Actually the MF Global Inc. trustee’s report released earlier this month pinpointed where much of the money was stuck and the main question that needed to be asked is why is everyone still quoting the $1.2 billion figure when it simply doesn’t add up. I guess a simple math question is not as sexy as citing unnamed sources.

Perhaps the anomaly is a tale of two trustees’: one whose mission is to get customer money back, the other to preserve capital in the parent company so that creditors can claim it. So it would not be a wild stretch of the imagination to suspect that the insider suggesting fund’s vaporized came from the MF Global Holdings Ltd. side, suggesting the money is gone and the MF Global Inc. trustee can go home and customers should accept the 72¢ on the dollar they received — if they were not unfortunate enough to have money in accounts overseas or held precious metal certificates confiscated by the trustee—and go home. And that the source from the investigation saying they know where the money went is from the side looking for the money, with the goal—if not the will—to get it back. They are the ones who need to grow a backbone and go after the money at MF Global Holdings, MF Global UK and JP Morgan.

Legal entities aside, this was one company with one Chairman and CEO and the fact that it was split up for bankruptcy purposes the way it was seems a miscarriage of justice and done for no other purpose but to allow certain creditors to move in front of others. At least one court filing noted that there isn’t much use in customer priority rules if it can be rendered moot by moving funds from one legal entity to another of the same organiztion.

The Sapere motion offered a simply solution. Basically it would treat MF Global et al as one entity and apply the Commodity Exchange Act bankruptcy priority to it. It is what should have happened from the beginning but unfortunately Judge Martin Glenn ruled against Sapere earlier today. However, he did acknowledge in ruling against broad discovery that it was unneccesary because “the Justice Department, FBI, CFTC, SEC, SIPA Trustee, and Chapter 11 Trustee are all actively investigating the collapse of MFGI and MFGH.”

According to an FBI spokesman any FBI investigation is criminal, which raises the question, how does a government appointed trustee refuse to cooperate with a Federal criminal investigation? MF Global Holdings Trustee Louis Freeh (coincidently a former Director of the FBI) has withheld certain information requested by the CFTC in its investigation. We do not know if this same information was requested by the FBI but if it wasn’t that raises another question. For the judge to suggest Freeh is investigating is a bit of a stretch. The trustee for MFGH is clearly working for the interests of the Chapter 11 creditors and against the interests of customers as he even attempted to prevent the third bulk distribtuion of funds from the MFGI estate. Since we know funds were moved illegally out of segregation, any information as to where those funds went should be made public so the process of clawing those funds back can begin. Any attempt to withhold information should be viewed as obstruction of justice.

The tax is gaining plenty of support across Europe – with the United Kingdom being the most prominent holdout, which is ironic, because they have been doing something similar for decades.

But support isn’t coming only for the reason Sarkozy mentioned – namely, that the tax will help cut the deficit.  That may be the selling point for voters, and it may even be the reason he feels it will resonate with voters in other countries – especially those without major financial centers – but the reasons being kicked around the halls of the European Commission, the IMF  and Washington, DC, are a bit more nuanced.  The more common argument is that a transaction tax will be used not to reduce the deficit, but to both fund stronger regulation of the financial system, reduce speculation and to act as a sort of down-payment against the next big debacle.

Former JP Morgan Managing Director John Fullerton is one of a handful of finance professionals who have come out in favor of the tax, which he concedes may make the financial system less efficient, but which he says will make it more resilient.

“Efficiency is the ability of a system to grow and expand and process throughput,” he told us in an article to be published later this week. “While resiliency is the ability of a system to recover from a shock.”

It’s an argument he’s made before, and it’s one we will be exploring in an upcoming online Futures exclusive, tentatively slated for publication later this week, and tentatively titled “Is a financial transaction tax the market’s salvation?”

