Regulators are investigating whether MF Global Holdings Ltd. intentionally used customer funds to cover the bankrupt firm’s margin payments on European government bond trades, bolstering their ability to retrieve the missing money, people with knowledge of the probe said.
Investigators including the Securities and Exchange Commission, the Justice Department, the Commodity Futures Trading Commission and the bankruptcy (LEHMQ) trustee are reviewing the brokerage’s accounts seeking proof of fraud, which would allow them to recover some of the lost $1.2 billion, said the people, who declined to be identified because the probe is ongoing. Unless regulators find illegal activity, margin payments on repurchase trades can’t be returned under bankruptcy law, said Lauren Teigland-Hunt, a lawyer who has represented money managers in the Lehman Brothers Holdings Inc. bankruptcy.
“It has to be actual intent to defraud, and that’s a high bar,” said Teigland-Hunt, managing partner at Teigland-Hunt LLP in New York. “The whole goal is to try to ensure that if you’re a participant in the market and receive payment of margin, that won’t be reversed on you if a customer goes down.”
MF Global’s failure and the customer-funds deficit, which scuttled a last-minute acquisition that would have averted the eighth-largest bankruptcy, are the focus of congressional hearings in which Jon Corzine has made his first public comments since quitting as chief executive officer on Nov. 4. Corzine, 64, who engineered the $6.3 billion in European bets, told the House Agriculture Committee on Dec. 8 that he didn’t know what happened to the missing money.
Corzine told the Senate Agriculture Committee today that he “never gave any instructions to misuse customer funds” and never intended that anyone at the New York-based firm do so. The agriculture committees in the House and Senate preside over the CFTC, which was MF Global’s main regulator.
James Giddens, the bankruptcy trustee, is looking at all activity in the final days of MF Global to locate the missing money. He found “suspicious transactions” in the days before the Oct. 31 filing, James Kobak, a lawyer for the trustee, told the presiding judge in the case last week. Even if all the available money at U.S. depositories is recovered, there will still be “a significant shortfall” of as much as $1.2 billion, Kobak said on Dec. 8 at the House hearing.
“Our primary focus is how much money is missing, where did it go, and do we have a legal way of getting it back?” Kobak said.
Corzine, who hasn’t been accused of any wrongdoing, said at the hearing last week he was “stunned” to learn on Oct. 30 that MF Global couldn’t account for hundreds of millions of dollars in client money.
“I remain deeply concerned about the impact this has on MF Global customers and others,” said Corzine, the ex-Goldman Sachs Group Inc. co-chairman and former senator and governor from New Jersey. “I simply do not know where the money is.”
The missing money doomed a sale of MF Global’s futures brokerage to Interactive Brokers Group Inc., Hans Stoll, a board member of the potential acquirer, said last month.
One working theory for the missing money is that it was taken from customer accounts and not replaced with equal collateral, as mandated by law, according to the people familiar with the investigation. Then, they said, after the funds were moved to the broker-dealer unit of MF Global they may have been used to pay margin on the repurchase agreements.
Crisis of Confidence
Under U.S. law, futures brokers are required to keep customer money segregated from their own accounts so that if a firm fails its clients can quickly move positions and cash to a new company. MF Global’s bankruptcy is “unprecedented” in that for the first time, customer funds have gone missing, Terrence Duffy, executive chairman of Chicago-based CME Group Inc. (CME) said at the hearing.
Disclosures on the extent of Corzine’s wagers on debt from countries including Italy and Spain led to a crisis of confidence in the firm in October, culminating with its Chapter 11 filing at the end of the month. In the week before it entered bankruptcy, MF Global plummeted 67 percent and Moody’s Investors Service and Fitch Ratings reduced its credit rankings to junk.
Cut to Junk
MF Global’s counterparties may have demanded more collateral if the price of the underlying bonds in its European sovereign-debt trades declined or if the firm had its credit rating cut. The downgrades on Oct. 27 “sparked an increase in margin calls” that were “threatening overall liquidity,” Bradley Abelow, MF Global’s president and chief operating officer said in the company’s bankruptcy filing.
The trustee will make a legal determination as to whether it can recover customer funds, said Kent Jarrell, a spokesman for Giddens. “If we believe there is, we use all legal avenues available to us,” Jarrell said.
Any payments made from customer accounts may be considered fraudulent, said David Skeel, a University of Pennsylvania law professor whose research areas include bankruptcy and corporate law.
Unless fraudulent intent or another overriding legal principle can be found that trumps the protection of margin payments under the liquidation laws, any MF Global customer funds used for the repo trades would be lost, two of the people familiar with the probe said.
If the money were recovered, customers may not have top priority in being repaid, Skeel said.
“I don’t think they would have any special claim,” he said. “They would just be treated like general creditors with respect to fund retrieved, and would have to share with other general creditors.”