MF Global news hit the front pages again last week, and gauging from it, I expect much more news in the future. There was a report issued by Trustee Louis J. Freeh saying that Jon Corzine, the former CEO, deserves “much of the blame” for the firm’s collapse. Freeh is moving ahead in civil court to sue Corzine and other senior executives. There was also a plan submitted in January for the final liquidation of MF Global assets that was accepted by the court. Under the plan, they expect unsecured creditors to receive up to 41.5 cents on the dollar for their claims and the domestic customers to receive 93 cents on the dollar. Only 4 creditors voted against the plan and those creditors represent only $350,000 in claims.
What Did Jon Corzine Do Wrong?
On the subject of Jon Corzine, there are really two parts to the accusations. First, does he deserve the blame for the collapse of MF Global? On that account, the answer is “yes.” There is no doubt Corzine was a bad CEO at MF Global: he ignored risk management, spent too much time trading his prop book, made a major trading mistake by keeping the RTM (Repo-To-Maturity) trades too long after the accounting rules had changed, he tried to make a futures broker into mini-Goldman Sachs in 18 months, he didn’t sell the firm in time, and as everyone regulator and government official likes to point out as the main cause to the firm’s destruction, he built up front office without enough attention to the back office and support areas.
I view the back-office and support area delinquencies as flaws, but not causing the firm’s collapse. They were, in fact, a factor which contributed to the misuse of the customer Seg. funds, but they didn’t cause the firm to lose money, and certainly did not cause the liquidity crisis the week before the bankruptcy.
- Risk Management – At Goldman Sachs, there had been checks and balances for Corzine and his risk-taking style, and that system served to keep the firm under control. At MF Global, however, there were no such controls, as Corzine hired ex-Goldman cronies and surrounded himself with yes-men. Unlike the Goldman Sachs turnaround plan fifteen years earlier that had included heavy emphasis on risk management, the subject of managing risk was largely ignored at MF Global. In fact, as Mike Roseman could testify, if anyone stood in the way of increased risk, Jon Corzine showed them the door. Corzine’s own trading was minimally supervised and when Corzine wanted increased risk limits, no one stood in his way, at least no one after Roseman was gone.
- Hanging On To A Trade After Circumstances Had Changed – As it turned out, the RTM trades weren’t exactly sold to maturity. LCH.Clearnet’s policy is that they do not accept bonds to the full maturity date, the closest they will clear and settle bonds is two days before maturity. That means that what were termed RTM trades really weren’t RTM. Regardless of why, it means that the default risk was assumed by MF Global during those last two days of each trade and clearly not a “true sale,” per the accounting definition of that term. Three months before the RTM trades were at their peak, FASB, PriceWaterhouseCoopers, and the SEC were looking into the firm’s accounting practices. On March 16th, the SEC sent a letter to MF Global asking them to justify how it accounted for their RTMs for the year ended March 31, 2010, the year prior. MF Global responded that they treated RTMs as sales, but that was just the beginning. A few weeks later, FASB revised their interpretations of the rule, as did MF Global’s accounting firm, PriceWaterhouseCoopers. So, even after regulators and auditors were looking into the RTM trades, Corzine continued to increase their size. It was not until Corzine was forced by the board to reduce the RTM positions that the trades were down to a number settling in at $6.3 billion in September 2011, a significant decrease in size from their $11.5 billion peak in June.
- Trying To Make A Futures Broker Into A Mini-Goldman Sachs – After 18 months with Corzine at the helm of the firm, MF Global’s profits weren’t increasing, but the headcount was. Corzine had cut the company’s work force to about 2,600 from 3,200 employees overall. He had trimmed the old workforce down, then proceeded to build up the firm with new employees. Many of these new hires were traders coming out of big investment banks, traders who didn’t understand a brokerage company or how risk is managed in a brokerage organization, instead, they understood big bank risk culture – take big risks and make big bonuses. And the new hires cost a lot more than the employees let go. Many of the old employees received large severance packages, whilst the new staff members were enticed with sign-on bonuses and big stock awards. Those severance packages and signing bonuses paired with guaranteed compensation were a mounting expense to the firm. On top of that, there was entirely new management. These new leaders had difficulty managing both the new Goldman-esque employees and the legacy Man Financial, GNI, and Refco employees. There was a clash of cultures and divisions at all levels of the organization. You were either part of the Corzine team or you were persona non grata. And none of the changes addressed the major problem in MF Global’s core business, futures brokerage. That division was still mostly unprofitable. The economy was weak and short-term rates remained near 0.0%, so the firm was struggling to make minimal revenue from investing their clients’ margin cash. Business divisions that had always been profitable, like foreign exchange and fixed income, were struggling with volatile markets and declining volumes. MF Global’s revenues were further blighted by unprofitable quarters in the equities and retail brokerage divisions, both of which continued to bleed the company’s resources. In the end, Corzine’s strategy of hiring and turning MF Global into a proprietary trading shop was too costly, leading to the disastrous third quarter 2011 earnings report of a $191.6 million loss. The firm’s revenue just could not nearly cover all the expenses.