I’m a proud American but sometimes when watching Congress at work I wonder if our Founding Fathers were a bit daft. Case in point: The House Agriculture Committee hearings on the MF Global failure held Dec. 8. Between the redundant, silly, random and political ax grinding questions, it’s a wonder anything was learned. However:

• We did learn Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler was in Europe during these hearings, which made some Congressmen indignant.
• Jon Corzine admitted that he didn’t know where the missing money was, and that he was “stunned” when told on Sunday, Oct. 30, “that MF Global could not account for many hundreds of millions of dollars of client money.”
• We also learned from Corzine that the $191.6 million second quarter loss was largely made up of deferred losses that had to be recognized. Only $18 million of that was due to operating losses, none of which, said Corzine, was due to the repurchase transactions to maturity or RTMs, which was a main focus of the hearing by the Congressmen.
• MF Global had been a troubled company for years. In February 2008, in the so-called “Dooley Trading Incident,” the firm lost $141 million alone because of a rogue broker out of Memphis. That fiscal year it had a $71 million loss, followed by a $69 million loss in 2009, $168 million loss in 2010 and 2011 was looking more bleak. So despite the effort to make it look like it was only the sovereign debt trading that put the nail in MF’s coffin, it was many factors.
• CME Chairman Terry Duffy testified that on Thursday, Oct. 27, two CME auditors (CME was the designated self-regulatory organization for MF Global) made an unannounced visit to MF’s Chicago offices to review the daily segregation report, and they found “segregation was intact.” The auditors continued reconciling the books until Oct. 29, Friday evening — remember this day — when they left the office having found “only immaterial discrepancies.” That same day, the CME received a report from MF Global stating everything was in full compliance. During questioning, Duffy said that Chairman Gensler had called him on that Friday to see if the exchange was worried about MF Global’s capital. Duffy said he didn’t know and they would need to talk to the clearinghouse.
• CME auditors returned to MF Global offices on Sunday, Oct. 30 because “we learned from the CFTC that the draft segregation report for Friday, Oct. 28, which had been provided to the CFTC that day, showed a $900 million shortfall in segregation caused by an “accounting error.”
• At 2:00 a.m. on Monday, Oct. 31, MF Global told the CME and CFTC that customer money had been transferred out of seg fund accounts. As Duffy testified, “Transfers of customer funds for the benefit of the firm constitute serious violations of our rules and of the Commodity Exchange Act.” It appears on Friday, when CME auditors were at the firm and when Gensler was contacting Duffy, transfers had been made out of customer seg funds, but to where is still the question. Further, according to Corzine, he didn’t know about it until Sunday.

This story still is unfolding. Check out our coverage by Managing Editor Dan Collins (MF Global failure highlights cracks in the system and CTAs on the front lines of MF Global battle), as well as updates here on futuresmag.com.

The futures industry says the seg funds system works, but apparently not if money is missing and fraud occurs. Perhaps red flags need to be acted upon faster; and in MF Global’s case, there were plenty until it finally raised the white flag.

The good news is that the trustee located and began to bring in $1.3 billion in customer segregated funds. This may have prompted CME Group to increase the guarantee it made to the trustee to $550 million from $250 million. This is not an allocation but a “good faith” attempt by CME Group to expedite allocation of customer funds by the trustee. This followed the shocking news that nearly three weeks after the bankruptcy filing the trustee stated that the shortfall in customer funds could be twice as much as previously believed. 

Adding to the growing confusion was the trustee’s insistence that the additional $1.3 billion in customers segregated funds did not change their opinion that the shortfall was larger, $1.2. billion or more, than what had been reported basically from when it was first discovered. 

The trustee did not explain how this could be even though a trustee spokesman acknowledged that the total of customer funds secured — funds that have been allocated back to customers and funds being held to eventually be allocated in an expedited claims process — was now north of $5 billion. CME Group disputed that the shortfall was much larger.

The apparent anomaly is in what MF Global should have had segregated at the time of the bankruptcy. CME Group estimates this number to be just short of $5.5 billion, the trustee does not acknowledge what this number should be, though they acknowledge that they have secured more than $5 billion so the only conflict appears to be what that number should be.

We do know that many customers going into the bankruptcy were pulling funds away from MF Global and that MF Global had, in the weeks prior to the bankruptcy, altered its approach to moving customer funds. We have heard from several sources that the broker stopped executing wire transfers and instead began cutting checks to move customer funds. Some of those checks bounced. If the difference in what should have already been moved out and what actually had been moved out is the cause for this discrepancy, the process could become even sloppier.

