The core integrity of the commodity markets has been destroyed and an “industry of investor protections” with an exemplary regulatory record for protecting customer funds, now demands a rewrite.
This is the story we are supposed not to discuss? Is it really too complicated for mere mortals to understand?
Explaining a Complex Story with a Simple Analogy
One critical goal among those on the side of JP Morgan and other creditors is that they are attempting to confuse the issue, so it helps to start with a simple analogy of what occurred.
Imagine for a moment that MF Global was your bank. One day you woke up and discovered that the account holding your college savings was gone. Poof! The money in your retirement accounts and related checking accounts had just been “vaporized.” You go to ask the bank where you money is and you are locked out of the bank while strangers who are not depositors are allowed to enter and take assets from the bank, including the contents of the “safe” deposit boxes. You finally hear from the bank and the authorities, who essentially say that while they can see all the transactions of the bank over the last month, for some reason, there is just no longer any trace of the money, and no explanation of what happened. The funds just “vaporized.” And after a few weeks of minimal information dribbles, you hear the search has gone cold. You are told the money disappeared in a chaotic tsunami of transactions and there is no evidence of any criminal actions. But, if money happens to get found, you might get some of it. Oh, and the contents of your safe deposit box are going to be auctioned off, with only a portion of the funds returned to you (this was the fate of the unlucky souls who held gold and silver bars on deposit in their own name with MF Global). That’s all…talk to you later. Good bye and good luck.
How would you react? Would the notion that your money “vaporized” elicit outrage?
Welcome to the MF Global case, one that is currently being swept into the tangle of questionable bankruptcy litigation and under the media rug.
In Criminal Investigations, Shouldn’t The Witnesses to a Crime And Suspects Be Interviewed Before a Case “Goes Cold”
In the case of MF Global, claims of customer “seg funds” being “vaporized” and the “case going cold” are made without investigators interrogating the primary suspect and individual in charge, former MF Global and Goldman Sachs President, New Jersey Senator & Governor, Jon Corzine. As the New York Times reported last week, “…authorities have yet to interview key witnesses — including a person who is believed to have transferred client funds in the firm’s final days.” Yet around the same time, Reuters reports: “Criminal Probe Trial going cold at MF Global.”
One would, of course, think a “case gone cold” proclamation is made only after investigators have finished examining all evidence, and only after questioning the primary suspect and all witnesses. That’s not the case – investigators claim they haven’t finished reviewing documents, but they are pretty sure the “case is cold.” Further, and as an aside, Mr. Freeh, trustee for MF Global Holdings has agreed to release documents from October 17th going forward, but nothing from before that date. Why would a US Trustee, under the authority of the Department of Justice, withhold anything needed for the investigation? (Many questions regarding Mr. Freeh’s appointment as trustee, and who recommended that appointment, are not being addressed in this document.)
Is this the information the financial services industry is asked to accept and then “vaporize” from its collective mind?
The “vaporized propaganda campaign” is a well-coordinated effort intended to confuse, divert and distract from the truth surrounding the crime of taking over a billion of customer funds. That’s the goal. In fact, it’s impressive how “Mr. Vaporized” has managed to keep this case out of the news so well.
How “Vaporized” and “Mr. Vaporized” Entered the Picture
On January 24, 2012 a jarring news leak, first reported by Wall Street Journal reporters Scott Patterson and Aaron Lucchetti, was said to come from sources close to judicial proceedings. The report made the now famous claim that MF Global customer funds had simply “vaporized.” After months of rapt attention to the question of “where’s the money,” those in the media still paying attention were now told the money just simply disappeared without a trace! Poof!
After initial, and inaccurate speculation, a potential source for the leak emerged and was summarily dubbed “Mr. Vaporized.” It is the author’s speculation that “Mr. Vaporized” is none other than Kent Jarrell, the third party media management consultant hired by customer trustee James Giddens. When reached for comment Mr. Jarrell responded “I have no idea where that word ‘vaporized’ originated from and I don’t know what you are talking about.”
Mr. Jarrell is a highly connected Washington DC media operative, who works for APCO Worldwide, a marketing, brand management and public relations firm with significant experience in “community relations” and strategic media planning. Mr. Jarrell is director of APCO’s Washington, D.C.-based litigation communication practice. The firm’s web site states “He advises CEOs, general counsels and boards of directors on preparation for unfolding material events.” And that, “He currently …advises the trustee in the liquidation of Lehman Brothers Inc.” Attorney James Giddens is also the Lehman Brothers Liquidation Trustee, a case in which $160 million was said to have been billed by trustees in legal fees.
Mr. Jarrell’s role in MF Global has been limited to communications regarding the liquidation and bankruptcy, as well as controlling the message and public expectations. Early in the process, Mr. Jarrell relayed a message through the media to MF Global clients that they should be prepared to “share” the MF Global proceeds with creditors such as JP Morgan. The message further stated that customers would only receive on a pro rata basis what is “identified by the trustee as available for distribution.” Further, that “The trustee then would be unlikely to find much value within the estate to pay back commodities customers, unless he can locate the missing cash,” noted a Reuters article.
