Jon Corzine, the former head of MF Global Holdings Ltd. (MFGLQ), failed to oversee the futures broker, leading to the eighth-biggest bankruptcy in U.S. history, according to a lawsuit filed by Louis J. Freeh.
Corzine, a former governor and senator from New Jersey and once a co-chairman of Goldman Sachs Group Inc., was sued along with senior executives Bradley Abelow and Henri Steenkamp in U.S. bankruptcy court in Manhattan yesterday. Freeh, a trustee for the failed holding company of the brokerage, alleged that they failed to act in good faith and implemented strategies that caused the company to fail.
During their tenure, the three executives “dramatically changed the company’s business plan without addressing existing systemic weaknesses that ultimately caused the plan to fail,” Freeh said in the complaint.
The lawsuit seeks unspecified damages “to be determined at trial,” as well as legal fees, according to the 61-page filing. It follows a 124-page report published this month by Freeh which blamed Corzine and his management team for bungling an expansion of the company’s traditional business model while ignoring deficiencies in its risk controls.
The parent company of brokerage MF Global Inc. filed for bankruptcy on Oct. 31, 2011, after a wrong-way $6.3 billion trade on its own behalf on bonds of some of Europe’s most- indebted nations. The company listed assets of $41 billion and debts of $39.7 billion.
There is no basis to the claim that Corzine breached his fiduciary duties or was negligent, said Corzine spokesman Steve Goldberg in an e-mailed statement.
“To the contrary, Mr. Corzine was recruited to revitalize a troubled company, and during his entire tenure as CEO he worked tirelessly with the Board, firm management and world class consultants to improve MF Global’s operations and performance,” Goldberg said. Freeh’s lawsuit ignores the failure of counterparties to fulfill their obligations to MF Global, he said.
Goldberg said that Corzine’s defense looks forward to “proving the actual facts in court” and questions why the lawsuit is filed while Freeh is “participating in court-ordered mediation of these very claims.”
The Commodity Futures Trading Commission, Federal Bureau of Investigation and other agencies had all analyzed events leading to the bankruptcy, when as much as $1.6 billion in client funds went missing. No criminal charges have been brought, and Freeh has been in mediation with Corzine before today’s lawsuit.
The lawsuit may a “pressure point” that Freeh will use to try and get more money for a settlement that would pay MF Global creditors, said Michael Weinstein, a former trial attorney with the Department of Justice and chairman of Cole Schotz’s white collar practice in Hackensack, New Jersey. Corzine is “out of the woods criminally,” Weinstein said, as the time frame for criminal investigations has come and gone.
When Corzine joined MF Global in March 2010, it was already suffering as it depended on interest rates for revenues at a time when rates were declining, Freeh said in the lawsuit. As Corzine moved to convert it into a full service broker dealer and investment bank, setting up a proprietary trading desk, he didn’t improve already deficient controls, the complaint said.
Corzine engaged in risky trading strategies with European debt that strained the company’s liquidity and couldn’t be properly monitored by inadequate controls, according to the lawsuit. Abelow and Steenkamp, his hand-picked deputies, breached their fiduciary duties by failing to ensure that the company’s controls were adequate for its new business plan, Freeh said.
For example, MF Global couldn’t determine its liquidity in real time or stress-test it. It also couldn’t track intra- company transfers from the broker dealer unit to the futures unit, the complaint said.
The three executives also breached their fiduciary duties by failing to inform the company’s corporate board about liquidity challenges, and didn’t heed the chief risk officer’s warnings about worsening market conditions in Europe, Freeh said.
Freeh’s lawsuit comes five months after U.S. House Republicans also faulted Corzine’s leadership in a report released in November. That report, reached by majority Republicans on a Financial Services subcommittee, described a lack of coordination between the CFTC and the Securities and Exchange Commission, primary regulators for MF Global’s U.S. operations.
Freeh has been unwinding the company under Chapter 11 bankruptcy in an effort to repay creditors. James Giddens, a separate trustee for the failed brokerage arm, is liquidating assets to repay customers under the Securities Investor Protection Act.
