The MF Global collapse into bankruptcy on Oct. 31, 2011 is a date that will live in infamy for many farmers who lost money when their cash went missing. The company, which couldn't find $1.6 billion in customer cash, had leaders who claimed they didn't know what happened. A new report from the trustee overseeing the liquidation of MF Global is based on an independent investigation into the failure of the broker-dealer with the U.S. Bankruptcy Court for the Southern District of New York Monday.
In that report, James Giddens, the trustee, pulls no punches and even intimated further potential legal action against some former MF Global managers, though his office can take no legal action. "As attempts were made to transform MF Global into a full-service global investment bank, management failed to add to its Treasury Department and technology infrastructure, which was needed to meet the demands on global money management and liquidity," says Giddens. "My investigation has concluded that management's actions, along with the lack of sufficient monitoring and systems, resulted in customer property being used during the liquidity crisis to fund the extraordinary liquidty drains elsewhere in the business, including margin calls on European sovereign debt positions."
He adds that in light of those claims "I have determined there may be valid claims against individuals and entities. In my capacity as Trustee, I will make every effort to ensure that such claims results in the greatest possible returns to customers in an efficient and fair manner, whether those claims are pursued by my office or others."
The Trustee's findings are based on more than 100 interviews, along with a review of hundreds of thousands of documents and an extensive forensic accounting review by Ernst & Young. The Trustee, however, doesn't have law enforcement or regulatory authority, and because of that the report draws no conclusions about possible criminal liability or whether sanctionable regulatory violations occurred. The statement says the Trustee has been cooperating with the various law enforcement and regulatory agencies investigating MF Global's collapse and "does not wish to impede those efforts."
The statement detailing the new report says the Trustee has concluded that valid claims may be asserted against certain individuals and entities. "He will use his efforts to pursue these claims, either through litigation or negotiation, or to support the pursuit of these claims by others to recover customer property in accordance with his goal to return as much customer property as possible." Here's a rundown of those potential claims, from the statement (presented here directly from the statement):
The Trustee is working diligently and expeditiously in the pursuit of potential claims:
- DIRECTORS & OFFICERS: The Trustee believes that claims, including claims for breach of fiduciary duty and negligence, may be asserted against former MF Global CEO Jon Corzine, former MF Global CFO Henri Steenkamp, and former MF Global Assistant Treasurer Edith O'Brien, among others. The Trustee is already consulting with commodities' customers' class action counsel about actions against officers and directors and other employees, and the Trustee has also communicated with relevant insurers.
- JPMORGAN CHASE: The Trustee is engaged in discussions with JPMorgan Chase (JPM) with respect to transfers that the Trustee believes may be voidable or otherwise recoverable. JPM has cooperated with the Trustee's investigation, and the Trustee has announced publicly that he is engaged in active discussions with JPM with respect to these matters. In the event these discussions do not result in an agreement, the Trustee, if appropriate, will commence litigation. To date, JPM has returned approximately $89.2 million in customer property and $518.4 million in non-segregated unallocated MF Global Inc. assets, subject to certain reservations of JPM's security interest in such funds. This sum includes $168.1 million in funds representing the proceeds of excess collateral that JPM held at the commencement of MF Global Inc.'s liquidation, which will be subject to an appropriate allocation.
- 30.7 FUNDS: Legal proceedings are underway in the U.K. to restore property that was or should have been segregated for customers trading on U.K. and other foreign exchanges. A procedural hearing, the first before the U.K. Court, was held this past Friday, in part setting the schedule for this litigation.
The report explains that the Trustee does not believe, based on his investigation and his counsel's analysis, that there are likely to be sound bases for pursuing claims against non-insider customers for return of accounts.
The Trustee, in his efforts to preserve his negotiating position, cannot comment on the details of the potential causes of action that may be available to him or to others to restore customer property.
MF Global Inc. Estate
The current gap between the value of allowable commodities claims and the assets that are under the Trustee's control continues to be approximately $1.6 billion, consisting of an approximate $900 million deficiency in domestic accounts (both commodities and securities) and an approximate $700 million deficiency related to trades by customers on foreign exchanges (30.7 funds).
