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.

Case in point is a Wall Street Journal article from Jan. 30 that ominously states in its headline: “Money from MF Global Feared Gone.”  Worse yet the story states that the money “could have vaporized.”

I am not sure if that is a legal term but my American Heritage College Dictionary defines vaporized as “to be converted into vapor;” vapor is defined “barely visible or cloudy diffused matter, such as mist or smoke.”

But the MF Global customer money is not mist or smoke. It is money that by law should have been segregated away from the firm’s money in accounts clearly labeled as such.  There are lots of things you can do with money: you can steal it, you can spend it, you can transfer it, you can lose it and you can give it away but it does not simply disappear.

It seems odd that the Wall Street Journal would protect a source that provides an answer appropriate to a five-year-old with his hand caught in the cookie jar.

Stanley Haar, a money manager and former MF Global customer who is a part of the Commodity Customer Coalition took great exception to the WSJ story in a letter to the WSJ that he also posted on an MF Global customer forum. Haar wrote, “Client money in segregated bank accounts was not “vaporized”; it was stolen via illegal transfers to support MF’s proprietary trading positions and to repay creditors such as JP Morgan. Those transfers are and always were illegal.”

That is the crux of the matter and what is so frustrating to customers. Regulators and the MF Global Inc. trustee have been treating this as a mystery instead of a crime, which is what it is. And we know, if not the guilty party then certainly the responsible party. There was an acknowledgement by MF Global Holdings that money was transferred out of segregation into the broker/dealer. That money needed to be returned on day 1.

There is a long held procedure when dealing with trade execution errors in the futures world. It is that you correct the problem first and determine fault later. The error (crime) was that money was transferred out of segregation. That money should have been returned from the parent company, which is the responsible party.  After that you listen to the tapes or do your forensic accounting. Perhaps if the liquidation where in the hands of people experienced in futures execution and back office procedures this would have occurred but it was instead put in the hands of the Securities Investor Protection Corporation (SIPC) under the Securities Investor Protection Act (SIPA).

A point highlighted by Haar in his letter. “Under a properly executed FCM bankruptcy process, customer segregated funds always have absolute priority over all other creditors. Instead, MFGI was placed under a SIPA liquidation, even though 98% of the accounts were commodity accounts not covered by SIPC protection. … the assets under the control of MFGH were not frozen and that entity was allowed to continue operating under Chapter 11 bankruptcy rules. This allowed unknown billions in assets to be dumped into the hands of George Soros, JP Morgan and various hedge funds at bargain prices.”

Haar adds that customer money was stolen twice, first by MF moving customer money out of segregation and later by “the fraudulent way in which the bankruptcy was structured.”

The SIPC web site has a “who we are” page. Nowhere does it say anything about futures. It says, “SIPC provides that customers of a failed brokerage firm receive all non-negotiable securities that are already registered in their names … At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000.”

Who SIPC is has nothing to do with futures accounts that cannot access the SIPC reserve.

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?”

In a statement, Lisa Madigan, Illinois attorney general, said S&P compromised its independence by issuing the ratings as part of a strategy to boost market share and win more business from banks that created the securities instruments. “Privately, S&P abandoned its principles and instead used every trick possible to give deals high ratings in order to retain clients and generate revenue,” she said in a statement.

According to Madigan, much of the lawsuit focuses on S&P’s claims of independent ratings, which she says was not the case. Instead, she says S&P went out of its way to cater to investment banks and give artificial ratings just to win more of their business.

Considering that it has been four years since the financial meltdown, the number of Congressional hearings that have been devoted to uncovering what the rating agencies did leading up to the crisis and at least one new law (Dodd-Frank) has parts devoted to lessening the power wielded by ratings agencies, it’s hard to imagine what took so long for these lawsuits.

What’s your opinion? Do credit rating agencies still have too much power? Do they still serve a useful purpose?

And it only took them just under 12 weeks to put that out. It came out the same day that CME Group, the National Futures Association and other self-regulatory organizations (SROs)  announced the forming of a committee to review how (SROs) can strengthen current safeguards for customer segregated funds held at the firm level in light of the MF Global bankruptcy. Perhaps it was something in the air.

For the CFTC it may have been a challenge to its relevance in the face MF Global Holdings Ltd. trustee Louis Freeh refusing to release certain documents to the agency earlier this month.

