MF Global: The Untold Story of the Biggest Wall Street Collapse Since Lehman

By Pam Martens: April 21, 2012

Only on Wall Street can you bankrupt a company; misplace $1.6 billion of customers’ money; lose 75 percent of shareholders’ money in two weeks; speed dial a high priced criminal attorney and get a court to authorize the payment of your multi-million dollar legal tab from the failed company’s insurance policies; have regulators waive your requirements to take licensing exams required to work in the securities and commodities industry; have your Board of Directors waive your loyalty to the firm; run a bucket shop out of the UK; and still have the word “Honorable” affixed to your name in a Congressional investigations hearing.   

This is not a flashback to the rotting financial carcasses of 2008. This putrid saga has been playing out in five Congressional hearings since December with the next episode scheduled for Tuesday, April 24, before the Senate Banking Committee under the auspicious title: “The Collapse of MF Global: Lessons Learned and Policy Implications.” (The title might more appropriately be, “MF Global: Lessons Never Learned and Policy Implications of a Wild West Financial System Just One Trade Away from the Next Taxpayer Bailout.”) 

There are plenty of lessons to be learned from MF Global and heart-pounding policy implications; all of which we can count on Congress to ignore at the behest of the Wall Street money and lobby machine until the next epic financial crisis – an eventuality that is growing more likely each day as Congress refuses to restore the Glass-Steagall Act, the depression era legislation that bars Wall Street securities firms from owning banks holding insured deposits. 

MF Global, the eighth largest bankruptcy in U.S. history, held 36,000 customer accounts in the U.S., over 5,000 in the U.K., and an unknown number in Japan, Australia, and Hong Kong. It’s a forensic accounting mess.  Can you imagine what it would be like if one of the major Wall Street firms failed with more than 3 million customer accounts? 

MF Global filed for Chapter 11 bankruptcy in the U.S. on October 31, 2011 because of off balance sheet transactions and proprietary trading – a quaint name for betting the house with other people’s money – resulting in a downgrade of their credit rating to junk and a resulting collapse in liquidity. 

In MF Global’s unique world of risk controls, the CEO of the firm was doing the proprietary trading. Off balance sheet transactions blew up Citigroup in 2008, requiring hundreds of billions in taxpayer funds and guarantees to shore it up.  Proprietary trading, of the heads we win, tails you lose kind, has cost Goldman Sachs and Citigroup serious reputational damage with customers.  And yet, no lessons have been learned.  Off balance sheet bombs are still lurking all over Wall Street and the SEC continues to stall on outlawing proprietary trading at securities  firms holding customer accounts. 

The CEO of MF Global when it disintegrated was Jon Corzine, the former New Jersey Senator and Governor and former co-head of Goldman Sachs & Co.  Corzine took the reins of MF Global in March 2010.  Conflicts abounded with the knowledge and rubber stamp of the Board of Directors.  Corzine was not just Chairman and CEO, he was the firm’s top trader of volatile  European BIIPS debt – Belgium, Italy, Ireland, Portugal and Spain.  Corzine took the firm’s position from approximately $500 million when he was hired to $8.1 billion (including Greece and France) in the 19 months it took him to blow up the firm. (How does the CEO of a financial firm police a cowboy trader when he’s the same individual?)  When the Chief Risk Officer of the firm, Michael Roseman, raised warnings about the risk with the Board of Directors, Roseman was asked to leave and replaced with a new Chief Risk Officer acceptable to Corzine, according to Congressional testimony given by Roseman and Corzine. 

But wearing the three incompatible hats was not the only fatal flaw in Corzine’s management model: he contractually did not owe his total loyalty to MF Global. The August 11, 2011 proxy issued to shareholders and filed with the SEC carried this caveat: 

“During the term of Mr. Corzine’s employment agreement with the Company, Mr. Corzine will spend substantially all of his business time and attention on Company matters, except that he may serve as an operating partner of J.C. Flowers. Pursuant to his contract with J.C. Flowers, Mr. Corzine will not receive any salary from J.C. Flowers as long as he is serving as Chief Executive Officer of the Company, but he will have a financial interest as a limited partner in certain of J.C. Flowers’s investment management entities. Mr. Corzine’s employment agreement with the Company contains a provision regarding corporate opportunities. In general, this provision provides that, if Mr. Corzine acquires knowledge from J.C. Flowers (and not the Company) of a potential transaction or other business opportunity that may be a business opportunity for the Company he will have no duty to communicate or present such opportunity to the Company…” 

JC Flowers was the namesake of  J. Christopher Flowers, a former colleague of Corzine’s at Goldman Sachs. Flowers had acquired a stake in MF Global to help shore it up in 2008 after a trader blew up $141 million of the firm’s money overnight in what the firm called an unauthorized trade. It was Flowers who invited Corzine to become CEO of MF Global.  Corzine left MF Global on November 4, four days after its bankruptcy filing, at the request of the Board. 