- Not Selling Out Earlier – Corzine knew the firm was in trouble in the spring of 2011. During that time, he approached The Bank of New York Mellon, Newedge, and Interactive Brokers, among others. Instead of selling at a more opportune time, he waited until there was a crisis and the firm was collapsing, which was certainly not the best marketing strategy. The day before the bankruptcy, Interactive Brokers certainly would have closed on the deal had there not been missing Seg. funds.
- Building Up The Front Office, Neglecting The Back-office And Support Areas – A 2011 internal audit noted the lack of a comprehensive risk-mitigation policy, citing the fact that “risk policies had not been updated to reflect the current operating environment.” The audit also noted “the absence of reliable liquidity reporting tools,” pointing out that the firm was relying on an assistant treasurer’s personal expertise to mitigate liquidity risk. In June 2011, another internal audit report identified gaps in the firm’s management of liquidity, capital, and systems for monitoring its funding.” Too many processes were manual: operations, accounting, and compliance.
Mistakes That Were Really Not Mistakes
- RTM Trade Misconception – The RTM trades did not cause losses, at least not before the “fire sale” bankruptcy liquidation. All the bonds in the RTM portfolio that MF Global owned were paid off and none of the bonds defaulted. In fact, about 50% would have matured by the end of 2011, just two months after the collapse. No, the RTM trades did not lose money for MF Global, but they did contribute to the drain on the firm’s liquidity beginning in July 2011 and the restatement of their financial condition for July 31, 2011, certainly two events which added to the liquidity crisis.
- Money Lost – Most of the financial losses suffered by MF Global shareholders were due to the liquidation. I estimate that over $500 million was lost from the forced bankruptcy and quick liquidation of the firm. Positions sizes were leaked to competitors and when LCH.Clearnet liquidated the remaining $4.8 billion in European sovereigns, they liquidated the trades separately, instead of some trades sold together as spread trades, (e.g. long Italy and short France). George Soros bought about $2 billion in the LCH auction at a deep discount and reported an immediate $140 million profit within a month after the auction. The messy liquidation was not the fault of Jon Corzine.
The “Missing Money”
The second accusation against Jon Corzine is his culpability for the missing client money. Yes, funds were taken out of the customer Seg. fund accounts and that is a crime. If there was any direct evidence showing a direct order from Corzine to use customer funds (“As Per JC’s Instructions”), it would have surfaced by now and would be the basis for a criminal charge. However, the largest fallacy of the whole MF Global affair was that the $1.6 billion in customer money was “stolen,” “taken,” or even “missing.” All along, as the MF Global bankruptcy attorney stated in court on October 31, 2011, “the money is all accounted for.” In the end, we learned the money had really just been “misplaced.” As MF Global slipped into bankruptcy, their clearing banks, central counterparties, and funding counterparties all grabbed as much margin as possible. Not that I blame them, the bankruptcies of Bear Stearns, Lehman Brothers and AIG were still fresh in everyone’s minds. In the end, that $1.6 billion was “found” at the CME, DTCC, FICC, LCH.Clearnet, JP Morgan Chase, MF Global’s UK office, BNYM London, Citibank London, and many of the Repo counterparties. As of today, the Trustees have officially announced they’d be paying the domestic futures clients more than 93 cents on the dollar, though everyone “expects” the clients to be fully paid back. When the clients are all fully paid back, I hope there will be as many news headlines as the $1.6 billion in “missing” funds stories that sloshed around for months.
* For former MF Global readers, please feel free to email me if you disagree with anything or if you have something to add.