“Our investigation showed potential causes of action against Corzine and others in June 2012,” Giddens said in a statement. “Last year, on notice to all creditors and approved by the court, we joined the already filed class action lawsuit because it was the most efficient way to get money to customers and creditors.”
U.S. Bankruptcy Judge Martin Glenn, overseeing the wind- downs of the holding company and its operating unit, ruled in April 2012 that Corzine and other former executives could use insurance funds to cover “reasonable” defense costs, setting an initial cap of $30 million.
“It’s fair to assume that this litigation and defense is probably very, very expensive -- likely that that cap will be blown through,” Weinstein said.
Corzine and Steenkamp, the chief financial officer, knew that the company’s controls were flawed as early as May 2010, according to Freeh’s report.
“Being a steward of customer money is a super serious responsibility,” CFTC Commissioner Bart Chilton said in an e- mail commenting on the lawsuit. “Anyone who violates the law, and particularly anyone at MF Global who used a billion bucks of customer cash that should have been protected, should be punished.”
Corzine testified before Congress that he asked for overdrafts with JPMorgan to be corrected, and that he never gave any instruction to misuse customer funds. He also said he didn’t believe anything he said could reasonably have been interpreted as an instruction to misuse customer funds.
Freeh’s report painted Corzine as a tunnel-visioned leader, insulated from criticism, who, although fully aware of the limitations of the company’s system, pushed to transform MF Global into an investment bank by taking on greater risk.
Corzine had unlimited power in his role at MF Global, holding positions that were previously filled by two different individuals, according to Freeh’s report. Corzine hired Chief Operating Officer Abelow, who was once his chief of staff as governor, and favored Steenkamp over then-CFO Randy McDonald. Under Corzine, the board reduced its executive committee to four members from five, according to the report.
To implement his strategy for the company, Corzine handpicked traders with whom he worked and began trading on his own, under minimal supervision, in June 2010 using an existing Treasury Department account, according to the report. He maintained his own portfolio for the company in accounts that bore his initials JSC and was known to place trades in the middle of meetings.
Corzine was the driving force behind MF Global’s European trading portfolio and personally instructed traders “when to enter and exit various positions,” Freeh said in the report.
The company’s problems were exacerbated by MF Global’s method of accounting for its European trades, according to the report. The so-called repurchase to maturity transactions allowed MF Global to immediately recognize income while removing the transactions from the company’s balance sheets, according to the report.
Under Corzine, MF Global’s position in such investments increased from $400 million in mid-September 2010 to $8.3 billion at the end of August 2011, according to the report.
The trades, which required a margin payment, “jeopardized the company’s available liquidity and left the company highly leveraged,” Freeh said in the report.
In the summer of 2011, former Chief Risk Officer Michael Stockman recommended that MF Global stop investing in the European debt and start hedging its exposure, according to the report. Management ignored the advice and searched for additional sources of liquidity to support the trading strategy, even debating how aggressively brokers could borrow on an intraday basis customer funds that were required to be kept in segregated accounts, Freeh said.
By the week leading up to its collapse, MF Global needed to rely on its Operations, Risk and Treasury Department systems, which were fatally flawed, Freeh found. The failure of Corzine and other members of his management team, including Abelow and Steenkamp, to address the deficiencies contributed to the company’s demise, Freeh found.
Freeh estimates the losses to MF Global and its finance subsidiary from $1.5 billion to $2.1 billion. Giddens, the brokerage trustee, estimated a shortfall of $1.6 billion in customer funds.
The SEC didn’t include the CFTC in several meetings in 2011 about the brokerage’s capital and business strategy that would have been helpful for oversight, according to the Republicans’ report. The CFTC didn’t inform the SEC that the broker was using an alternative method of calculating customer funds, the report showed.
Freeh’s report didn’t focus on the causes for the shortfall in customer funds because recovery of those funds is outside the scope of his authority, lawyers for the trustee said in the court filing.
The adversary case is 13-01333; U.S. Bankruptcy Court, Southern District of New York (Manhattan). The holding company’s Chapter 11 case is In re MF Global Holdings Ltd., 11-bk-15059, and the liquidation of the broker is In re MF Global Inc., 11- bk-02790, both in the same court.