One Year Later – Lessons from MF Global


by Katie Micik, DTN Markets Editor


OMAHA (DTN) — Even as rumors swirled about MF Global's liquidity crisis late last October, John Fletcher made the margin calls on Thursday and Friday that were necessary to keep his elevator's hedge in place. He went home Friday afternoon, unworried.


He sat in bed the next Monday morning checking emails, with Don Imus's talk show on in the background, when he heard the news: At least $600 million of segregated customer funds had vanished from MF Global's accounts. The futures commission merchant (FCM) was going bankrupt.


“I was more incredulous than anything else,” the general manager of Central Missouri AgriService recalled nearly a year after MF Global filed bankruptcy on Oct. 31, 2011. He remembers that his wife asked him what was wrong. “I said, well, you wouldn't understand, but my long-held belief about how things work has just been crushed.”


To Fletcher's amazement — and that of hundreds of elevator managers, farmers, brokers and regulators — the nation's eighth-largest bankruptcy exposed a gaping hole in a foundational principal of the futures market. Funds held by brokers and FCMs as collateral to secure market positions were supposed to be untouchable, sacrosanct, never mingled with the firm's own money.


And yet $1.2 billion disappeared, twice the initial estimate. Regulators in the office just days before the collapse hadn't noticed anything strange, and concern about the effectiveness of the market's self-regulatory structure began to grow.


For most, MF Global's fall was a fast education on how FCMs actually function, instead of how people believed they functioned.


“I've been in the business for 30-some-odd years, and it never entered my mind that segregated funds were anything other than segregated funds,” Fletcher said. If he had thought there was an issue, he wouldn't have kept making margin calls. “Maybe I couldn't have gotten anything back, but I sure as the dickens wouldn't have put more in.”


The MF Global debacle touched off a complex discussion within the futures and brokerage industries about different segregation models that would better protect customer funds. MF Global customers learned that unlike equities markets, there's no insurance backing up commodities accounts if their FCM fails.


MF Global's unprecedented collapse exposed structural flaws in how the market worked. It generated a massive, confusing bankruptcy case that will take years to sort through. And it erased futures users' trust that the market will work the way it's supposed to, shaking the confidence that's crucial to a properly functioning market.


In this series, DTN will look at the current state of MF Global's affairs, but more importantly, it will focus on what's next for the grain industry. CFTC's recently proposed regulatory reforms will provide better tools — it's a step in the right direction, industry users say — but the real fixes need to be made in the bankruptcy code and segregation models. Those fixes will play a crucial role in restoring customers' confidence in the market.




Jon Corzine, former New Jersey senator and Goldman Sachs alum, took over MF Global in March 2010, hoping to transform it into a Wall Street powerhouse. He took steps to earn the right to lend to the federal government and to aggressively grow MF Global's market share.


As part of that vision, MF Global took an $11.5 billion position on sovereign European debt. When forced to disclose the size of their position, investors panicked. Regulators told them they needed more capital. MF Global pushed back, but the regulators eventually won.


MF Global's bond rating was downgraded just a day before the firm announced a $186.6 million second-quarter loss. MF Global started shopping for someone to buy its brokerage unit to stop the hemorrhaging. Meanwhile, MF Global's account with JP Morgan's branch in London was over-drafted by $135 million and the company scrambled to find money to pay the bank back.


Then a potential buyer started to dig though MF Global's accounting, unearthing the shortage in segregated customer funds that MF Global told regulators was just an accounting error a day prior. The deal was off, and MF Global filed for a Chapter 11 bankruptcy on Oct. 31 amid scandal.




MF Global's roughly 30,000 futures users weren't allowed to touch their accounts for several days. Fletcher's account was valued at $1.2 million on Halloween of 2011, the day MF Global filed for bankruptcy. His account was transferred to a new FCM the following Wednesday, but at that day's market prices, not the price the day MF Global filed. While the account remained frozen, its market value increased and Fletcher soon had $1.5 million tangled up.


“Of everything that's happened in this whole deal, the thing that irritates me more than anything else is the way CME handled the transfer of accounts,” he said. Now he had more exposure, “and some counterparty someplace had less. So you've got one group of traders whose exposure to MF Global is greater and another group of traders whose exposure to MF Global is smaller.”