Think about that for a second. We are in the midst of one of the greatest scandals in our industry and the regulatory agency charged with policing futures markets gets told by the firm responsible to go blow. Don’t understand why the CFTC didn’t simply march into the office weeks ago and demanded the documentation.

The crisis reminds me of what would happen in the trading pit when an explosive bit of news comes out — be it an unemployment report or Federal Reserve auction out of line with expectations or some other shock — causing the market to spike rapidly in one direction or the other.

Every participant is looking for someone to make a market for them to get out of a position that is rapidly going against them but there is no one making a market. All the locals have put their hands in their pockets. You can’t blame them. If the whole world is looking to sell, no local is willing to be road kill as the market is destined to move several handles in matter of mere seconds.

When it was learned that the sale of MF Global broke down due to a shortfall in their customers segregated funds all bets were off—it was as if nonfarm payrolls came out -200K when everyone was expecting it to be +200K. Everyone wanted to sell but all the locals (industry leaders in this case) were making themselves scarce. When the shortfall in customer funds was announced the CFTC, NFA, MFA (Managed Funds Association), FIA (Futures Industry Association) and even the CME Group appeared to have their hands in their pockets.

As market participants looked to industry leaders to, in essence, make a market, those institutions were slow to act. This is particularly true of the CFTC whose decision to put this in the hands of the Securities Investor Protection Corporation (SIPC) and not fight for jurisdiction has made the process more difficult.

Posted on the CFTC’s web site is the agency’s missing statement: “The CFTC’s mission is to protect market users and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives that are subject to the Commodity Exchange Act, and to foster open, competitive, and financially sound markets.”

The commission should think about how they are fulfilling that mission in this crisis.

According to Bloomberg, the decision came after a fourth quarter that some analysts predicted was the worst for investment banking and trading since the financial crisis in 2008. Last year companywide compensation and benefits rose 6% to $12.7 billion as revenue climbed 13%.

This is the latest news of how the financial crisis is beginning to catch up with Wall Street. Last year we heard announcements from UBS, Citigroup, Morgan Stanley and others that they are planning significant layoffs.

What’s your take on bonuses at investment banks? Will we see more caps in the future, or will investment banks have to become more stingy in other areas?

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.

Although the Trust was established in 1969 to provide financial assistance to customers if a brokerage became insolvent, because federal laws required customer funds to be segregated made the prospect that customers actually would need the money remote. As a result, the CME board voted to turn the Trust into a charitable foundation in 2005.

Some of the largest beneficiaries of the CME have been the Renaissance Schools Fund, which supports charter schools and has received $3.1 million since 2006; the University of Chicago, which has received $2.5 million since 2006, and the Erikson Institute, which specializes in early childhood education and has received $1.625 million.

As a result of the MF Global bankruptcy, CME has put all future grant applications on hold, but has said it will honor current grant obligations.

From our perspective and the perspective of our readers, the machinations of MF Global and its discredited leader Jon Corzine are less important than the ongoing effort to return customer money and addressing the structural breakdown in Futures regulation as it pertains to segregated funds.

But now we are hearing talk that certain off balance sheet account maneuvers may be the cause of the MF Global’s trouble — related to the firms over-leveraged bets not the seg fund shortfall that is the result of: a) illegally comingling customer funds, b) extremely poor accounting/record keeping processes or c) what is behind curtain number three.

Reuters reported Friday that the firm needed to be creative because other sources of income such as the float have dwindled. “MF Global earned $286.8 million in its last full fiscal year from interest income after expenses. Three years earlier, that figure was $502.1 million,” noted a Reuters story.

Maybe it would be a good time to tighten the rules on ways futures commission merchants (FCMs) can invest segregated customer funds to earn interest. These rule 1.25 investments may be involved in the so called customer shortfall.

At Futures we have been reporting for several years on the frustration the current low interest rate environment has been causing FCMs. Historically FCMs earned a large portion of their profits through interest income i.e. the float. That is hard to do in a zero interest rate environment. Perhaps MF Global was getting overly creative with these investments as well.

Most heads of FCMs we spoke to over the last few years have concluded that they no longer can count on the float as a revenue stream. That may be a good thing. It was always a little strange that a broker can make money on your money, backing your trades that they already earn a commission on. Some FCMs return interest income to its customers. And large institutional customers sweep their accounts daily moving excess margin capital into a third party cash manager to earn a few basis point above the risk free rate.

Seeing that the current environment does no leave room for brokers to earn interest on the customer funds it holds, now might be the ideal time to end the practice.

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