MF Global Holdings Ltd.’s bankruptcy, the eighth-largest in U.S. history, is exposing a lack of internal controls that may have prevented a last-minute rescue of Jon Corzine’s futures broker.
The day it filed for Chapter 11 protection, New York-based MF Global disclosed a shortfall in customer accounts that people with knowledge of the matter said may be about $700 million. CME Group Inc., which has the authority to audit those accounts, said yesterday it didn’t know how much client money was missing.
Corzine, 64, steered MF Global into bankruptcy proceedings on Oct. 31 after increasing risk-taking at the firm, including investments in European sovereign debt that roiled markets. Discrepancies over the missing funds that were used to back futures trades sent Interactive Brokers Group Inc. fleeing from a potential acquisition that may have averted the filing, according to a board member at the Greenwich, Connecticut, firm.
“The board certainly considered that purchase and stepped away from it at a point where it became clear there were lots of uncertainties about the accounts and segregated funds,” Hans Stoll, an Interactive Brokers director and a professor of finance at Vanderbilt University in Nashville, Tennessee, said yesterday in a telephone interview.
MF Global violated requirements that it keep clients’ collateral separate from its own accounts, Craig Donohue, CME Group’s chief executive officer, said yesterday on a conference call with analysts.
“While we are unable to determine the precise scope of the firm’s violation at this time, we are investigating the circumstances of the firm’s failure,” said Donohue, who heads the world’s largest futures exchange.
Last week’s disclosure of the extent of Corzine’s $6.3 billion of bets on debt from Italy, Spain, Belgium, Portugal and Ireland eroded investor confidence in MF Global. The firm drained almost all of its $1.2 billion in credit lines as it reported a record quarterly loss of $191.6 million. Its shares plummeted 67 percent and bonds began to trade at distressed levels.
The broker’s downgrade to below investment grade sparked an increase in the margin needed to back transactions, squeezing its available cash, MF Global President Bradley Abelow said in an affidavit filed with the bankruptcy court.
MF Global told regulators about shortfalls in accounts that it managed for clients in the futures market, the Commodity Futures Trading Commission and Securities and Exchange Commission said.
MF Global has accounted for all the client funds, Kenneth Ziman, a lawyer for the company, said yesterday at a bankruptcy court hearing in Manhattan.
“To the best knowledge of management, there is no shortfall,” Ziman told U.S. Bankruptcy judge Martin Glenn, who inquired whether the deficit cited in media reports would affect the case.
The Securities Investor Protection Corp., the government-created entity which is overseeing the liquidation of the brokerage, hasn’t verified whether the assets are accounted for, said Stephen Harbeck, president and CEO.
“I certainly hope it’s true, but it’s far too early for me to know one way or the other,” Harbeck said.
MF Global was ordered by the CFTC’s enforcement division to preserve records for the review, according to a person with knowledge of the matter. The shortfall may be about $700 million, two other people with knowledge of the matter said yesterday.
MF Global’s board met through the weekend to consider options including a sale, a person with direct knowledge of the situation said. The firm was in discussions with five potential buyers for all or parts of the company, including banks, private-equity firms and brokers.
Thomas Peterffy, Interactive Brokers’ CEO, declined to comment.
MF Global declined $2.48 last week to $1.20. Shares fell to 23 cents as of 2:34 p.m. in New York as trading resumed today.
Jim Mindling, a former seat-owner on the New York Mercantile Exchange and an MF Global customer, has been unable to get his money from the firm, which told him Oct. 31 that his account was frozen and that it didn’t know when the funds would be freed up.
“There’s nothing that stops the brokerage firm from invading those funds and comingling them” with its own money, he said. “It’s an honor system, so it’s just a house of cards.”
Mindling has less than $100,000 with MF Global, which backed his trades in energy, metals, currencies and equity index futures transactions, he said.
‘Funds At Risk’
“Segregated accounts don’t necessarily imply safety, there’s no control,” he said. “It’s really under the direction of the brokerage firm, so if they’re not acting properly or are dishonest, your funds are at risk. That’s my conclusion.”
After Corzine, the co-head of Goldman Sachs Group Inc. from 1994 to 1999, joined MF Global in March 2010 as chairman and CEO, he sought to transform the broker into a mid-sized investment bank modeled after his former firm. As part of his strategy, the former New Jersey governor expanded the firm’s role in the over-the-counter swaps market and hired traders in mortgage debt.
MF Global was among at least 19 smaller broker-dealers and financial firms that pressed regulators to force swaps clearinghouses to lower entry barriers to improve competition in the $601 trillion privately negotiated derivatives market.
‘Getting My Money’
The firm has faced scrutiny over its controls before. In January, MF Global reached a preliminary agreement to settle a shareholder lawsuit filed over a $141.5 million wheat loss in 2008. It paid $10 million to resolve a CFTC probe concerning failures of supervision, without admitting or denying the allegations.
Customers have been calling the Washington offices of the SIPC asking for their money, a lawyer for the corporation said.
“What customers ask is, ‘When am I getting my money?’” said Kevin Bell, senior associate general counsel of the government-created entity. “You tell them to sit tight, and start gathering their information so they can file claims. Canceled checks, trade confirmations, account statements.”
After the concerns raised with how MF Global failed to protect its customer funds, CME Group should step in to make changes to the customer segregation system, Mindling said. Third-party custodians should be required to hold all customer money, he said.
CME “will put enough pressure on all the parties to bring about a change in regulation because it’s crucial to their business model that people have confidence in them,” he said. “This doesn’t inspire confidence.”