Why Corzine, a man of great wealth and political stature, would join an obscure brokerage firm  is a mystery worthy of pursuit by the FBI, which is investigating the missing customer funds according to Congressional sources.  One avenue worthy of pursuit according to Wall Street veterans, is whether Jon Corzine turned MF Global into a giant parking lot for other Wall Street firms’ bad bets on sovereign debt. Fueling that speculation is the fact that JPMorgan, Citigroup and Bank of America were part of a syndicate of 22 banks that provided MF Global with an unsecured $1.2 billion revolving credit line that required no posting of collateral, despite the company’s string of losses and weak credit rating.  The firm heavily tapped this line of credit in its last days. 

The trustee of the Chapter 11 proceeding for the parent holding company is Louis J. Freeh, a former FBI director. On April 19, Freeh asked the court for an expedited hearing to grant him the ability to issue subpoenas to “the Debtors’ affiliates and subsidiaries, the Debtors’ former employees, current and former officers, directors and employees of the Debtors’ affiliates and subsidiaries, lenders, investors, creditors and counterparties to transactions with the Debtors…” 

The court is allowing Freeh’s own firm, Freeh Group International Solutions, to perform the accounting work. Four docket entries show that Freeh has asked for and received four extensions by the court to file a list of assets of the holding company. 

Compared to Corzine’s former employer, Goldman Sachs, MF Global was a flea on an elephant’s back.  It had experienced a string of quarterly losses since 2007, was predominantly a Futures Commission Merchant (FCM) holding retail and institutional commodity and futures trading accounts, and had 80 regulatory actions against it since 1997.  It had a securities brokerage unit with 300 to 400 U.S. accounts according to the trustee. How big those accounts were is unknown.  If they were all institutional or hedge fund accounts, it could have been a sizeable operation.  One known account, which presciently moved out before the bankruptcy, belonged to the $100 billion private energy firm, Koch Industries, majority owned by Charles and David Koch, financial backers to numerous corporate front groups. 

Corzine had no expertise with running a commodities firm.  His trading background at Goldman was in U.S. Government bonds, not commodities.  According to a spokesman for the National Futures Association, Corzine passed a limited exam called the Series 32 on August 17, 2010 but never took the full National Commodity Futures Exam, Series 3, which would be expected of Registered Associated Persons working for an FCM.  The spokesman suggested Corzine may have been given a waiver. 

Corzine testified to Congress that he was trading debt instruments.  That would have required a valid Series 7 securities license.  But the Financial Industry Regulatory Authority (FINRA) shows that Corzine last took his Series 7 on June 21, 1975 – 37 years ago.  Securities rules require that if one has a gap of more than two years in working for a securities firm, they must retake the exam.  Corzine had a nine year gap while serving as U.S. Senator and Governor of New Jersey.  A FINRA spokeswoman said Corzine was given a waiver.  Corzine would have also been required to take ongoing continuing education  – some of which can only be administered by the securities firm one works for.  Since Corzine didn’t work for a securities firm for 9 years, it’s difficult to see how that requirement could be waived. 

According to FINRA’s rules, “Principal examinations are rarely waived.” A Principal is the person charged with supervising other security personnel and requires a Principal’s license. Based on Corzine’s testimony, he was not only trading debt but he was instructing others to write tickets.  Corzine’s Principal license, a Series 24, would have lapsed when he left Goldman Sachs in 1999.  Even though its own rules say that waving a Principal examination should be a rare occurrence, FINRA waived that for Jon Corzine as well, according to a spokeswoman. 

Against this backdrop of regulatory and Board waivers, it is painful to watch 10 hours of Congressional hearing videos and listen to the Chief Executive Officer, two Chief Financial Officers, Chief Operating Officer, Chief Risk Officer and General Counsel tell Congress and the American people they have no idea how $1.6 billion of what should have been legally segregated funds in customer accounts is missing. Edith O’Brien, the former assistant treasurer, took the fifth in house hearings, while smiling like Mona Lisa.   

The final meltdown of the firm came during the week of Monday, October 24 through Monday, October  31, 2011 – the day the firm filed bankruptcy.  On Monday, October 24, according to a Congressional memo, Michael Stockman, the Chief Risk Officer who had replaced Michael Roseman, sent an email that listed the firm’s net funded exposure to European sovereign debt from Greece, Ireland, Italy, Spain and Portugal at $7.687 billion and $422 million for Belgium and France.  On the same day, the ratings agency, Moody’s, downgraded MF Global to the lowest investment grade rating, Baa3. 

According to an email obtained by Congress, on October 24, Henri Steenkamp, the CFO of the holding company for MF Global, sent an email to Standard and Poor’s, writing that MF Global’s “capital and liquidity has never been stronger…MF Global is in its strongest position ever….”  Mr. Steenkamp is still employed at the firm and is signing financial documents for the bankruptcy trustee of the holding company.

On Tuesday, October 25, the firm announced the largest quarterly loss since going public in 2007, a net loss of $191.6 million.  Corzine was on the earnings call with investors and explained his bets on sovereign debt as follows: “…the structure of the transactions themselves essentially eliminated market and financing risk.” The stock price lost 44 percent on the day. 