The Trustee's goal remains a 100 percent return of property to all public commodities and securities customers. The Trustee has determined that the elimination of the shortfall and the possibility of a 100 percent return of property to all public commodities customers will require a combination of three material developments: first, successful recovery of funds in the U.K. proceedings; second, recoveries, if available, through litigation and negotiation with third parties; and third, allocation of non-segregated property to the pools of customer property pursuant to the Securities Investor Protection Act and the Commodities Exchange Act, and the regulations thereunder.
At this time, the Trustee continues to expect that the prospects for substantial dividends to general unsecured creditors are low.
Detailed accounting of MF Global's demise
The Trustee's report provides extensive details about the factors that led to MF Global Inc.'s demise, the nature of the liquidity crisis and flow of funds and transactions in the last week of MF Global Inc.'s existence, and the circumstances surrounding the invasion of customer property.
The investigation shows that MF Global's business dramatically changed after Jon Corzine took over as CEO and Chairman of the Board of MF Global Holdings in March 2010. The company moved from being a modest customer and proprietary security business into a full-service global investment bank, with new lines of business that increased demands for daily liquidity. Despite the increased demands on global money management and liquidity, the firm's Treasury Department did not expand or modernize and the firm never implemented systems or tools for accurate real-time monitoring of liquidity. The firm often tracked liquidity and ability to transfer funds by informal means that were derived from several different reports, both computerized and oral.
Under the personal direction of Corzine, MF Global began trading European sovereign debt securities. Those investments peaked at nearly $7 billion in October 2011, and the exposure was more than four-and-a-half times the firm's total equity – a level of risk that was orders of magnitude greater than the relative exposure at other, larger institutions.
The Trustee's investigation shows that a risk analysis conducted by MF Global in September and October 2011 examined the likely sources of losses and demands for funding if the company suffered a significant financial disaster, including a downgrade, but seriously underestimated both the speed and extent of demands on liquidity. The total underestimating was between $600 million and $1 billion, which was the approximate amount of customer funds released from segregation and not returned during the final days of the firm's operation.
The investigation found that a customer "run on the bank" and unwinds of repo counterparty and proprietary positions, all within a three-day time period, overwhelmed MF Global, which one former MF Global executive called the "liquidity asphyxiation" of the company.
During the last week of MF Global's existence, as intraday transfers significantly increased, there was a panic regarding segregation compliance within MF Global's Treasury Department. If customer funds had been properly protected, those funds should have been largely, if not completely, unaffected by the liquidity crisis. Instead, those funds were used to fund MF Global's liquidity needs in at least the latter part of the week of October 24th, ultimately resulting in the firm reporting that there was an approximately $952 million shortfall in segregated funds.
The report also includes a discussion of the Trustee's recommendations for legislative, regulatory or other reforms that might help avert similar liquidations in the future, or at least alleviate their consequences:
- Abolish the alternative calculation method and implement a requirement to segregate an amount in excess of 100% of customer funds.
- Eliminate the segregated versus secured distinction in Commodity Futures Trading Commission (CFTC) Regulation 30.7, ensure consistency of customer protection when trading overseas, and monitor compliance abroad closely.
- Create a protection fund for futures and commodities customers under a certain threshold, and implement suitability standards for customers of Futures Commission Merchants (FCMs).
- Provide for civil liability for officers and directors in the event of a commodities segregation shortfall.
- Consider simplifying some CFTC rules for bulk transfers and claims in an FCM liquidation proceeding.
- Enact legislation explicitly authorizing Trustee standing on behalf of customers.
Interim report and fees
The Trustee today also filed with the Bankruptcy Court an interim report on claims processing and fee applications for his legal counsel.
The Trustee has now determined virtually all commodity claims and will, to the extent possible, shortly commence making interim distributions authorized by the Bankruptcy Court to both 4d commodity customers and 30.7 commodity customers. Most retail claimants have agreed to the determinations made by the Trustee. The primary objections are for claims filed by administrators or trustees for MF Global entities, including MF Global UK Ltd. and MF Global Holdings Ltd., which represents primarily banks and bond holder creditors, the largest of which is JPMorgan Chase. These objections will be heard by the Bankruptcy Court, and the Trustee must continue to hold sufficient reserves until these objections are resolved. The Trustee is working expeditiously to resolve objections and will seek to make interim distributions while maintaining a sufficient reserve.
The Trustee also filed a motion with the Court for approval of counsel's fees through February 2012, which total approximately $17 million.
The Trustee's investigative report and interim report are available on the Trustee's website at www.MFGlobalTrustee.com.