Freeh Says Corzine’s Risky Strategy Helped Fell MF Global

Former MF Global Holdings Ltd. Chairman and Chief Executive Officer Jon S. Corzine helped accelerate the futures brokerage’s demise with risky business strategies and mismanagement, according to a report by bankruptcy trustee Louis Freeh.

The 124-page report blames Corzine and his management team for bungling an expansion of the company’s traditional business model while ignoring deficiencies in its risk controls. Corzine’s “aggressive trading strategy” that invested heavily in European sovereign debt produced no significant revenue, and he and Chief Financial Officer Henri Steenkamp knew that the company’s controls were flawed as early as May 2010, according to the filing yesterday in U.S. Bankruptcy Court in Manhattan.

“The trustee’s report, with its allegations of negligent conduct, is a clear case of Monday morning quarterbacking,” Steven Goldberg, a spokesman for Corzine, said in an e-mailed statement. “It intentionally ignores the failure of counterparties to fulfill their commercially contracted obligations to MF Global and the profound impact this failure had on MF Global’s customers and other stakeholders.”

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, once run by former Democratic New Jersey Governor and Goldman Sachs Group Inc. Co-Chairman Corzine, listed assets of $41 billion and debts of $39.7 billion.

House Report

“I don’t see any criminal allegations in here,” Stuart Slotnick, a lawyer with Buchanan Ingersoll & Rooney PC’s New York office, said of Freeh’s report. Corzine and other MF Global officials probably won’t face criminal charges at this point, as no evidence has arisen of fraud, purposeful misstatements, lying or intentional hiding of assets, he said.

Randall Samborn, a spokesman for acting Chicago U.S. Attorney Gary Shapiro, yesterday declined to comment when asked if any probe of Corzine or the firm is under way there.

Freeh’s findings come 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 Commodity Futures Trading Commission and 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.

Giddens Claims

Giddens, who has conducted his own probe into how the company failed, said in a report last year that he determined claims for breach of fiduciary duty and negligence against Corzine, Steenkamp and other officials.

Freeh’s report paints 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.

Freeh has no basis to suggest Corzine breached his fiduciary duties or was negligent, Goldberg said.

“When Mr. Corzine joined MF Global, the firm had lost money in each of the previous three years and in five consecutive quarters,” Goldberg said. “During his entire tenure as CEO, Mr. Corzine worked tirelessly and in good faith to turn the business around.”

Sovereign Debt

When Corzine joined MF Global in March 2010, the company was already struggling. Corzine moved to diversify the company away from traditional investment of client funds and make it a broker dealer and full-scale investment bank. By September 2010, he had begun asking the board to increase the company’s risk limits to invest in more European sovereign debt issued by countries such as Italy, Portugal, Spain and Ireland, according to Freeh’s report.

Corzine had unlimited power in his role at MF Global, holding positions that were previously filled by two different individuals, according to the report. Corzine hired Chief Operating Officer Bradley 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.

Driving Force

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.

MG Global’s board approved Corzine’s strategic plan, Goldberg countered. Outside auditors and consultants also reviewed the company’s internal processes and controls as part of the new strategy, he said.

Freeh called management’s behavior “negligent conduct” and said the lack of risk controls both made it impossible for managers to get a real-time snapshot of the company’s liquidity and prevented them from knowing in the final week of MF Global’s existence that customer funds were being used to satisfy the broker-dealer’s liquidity needs and an obligation to its U.K. unit.

Accounting Method

The problem was 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.

Fatally Flawed

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.

“In the end, the scale of the company’s trading put pressure on the company’s deficient controls without producing any significantly improved revenues,” Freeh said in the report.

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.

Fund Shortfall

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.

MF Global Holdings is scheduled to seek court approval of its final plan to liquidate tomorrow, which will pave the way for the eighth-largest bankruptcy in U.S. history to wind down under court protection. The plan is supported by Freeh and will repay creditors through income from potential lawsuits.

The holding company’s Chapter 11 case is In re MF Global Holdings Ltd., 11-bk-15059, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The liquidation of the broker is In re MF Global Inc., 11-bk-02790, in the same court.