On Wednesday, October 26, Standard and Poor’s issued a Credit Watch with negative implications, noting that it might soon downgrade the debt to below investment grade, i.e., junk. On Thursday, October 27, Moody’s again downgraded the firm’s rating, this time to junk (Ba2), citing the firm’s “outsized proprietary position.”  In the wee hours of Sunday morning, the firm owned up to customer money missing from the segregated accounts. A potential sale of the firm was aborted. On Monday, October 31, MF Global Holdings Ltd., the parent entity, filed for bankruptcy and the Securities Investor Protection Act (SIPA) liquidation proceeding was filed for the securities brokerage and Future Commission Merchant which held the customer accounts. 

Eighteen days before the firm failed, the Treasury, Finance Group, and a Senior risk officer prepared a hypothetical death spiral scenario for the firm titled “Break the Glass.”  Disturbingly, the following sentence appears in the document: 

“How quickly do we want to send cash back to clients, what is the message if we do not send immediately, what is the strategy if we want to keep the customer and wait until the storm passes…” 

The checks that were mailed to customers who wanted their money out of MF Global after its credit ratings downgrades and announcement of a record quarterly loss bounced.   

Customers have moved their accounts elsewhere now but the cumulative total of money missing in the customer accounts is $1.6 billion, according to the liquidation trustee hired by the Securities Investor Protection Corporation (SIPC), James W. Giddens of the law firm, Hughes Hubbard and Reed.  Hughes Hubbard has served as bond underwriting counsel for Citigroup, JPMorgan, and Bank of America on multiple occasions. These are three of the 22 banks which provided the unsecured credit facility of $1.2 billion to MF Global.  The law firm told the court it would drop JPMorgan as a client in response to letters of complaint from customers. The trustee is currently negotiating with JPMorgan to return money it says belongs to customers.  Hughes and Hubbard’s current relationship with the 21 other banks in the syndicate is unknown. 

Hughes Hubbard and Reed is the same law firm handling the bankruptcy of Lehman Brothers.  After more than three years, customers have yet to be made whole.  There are over 7600 law firms in New York City according to the legal web site, Martindale.com.  Why SIPC has selected the same firm for two of the largest Wall Street collapses in history is noteworthy. 

Hughes Hubbard and Reed hired the same public relations firm to handle both the Lehman and MF Global matters, APCO Worldwide.  APCO was originally formed as a subsidiary of Arnold & Porter, the law firm aligned with spin for Big Tobacco in the 90s. 

According to Wendell Potter, an insurance company public relations insider and whistleblower, writing in his book Deadly Spin, “One of the deceptive practices of which APCO has a long history is setting up and running front groups for its clients. In 1993, Philip Morris hired APCO to organize a front group called the Advancement of Sound Science Coalition in response to the U.S. Environmental Protection Agency’s ruling that secondhand tobacco smoke was a carcinogen. Philip Morris also hired APCO to manage what it called a ‘massive national effort aimed at altering the American judicial system to be more hostile toward product liability suits’ and to build a coalition to advocate for tort reform. According to the Center for Media and Democracy, the tobacco industry paid APCO almost a million dollars in 1995 to implement behind-the-scenes tort reform efforts and specifically to create chapters of ‘grassroots’ citizens’ groups called Citizens Against Lawsuit Abuse.”

Amy Goodman, host of Democracy Now!, interviewed Wendell Potter on November 17, 2010.  Potter revealed more about APCO and front groups: “…there was a front group that was set up called Health Care America, and the sole purpose for it to be set up was to attack Michael Moore [who was about to release his documentary on health care, Sicko] and to attack the notion of a single-payer system in this country…the media contact for it was a guy named Bill Pierce, who I had known and worked with in the past…He was listed as a media contact, and if you called his number, you would have reached him at his desk at APCO Worldwide… There was an article that the New York Times wrote as a kind of a review of Sicko, not really a review but just a story about the movie actually premiering in the U.S. in June of 2007. And the New York Times story quoted the Health Care America spokesman as saying that this represented a move toward socialism. And there was not an — apparently not an attempt on the part of the reporter, or any reporter that I saw, to disclose the fact that this was funded largely by the insurance industry.”

In the same month that Corzine was hired by MF Global, March 2010, there were confirmed  news reports that APCO Worldwide had been hired by the Financial Services Roundtable, a Wall Street trade group, to promote the image of Wall Street as trustworthy.  An APCO spokeswoman says they no longer represent the account.

While customers on this side of the pond are left in the dark as to how the sanctity of segregated accounts was bulldozed at MF Global, a recent filing by KPMG, the administrator of the bankruptcy proceeding in the UK of a subsidiary, MF Global UK Limited, provides more fodder for Congressional hearings.  The subsidiary was running an operation in the UK called spread betting.  That practice was known as bucket shops in the US in the 1920s and is outlawed here.  It involves making bets on the price direction of financial stocks, commodities, indexes, and other financial derivatives without the trades ever being placed on an exchange.  No security  asset is owned by the customer.

Another spread betting firm in the UK, WorldSpreads Group, was put under an administrator on March 18.  Customer accounts were frozen with a reported £13 million shortfall in client funds.

There is an old saying by Wall Street cynics: “Where are the customers’ yachts?”  Today, the public can’t even find out where are the customers’ funds.

This article originally appeared at www.AlterNet.org.