We do not understand how there can be confusion over this point at this stage of the game. We have heard plenty of anecdotal first person evidence that the trustee does not have a good grasp on futures operations and has not shown the appropriate sense of urgency in getting customer property back to them.

At the heart of this anomaly seems to be confusion over what customer segregated funds are or are supposed to be vs. typical claims in a bankruptcy. This may be because this is not the trustee’s area of expertise, which has been our first question in the whole process.

By some strange anomaly in the law regarding dually registered entities, a securities regulator was put in charge of what is predominantly a futures commission merchant liquidation. This made little sense and the entity we would expect to make this clear to the judge appointing a trustee, the Commodity Futures Trading Commission (CFTC), has been much less active than one would expect in this situation.

 The futures industry has grown exponentially in recent years not only because of its value in managing risk, but  in its structure that promises that customer funds are secure, even in case where a clearing broker fails. That principle is at stake. Great damage has already been done. In our December issue, that went to press just a week after the bankruptcy, we noted that a rather large story — the failure of MF Global, the eight largest bankruptcy ever — had become a sidebar in a larger story of why the customer protections we assumed would work in such cases, was not working. 

We already are seeing regulatory fixes, such as securities style insurance programs, being recommended for the futures industry. This seems extremely odd seeing that we still don’t know what happened in this case. The one focus should have been getting account holders their money back.

They are still waiting.

It is unlikely that the Commodity Futures Trading Commission would ever entertain such an idea for the existing futures clearinghouses but the concept might be applied to new ones set up to handle off-exchange swaps (Dodd-Frank allows private swapping more than you may have been led to believe).

Using the catchy phrase “ring-fencing,” advocates infer that they might not clear their private swaps at all if their funds might be at risk in the event of some stranger’s default.

Existing clearinghouses weathered the financial crisis (2008 – ?) without any federal bail-out. Risk mutualization is why.

Should this idea gain traction I have two suggestions. First, don’t let them be called “clearinghouses.” That would be like permitting MacDonalds outlets to call themselves “hospitals.” Second, adopt a more accurate name. The term “Titanic” comes to mind.

I can have a quiet visit with the boss and probably walk away – for my silence – with a promotion, a raise and/or a bonus, all the time showing my loyalty to the firm.

Or I could go first to the CFTC with the skinny, wait months while it investigates (all the time, insiders looking for the snitch) and hope that the CFTC wins a case or settlement in excess of $1 million (the minimum for bounties of any kind).

Chances are that I will choose the first option. Clean, quick and career-building.

Might the CFTC simply be adding leverage for me in negotiating with the boss? Funny thing — we will never know.

 Imagine that we were mandated to follow a particular religion but not until the word “god” is defined.

 The CFTC, of course, is right. Everything hinges on that decision. Dodd-Frank itself torpedoed the CFTC’s long-standing program for commodity options by flipping them into its “swap” definition and requiring that new rules be written. If instruments allowing physical delivery (in lieu of cash) are allowed by the CFTC to be classified as “swaps,” the distinction from futures could be swept away as well.

 Then, what? A lot of swaps will be exempt from the central trading/clearing requirement. Not so for futures. Collateral standards will be far more self-set by the parties for exempt swaps but not for futures.

New clearing systems created to handle these exempt swaps may not impose mutualized risk among participants, leaving every man for himself. Futures clearers will remain collectively responsible if a default occurs (a system that required -$0- TARP funds).

Keep an eye on this. There are massive incentives in D-F to choose the swap regime and, if the CFTC allows futures look-alikes to be classified as “swaps,” its rules and regulations will become historical footnotes. We may end up with what might be better named The OTC Derivatives Preservation Act of 2010.

