When MF Global collapsed, would you have predicted that within two years Jon Corzine would be charged in a lawsuit, the customer funds mostly returned, and the CFTC passed new regulations? Probably.
CFTC Civil Suit Against Jon Corzine
Jon Corzine was the first CEO charged in a lawsuit relating to the financial crisis, even though the crisis was well over by 2011. The CFTC filed a Civil Complaint against Corzine and MF Global Assistant Treasurer, Edith O’Brien in June. Remember, to understand the MF Global story, it’s necessary to understand that there were two “crimes” involved. There were bad decisions which led to the spectacular bankruptcy and, of course, the missing customer funds.
Jon Corzine was not such a bad trader at MF Global. The problem being that he was the CEO at the same time. The European sovereign debt repo-to-maturity (RTM) trades would have made money, had the firm survived just two more months when half of them matured. In short, the RTMs caused a liquidity crisis which sunk the firm, mainly because the trades got too large. They grew well beyond MF Global’s ability to finance their margin calls. That’s the part which goes back to Corzine’s CEO role. He maintained the CEO title and power and the board of directors approved whatever he wanted. In essence, Corzine was a head trader with no trading limits. When there were limits, they were easily pushed higher through strong-arming or eliminating the chief risk officer. That’s the bad CEO part, which is not a crime.
Failure To Supervise
One of the actual charges levied against Jon Corzine by the CFTC was the “failure to supervise.” In other words, someone who worked under his direction did something wrong and he should be held accountable. This charge targets the $1.6 billion “missing” Seg funds. Specifically, the $200 million in customer funds withdrawn on Friday October 28, 2011 by Edith O’Brien of which she then immediately sent $175 million to their JP Morgan Chase clearing account in London. That’s the famous “Per JC’s Direct Instruction” email. What was said on the phone that morning between Corzine and O’Brien is literally a “he said, she said” dispute. Corzine never left a paper trail anywhere, a strategy he attributed to his time in politics as Governor of New Jersey. Had there ever been an email or a recorded phone conversation, it would have come out by now.
The problem with this charge is that Corzine was the CEO of MF Global, so technically everyone worked under him. Can a CEO be charged with failure to supervise someone who worked three levels below him? Could the CEO effectively supervise the funds transfer clerk? This charge is somewhat unprecedented and somewhat of a stretch. It will be very hard to prove.
On another front, MF Global clearly had inadequate controls which allowed the firm to borrow their customers’ funds intra-day. Yes, that’s right. There was a formal procedure that allowed them to dip into customer funds, as long as the funds were returned by the end of the day. This charge, in my opinion, has legs. Between audits, reviews, and the normal course of managing a business, someone should have identified this process as inadequate, if not illegal.
In response to the CFTC lawsuit, Corzine, of course, denied the charges and filed a motion to seek a dismissal. He called the charges “rambling hindsight criticisms of complex management decisions, many of which were made during times of extreme stress.”
During the past two years I was surprised that not even one pinky finger of blame was pointed at the MF Global board of directors. The board clearly allowed Corzine to violate the firm’s risk limits, imposed no checks on his power, and were quick to disappear from public view after the collapse.
It’s the board of director’s job to watch the CEO. They’re, in effect, working for the shareholders. They’re supposed to be more than just high profile seats with large payouts. They’re supposed to be accountable to the shareholders, at least in some tiny way. In MF Global’s case, was the board really doing its job?
These days, it’s not fashionable to criticize central clearing counterparties (CCPs), they’re supposed to the be the new wave of the future. With the MF Global collapse, the role of the CCPs in assisting the collapse was severely under reported. As MF Global slipped into financial stress, their CCPs and clearing banks pried more and more margin from them. Some of it was justified, some of it was just strong-arming them out of their liquidity. It was a modern day bank run, except there were no people lining up outside the front doors. The power that clearing organizations wield and their ability to put a firm out of business is grossly underestimated.
Distribution of Client Funds
In the end, MF Global will be remembered for the $1.6 billion customer funds that were “missing.” There are plenty of people in the blogosphere under the impression that Jon Corzine and the greedy bankers at MF Global stole the customers’ funds and nobody’s been “brought to justice.” The money was never actually missing, as one MF Global officer explained to me, the funds were “misplaced.” They had been pledged as margin to clearing organizations. As the Wall Street Journal explained it, “money that had slipped away in MF Global’s final days to banks and clearinghouses” * Please note, in describing the funds as misplaced, I’m not trying to belittle that the funds we illegally removed in the first place. Just that people knew where the funds were the whole time.
In September 2013, James Gliddens, the MF Global Trustee announced that they had returned 98% of the missing money to U.S. customers. Those are the CFTC 1.25 Seg funds. Naturally, the number doesn’t include the foreign customer funds. He also said that the final payment was coming soon, perhaps as early as November.
New Rules And Regulations
Also last month, the CFTC issued new rules designed to further protect customer Seg funds. Those rules were finalized just yesterday:
- Futures brokers will be required to deposit more of their own funds along with the customer funds in the Seg accounts. Preliminary estimates show the futures industry, as a whole, might be required to come up with an additional $100 billion in capital. Higher capital costs for market access will eventually filter down to the customers and traders. It means it will cost more money to be in the business. For me, the more obvious solution would be to have no FCM funds mixed with customer funds. Keep the two completely independent. Instead of policing the cookie jar and watching it constantly, I’d rather just put a lock on it.
- Regulators will now have view-only access to an FCM’s Seg accounts at their clearing bank. This is clearly a good rule.
- The “Corzine Rule.” Going forward, the CEO must approve any large customer Seg fund transfers and sign-off on them. This is just another layer of rules. When you look at Sentinel and Peregrine, the CEOs themselves were involved in stealing the customer Seg funds in the first place.
Customer Insurance For Futures Accounts
There’s also another idea which was floated after MF Global and Peregrine. Given that there’s deposit insurance in banking courtesy of the FDIC, and for securities through SIPC, why not for futures? CFTC Commissioner Bart Chilton proposed a futures fund which would work along the lines of the SIPC to insure up to $500,000 in futures accounts. It would be effectively protecting the small futures clients, yet as another new cost to the futures industry as a whole. Naturally, the futures industry is against it with Terrence Duffy, Chairman of CME, becoming the first executive to openly oppose it.
For the whole story about MF Global, please don’t hesitate to buy my book !
* WSJ; “MF Global Repayments Near”; September 2013.