In previous cases where futures brokers failed, the customer accounts were either transferred to another broker prior to a bankruptcy filing or the customers were afforded priority protection above all other claims in the bankruptcy process, in accordance with the Commodity Exchange Act. (That customers are not first is only so because of the curious way in which the bankruptcy and liquidation were structured by the regulators and MF Global execs in the first place. The parent holdings company filed under Chapter 11, generally used for reorganizations—not liquidations—and the broker unit was forced into a SIPA liquidation by the Securities and Exchange Commission. This decision has been a highly debated topic, as the 99% of accounts that were futures customers were afforded no insurance under SIPA and no protections from bankruptcy that fall under the Commodity Exchange Act. All in all, another MF Global mystery.)
On October 31, 2011, the day of the filings (or, perhaps even before), MF Global and its regulators may have planned such a structure to put customers on the same footing as creditors. Whatever went on in those closed door meetings, these reports of a new set of rules came as yet another shock to futures industry participants.
How Stupid Do They Think We Are?
Rules of propaganda teach us that if you repeat something long enough, no matter how absurd, it will eventually be believed. Multiple sources and narratives have parroted the thematic evolution: there was an unknown amount of missing money, which became money that had somehow disappeared, and finally an investigation gone cold, setting the stage for customers to expect less than 100% of their money back.
In an article dated January 30, 2012, The Wall Street Journal reported “a ‘significant amount’ of the money could have ‘vaporized’ as a result of chaotic trading at MF Global during the week before the company’s Oct. 31 bankruptcy filing, said a person close to the investigation.” It is interesting to note the phrase “a person close to the investigation” might indicate someone associated with court proceedings or grand jury proceedings.
Is anyone so stupid to believe that customer funds held in a segregated account could simply “vaporize?” Yet sources quoted in the Wall Street Journal seem to believe that could be possible. The assertion was widely questioned by those with knowledge of the situation, including CFTC commissioner Bart Chilton and US Congressman Bill Posey.
Judging by reactions of expert industry participants on Twitter, the medium de jour for exchange among professionals in the futures industry, the outrageous stunt of the “vaporized” claim was met with shock and disbelief. Knowledgeable industry participants understand there are special documentation requirements for 4-D and 30.7 customer funds and strict regulations that must be followed to move funds in such accounts. Further, the brokers are subject to daily reporting requirements which, combined with the traditionally sacrosanct nature of segregated account protections, relentlessly drilled into industry participants, makes “mistakes” in this realm highly unlikely.
These claims of back office “mistakes” stand beside a less reported note. In sworn Congressional testimony CMEGroup Chairman Terry Duffy was clear. Just before the bankruptcy, critical documents given to regulators by MF Global had been falsified. Mr. Corzine’s sworn testimony had been called into question by an MF Global employee – an employee now potentially being prevented from talking, a story that needs to be told to prosecutors. Not only has potential fraud been publically disclosed, but a web of fraud may lie underneath the 8th largest bankruptcy in US history. But, as the propaganda campaign goes: Ignore MF Global. No fraud investigation required here.
With informed participants now detecting that an obvious agenda was in play by the media sources close to the bankruptcy, the question becomes: why the focus on back office “mistakes” rather than investigate fraud?
Why Avoiding a Fraud Investigation Is So Critical: The Safe Harbor
If fraud is investigated in a bankruptcy it is much easier for illicit money transfers to be “clawed back” in Court through preference actions by the trustee. Thus, in the case of MF Global, if $1.2 billion was wired out of MF Global to JPMorgan the week before the bankruptcy, this money could be safely returned to client segregated accounts. If fraud is not investigated, if illicit money transfers will be allowed to move out of MF Global into JP Morgan, then JP Morgan keeps the money.
Speaking on Bloomberg Law, a web-based video program, editor at large Bill Rochelle was clear: “Here is (why fraud) is an important point in the bankruptcy process,” Rochelle continued. “Congress passed what is known as a ‘safe harbor.’ What it says is the in a bankruptcy if money was paid in a stock transaction or if it was paid as margin, (MF Global account holders) can’t get it back. The only way you can get money back in a case like that if (the money) disappeared as a result of actual fraud. This report that the trustee was filing to me doesn’t sound like he (the trustee) is making a case for actual fraud, but rather (they are making a case for classical incompetence – and that may not be enough to get the money back,” which is a key point. Legal sources independent of Mr. Rochelle say if fraud is involved in a bankruptcy case, MF Global customer rights could be enhanced.
Trustee Giddens Softens Up MF Global Customers to Take it on the Chin
On February 6, 2012, James W. Giddens, the MF Global broker unit Liquidation Trustee, who is statutorily tasked with obtaining as much recovery as possible for customers, released a preliminary status report. In it, he sets the tone for ensuing media stories, toeing the “chaos and confusion” theme.