It was circa 1987 and we were in Switzerland on a boat from Lucerne to Bürgenstock for the annual Swiss Commodities and Futures Association meeting. She said she wanted to show me something and unzipped her suitcase to pull out a picture of two dogs. The picture was in the actual frame — not just a wrinkled polaroid. “I always travel with a picture of them,” she said. As a dog person, I thought it was endearing. As a journalist, that memory always reminds me that regulators are human and have softer sides that typically we — or those they regulate — don’t see. The “she” was Mary Schapiro, now chairman of the Securities and Exchange Commission (SEC). At the time she was general counsel of the Futures Industry Association (FIA). We both were a lot younger then, but having watched Mary of the FIA move to the SEC to the Commodity Futures Trading Commission (CFTC) to the Financial Industry Regulatory Authority (Finra) to now Chairman Schapiro at the SEC gives me a certain sense of pride of knowing her when. No doubt becoming the first female chair of the SEC was a more difficult road than the one we took to Bürgenstock.

As entrenched as the derivatives industry is with the CFTC — the regulator of the futures industry — the SEC is as important, and now becoming more so with the blurring of the business. Truth be told, the SEC is as much a regulator as the CFTC is in the derivatives industry — and the main enforcer for securities traders, investment advisors and hedge funds. With the one-year anniversary of the Dodd-Frank Act, we thought getting perspective from not only the chairman of the SEC but someone who knows intimately all parts of financial regulation would provide insight to what traders can expect going forward. We weren’t disappointed (see Mary Schapiro: In the eye of the storm by Managing Editor Dan Collins).

Schapiro took over the SEC in early 2009 during one of its most stormy periods. The agency was under siege. The financial crisis was roiling Wall and Main streets and Bernie Madoff was fessing up: Yes he was a crook and by the way, why hadn’t the SEC caught me sooner? In addition, Congress was hashing out the Dodd-Frank bill, which meant once passed, rules righting the excesses of Wall Street and beyond had to be written and vetted. Staff was short. Systems were out of whack. And traders had attached thrusters to their electronic programs.

Then on May 6, 2010 the market dropped 1,000 points in a, well, flash, losing billions of dollars for market players. Although the market closed only 350 points down, the Street was shaken. It wasn’t an economic report or announcement that was the cause but something out of a Terminator movie: Computers had taken on a life of their own and were torpedoing the market. High-frequency traders — whether guilty or not — found the limelight that day and haven’t lost it since. Today they make up at least 60% of the volume in the securities world.

This is the environment Schapiro mostly inherited but in which she seems to be thriving. Perhaps it was her experience at so many key agencies that made her the best choice for the job. Just as Gary Gensler brings his Goldman Sachs’ trader knowledge to the CFTC, Schapiro has brought intrinsic legal and regulatory smarts garnered from her Washington experience.

When asked what accomplishments she would highlight during her tenure thus far, Schapiro noted reforming how the SEC operates, putting measures in place to prevent another flash crash and Bernie Madoff, and writing the rules for the Dodd-Frank Act, not an easy task in the year since it was passed, all on the same budget as prior to the bill. Sometimes it takes a Washington insider to tame Washington outsiders. In this case, my money is on Schapiro.

Reg. 180.1 seems to absorb the Securities & Exchange Commission’s policy that reckless behavior is proof enough if deceptive measures are employed, even if the accused did not seek to affect market prices.

Reg. 180.2 seems to continue to use the CFTC’s traditional test that, when brute force alone is used (without any flim-flam) it must be shown that the accused had the deliberate objective (“specific intent”) to affect market prices – up, down or sideways.

While this approach appears to distinguish between schemes based on fraud (Reg. 180.1) and those where the 800-pound gorilla simply invades the chicken coop (Reg. 180.2), it will be to the considerable advantage of enforcement agencies and private plaintiffs to dig for anything that might be fraud in the latter situation because only reckless conduct would then be needed to find guilt.

In the future, counsel will need to comb through towering amounts of client records to guess whether Reg. 180.1 or Reg. 180.2 might be charged. And, of course, advising a client in advance of trading would be nearly impossible. Do it but leave no incriminating fingerprints? Do it but only a little? Don’t do it?

Speculators are a wonderous gift to any risk management system, including the CFTC’s markets. They take their lumps when the hedger wins, or they can score big if the hedger’s worries prove to be unwarranted. This is privately-funded insurance at its very best.

How will counsel recommend action (or not) in this environment? I fear that the larger speculators, faced with wobbly legal advice, will simply indulge their love of fine art or fancy cars instead. If hedgers suffer, it would be a tragedy.