While weâ€™re almost getting sick of writing about MF Globalâ€™s problems, we are still getting calls from concerned people, and the situation is far from resolved. There are still no clear answers coming out of the MF Global mess. Reports yesterday were all over the board, with quotes coming out of government agencies intermeshed with quotes coming out of the hearing on the non-broker-dealer side of MF Globalâ€™s business, causing even more confusion for people trying to figure out what in the world was going on. Itâ€™s a convoluted rumor mill, but as far as we can discern, hereâ€™s whatâ€™s up:
- An anonymous source from the regulators camp is reporting that MF Global officials admitted Monday to using client funds in the midst of the turmoil. No official confirmation from anywhere else just yet.
- The FBI is now involved and investigating.
- The SIPCÂ has set-up the preliminary website for filing claims and has started to put the wheels in motion. Based on our understanding, this does not apply to segregated futures accounts- only to securities clients of MF Global.
- In the initial bankruptcy hearing yesterday, the MF Global attorney stated that all funds, â€śto the best knowledge of management,â€ťÂ but that the subject of the hearing did not relate to the matter because they werenâ€™t discussing the brokerage business.
While the idea of fraud with segregated accounts on this kind of scale is unprecedented (even if it is only 10% of the total funds in segregated accounts with MF Global), the reaction, in our opinion, could have still been handled a heck of a lot better. Regulators and industry participants alike have floundered in the aftermath, leaving investors uninformed (or misinformed) and scared. Even if you do get a hold of someone at one of the regulatory agencies, you probably arenâ€™t going to get a straight answer- aside from, â€śWe donâ€™t know.â€ť
One of the more disturbing questions that no one seems to be effectively answering is whether this is a systemic problem across the futures industry.Â That is, are other FCMs comingling their money with customer money? In our opinion, the answer is a most definiteÂ no. The problem with MF Global, from our view, was that it turned its back on its primary futures brokerage business upon Corzineâ€™s entry in an attempt to transform into an investment bank, which in turn led to a chain of events whichÂ may have led to them using client money to plug holes in their balance sheet.
To our knowledge, that kind of direction is not prominent in the industry. And indeed,Â some FCMs were reaching out to clients yesterday talking about how they are not involved in such trading. Â In our view, every futures-focused FCM (like RJO, RCG, PFGBest, etc. â€“ not the investment banks like Goldman Sachs which also hold FCM status) realize that, in a world where their bread and butter comes from their brokerage clients, the clientsâ€™ happiness and security of funds is paramount. Â In our view, unless there is/was an industry-wide switch to an investment bank model like Corzine tried, then there is no risk of industry-wide problems such as those at Corzineâ€™s firm.
With that in mind, perhaps the more pertinent question was raised inÂ a post on Dealbreaker from Matt Levine. He postulates:
The main fallout will probably be that if you have the choice to work with a too-big-to-fail bank or a just-small-enough to fail bank, on a whole variety of things, youâ€™re going to go too-big-to-fail. Sure, there are lots of small brokers who are well capitalized and take the time to get the little things right, like segregating customer accounts. But how can you know unless you do a lot of diligence? Easier to just trust that a megabank squarely in the regulatorsâ€™ sights will get it right â€“ or, if they get it wrong, wonâ€™t be allowed to blow up in a way that blows up customers.
There are three things worth noting here.
- For many in futures trading, MF GlobalÂ was one of the big dogs. Maybe not a Goldman Sachs, but hey- even Corzine was betting they were too-big-to-fail. Everyone assumed that everyone else was on top of things because of how big MF Global was- despite the fact that they had long since departed from the purpose that had fueled their ascent.Â This is the 8th biggest bankruptcy in US history â€“ making it hard to believe being too small was the problem here.
- Even if you accept the premise that being at a megabank is the only place to be (because thatâ€™s where the bailouts are), the problem is you really canâ€™t be a futures trader at the top half-dozen banks without being a hedge fund which slings 1,000 lots around like it is nothing. Â The megabanks donâ€™t have an infrastructure to handle retail futures accounts trading on their own or through managers.
- The problem with due diligence on FCMs is, in the case of MF Global, traditional due diligence might not have raised any red flags. Their audits had gone off without a hitch. They had seamlessly responded to capitalization calls earlier this year. Their reporting was looking good. And then, all of the sudden, it wasnâ€™t. Outside of gaining access to all of their accounting records (and good luck with that), what kind of due diligence could have prevented this?
Our take? We believe the situation unfolding with MF Global is not indicative of failure in the system, but an isolated blow-up related to the decisions made by management regarding the companyâ€™s focus. There are no easy answers here, and the repercussions of any fraud at MF Global could shake the futures industry for years to come- but is this common among futures-focused FCMs? Absolutely not. MF Global went a different direction than the rest of the industry, and that is why these problems exist, in our opinion. It isÂ what they were doing- not of the industry they were doing it in.
Perhaps if Corzine had succeeded, we would have seen more FCMs try and copy that success, but the failure bodes well for the health of the industry now, being a stern warning for any firms which decide to juice their returns by dabbling in other areas.
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