In various places, the report implies a degree of certainty about the flow of funds in MF Global’s final days, such as, “The Trustee’s investigators have now traced a majority of the cash transactions, totaling more than $105 billion, made in and out of MFGI in the last week before bankruptcy and are completing the process of tracing the remaining transactions.” And, “The Trustee has identified most of the parties that were the immediate recipients of transfers from MFGI during the final days and weeks of operation.”
Interspersed with these glimmers of hope, though, are statements about the reign of chaos, such as, “For three months the Trustee’s investigative team has worked to understand what happened during the final days of MF Global when cash and related securities movements were not always accurately and promptly recorded due to the chaotic situation and the complexity of the transactions.” And, “The company’s computer systems and employees had difficulty keeping up with the unprecedented volume of transactions [in the final week]. A number of transactions were recorded erroneously or not at all.”
But, where subject and medium converge is in Trustee Giddens’ confusing representation of cash movements at the broker unit during the month of October, 2011:
Figure 1: Actual chart provided by Trustee to "simplify" MF Global money transfer. Could straight lines have been drawn between various parties?
Mainstream Media Starts to Find the Scent
It seemed that certain mainstream and alternative business journalists had begun to take an interest in the unusual circumstances of the case. But the pattern of deception over truth would eventually persist, apparently taking a cue from Trustee Giddens’ early report about the back office. Bloomberg’s Bill Rochelle noted the trustee’s report characterized MF Global management as simply having “lost control of the backroom. The left hand didn’t know what the right hand was doing. They were not recording transactions. They (MF Global back office) ordinarily sometimes took out customer money but replaced it by the end of the day, but as the company was collapsing they weren’t able to.”
This characterization of MF Global back office behavior is noteworthy and requires critical examination. Would back office testimony contradict these statements? In fact, one familiar with MF Global operations and futures industry auditing procedures might express surprise at what was characterized as routine violations in back office behavior. We may never know, because investigators have determined the case “is cold” before any investigation into what industry professionals consider highly unusual behavior for any firm regardless of the level of “chaos.”
On February 9, Reuters reporters Nick Brown and Grant McCool reported that an investigation of some sort was taking place, but again downplayed the possibility for any serious charges due to “plenty of ‘chaos’ at MF Global in its waning days, but ‘no evidence of fraud,’” the article noted, quoting sources close to the investigation.
Unfortunately for MF Global customers, sweeping changes in the Federal Bankruptcy Code enacted in 2005 grant special super-priority status to derivatives in bankruptcy (including loans structured as repos) and prevent last minute margin transfers from being clawed back, except in the case of fraud (which everyone in charge refuses to discuss). The excuse, or in legalese, “safe harbor”, was again roundly questioned by many leading industry professionals, including R. Christopher Whalen, when he appeared on CNBC with Rick Santelli and in an article he penned at Zero Hedge titled “MF Global: Where’s the Cash — Part II.”
The February 9 Reuters article went on to note “and keeping with the message pattern identified, people familiar with the situation said some executives and employees who, in the normal course of an investigation would have been interviewed by authorities at this stage, have not been asked to provide their version of events.” The February 10 report was similar in context and tone, noting an investigation was ongoing but that investigation was stalling. This is a pattern that had developed, as increasingly pessimistic news concerning the potential for discovering the perpetrators was also accompanied by a dash of hope to add seasoning to the bad taste the investigation was leaving in people’s mouth.
Jubilation Over Justice Is Quickly Dampened
Fast forward to February 28, 2012. This is when solid news reports of a Chicago federal grand jury investigation surfaced in the CMEGroup annual report, which noted the exchange had received a subpoena. This news was cheered by many industry participants, as the potential for justice finally appeared to arrive. Just as quickly as the ray of hope of grand jury news reports were made public, another leak to the press emerged to dampen expectations that an investigation might yield results, again highlighting how the “case had gone cold.”
In an article titled “Doubtful Signs of a Criminal Case Against MF Global” on February 28, New York Times reporters Azam Ahmed and Ben Protess noted “Federal authorities are struggling to find evidence to support a criminal case stemming from the collapse of MF Global.”
Frustration Boils Over, Limited Options For Industry Participants
By now, growing discontentment from select industry participants with the investigation could be characterized as hostile. Questions were being logically asked as to how it can be that a investigation was growing “cold” without interrogation of the primary suspect or interviewing potential witnesses to the crime. Attempting to get their message heard with limited options, visible outrage occurred on Twitter, and a small group of industry participants, speaking behind the scenes, considered the motivation behind the press leaks. A strategy appears to have emerged, with the goal to dampen expectations for any serious criminal charges and keep confidential key documents and testimony regarding what transpired before and after the historic bankruptcy. Such suspicions grew with the next set of press leaks. Leaks apparently designed to discredit the more vulnerable.
Back Office Workers Defamed, Unable to Defend Themselves
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…
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Article written by Mark Melin http://www.Twitter.com/markmelin with Bob English www.economicpolicyjournal.com with thanks to others who contributed.