Once CME transferred the accounts, customers like Fletcher began to grow leery about when they'd see their money again. A trustee versed in securities law was appointed to oversee the liquidation. Trustee James Giddens found himself in uncharted legal territory in between bankruptcy law, securities law and commodities law, and had indicated that a claims process would precede any distributions, which likely wouldn't be made until June 2012.


An eight-month delay was simply too long for the industry to wait. The Commodity Customer Coalition, a non-profit organization that formed to represent the interest of futures customers, began calling legislators and pressing the trustee for an earlier release, according to the organization's co-founder, John Roe.


The CME Group, which was MF Global's primary regulator, also knew that long of a delay would be a devastating drain on the grain industry's capital. CME Group announced they'd provide Giddens with a $300 million guarantee to help facilitate the release of customer segregated funds. They upped that guarantee to $550 million 11 days later.


Bryan Durkin, CME Group's chief operating officer, told DTN in a phone interview that CME felt it had a responsibility to its customers to help expedite the release of collateral, “and get people such as our farmer and rancher customers up and operating as soon as possible. I strongly believe that would never have happened as quickly as it did had we not taken those unprecedented actions,” of proving the guarantee to the trustee.


Giddens made three bulk transfers before the end of January, bringing customer accounts to 72{8a1275384cb93b18aa3d41af404144e37302a793dec468d70d54c97b65cfac05} of their pre-MF Global value. Another distribution in June brought customers up to 80{8a1275384cb93b18aa3d41af404144e37302a793dec468d70d54c97b65cfac05}.


Roe, the co-founder of the Commodities Customer Coalition, said the trustee needs to keep a reserve against other kinds of claims in the bankruptcy case, but many of those claims are close to resolution, which should free up some funds for another distribution to customers.


He anticipates the trustee will make another transfer in the next three to five months that should bring customer balances up to 90{8a1275384cb93b18aa3d41af404144e37302a793dec468d70d54c97b65cfac05} of what they were before MF Global fell. The average Securities Investor Protection Act (SIPA) liquidation takes three years to resolve, and “that last 10{8a1275384cb93b18aa3d41af404144e37302a793dec468d70d54c97b65cfac05} will be the tough one, the one that takes two years to get,” Roe said.


Kent Jarrell, spokesman for the SIPA trustee, told DTN that “it is our intent to have an eventual distribution but have no immediate plans to do so.” He also noted that so far, $4.7 billion have been returned to former MF Global commodities customers.




The legal woes don't end with MF Global's bankruptcy. Last February, a group of Montana farmers filed a civil lawsuit alleging that three top MF Global managers, including Corzine, misled customers about the safety of segregated funds and committed fraudulent transfers of customer money. It also alleged that JP Morgan Chase, M.F. Global's primary bank, and PricewaterhouseCoopers, its auditor, aided and abetted in the fraud.


That case has been combined with dozens of similar ones from former MF Global clients. A federal court recently approved a cooperation agreement between the plaintiffs and Giddens, which “supports the trustee's goal to return as much customer property as possible as quickly as possible, while also minimizing duplication of efforts and expense.” The case is still in early stages but will move forward closely with the bankruptcy case.


While civil cases are pending, no criminal charges have been filed despite Congressional hearings that aimed to shake Corzine or MF Global Treasurer Edith O'Brien into admitting fault. Corzine answered Congress' questions when he testified, while O'Brien cited her Fifth Amendment rights against self incrimination. She has said she will cooperate with investigators on the condition that's she's given full immunity from criminal prosecution.


Violations of the Commodity Exchange Act are felonies, and the trustee reported in a lengthy report this summer that several crimes occurred at MF Global.


Roe said he knows the federal criminal prosecution takes time, but is frustrated that more than $1.2 billion “was taken out of people's accounts and used for other purposes. There's no telling how much money that's cost people in liquidations and market risk and everything else. If somebody doesn't take a shot at somebody in court here, there's no deterrent to anyone doing this again. That's the real injustice here.”




© Copyright 2012 DTN/The Progressive Farmer, A Telvent Brand. All rights reserved.

Posted with DTN Permission by Haylie Shipp



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