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.

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.

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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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.

Worse yet, we keep on hearing frustrating tales about poor communication whether it be from the Commodity Futures Trading Commission (CFTC), CME Group or the Securities Investor Protection Corporation (SIPC) trustee from MFGI customers who for years were told by the leaders of the industry that what has been happening could not happen. Namely that their segregated funds where safe and would not be put in jeopardy even — or especially — in case of an FCM collapsing.

While there has been progress of late there still has not been a viable explanation why it has been so difficult to get customers their money back. We understand there is a shortfall in customer segregated funds and we understand an investigation takes time but there has been no logical explanation from the trustee why they can’t pinpoint the size of the shortfall or why what customer money is accounted for hasn’t been returned to them already.

And perhaps most disturbing is that what progress has been accomplished so far has been attributable to a grassroots movement of a handful of angry customers and ad hoc organizations formed on the fly as opposed to the so called leaders of the futures industry who have appeared to be asleep at the wheel and willing to let futures customers twist in the wind.

CME Group blamed MF Global shortly after the bankruptcy claiming that on the week they were in trouble (later determined to be Wednesday Oct. 26) they completed an audit that showed MF Global was in compliance with its segregation requirements. They then learned on Oct. 31 that MF Global had a shortfall in customer segregated funds (and by the way put out a pretty specific estimate of the shortfall of $633,027,696). According to numerous back office sources an FCM is required to report its customer segregated funds to its designated self regulatory organization (DSRO), in this case CME Group, on a daily basis. At the point their audit was completed, it was common knowledge that MF was in much distress so we find it difficult to understand how CME was not more on top of it. As former CME regulator Peter Moy wrote on a comment board, “in previous situations like MF Global, the Audit Department would be present at the firm everyday to insure that all segregated customer funds were properly accounted for. The excuse that they transferred the funds after the audit is lame.”

The CFTC has been MIA for most of this as Chairman Gary Gensler recused himself due to his relationship with former MF Global Chairman and CEO Jon Corzine from their days at Goldman Sachs. The SIPC liquidation trustee has come under a lot of criticism but most of it has to do with his lack of knowledge of the industry, which is why many in the industry were perplexed the CFTC and CME Group didn’t fight for more control of the process. One former MFGI customer who still has nearly $185,000 frozen wondered whether the trustee assumed customers with positions got 60% of their money back instead of just 60% of the margin held at CME Clearing.

It is an important question because the trustee pledged last week—after much external pressure from groups like the Commodity Customers Coalition (CCC)—to have an interim distribution to “cash only” customers. The Intercontinental Exchange (ICE) sent a letter to the trustee pointing out that customers who exited their positions before the bankruptcy did not receive any allocation as the trustee just completed a transfer of positions and a portion of the margin used to hold those positions. While the cash only transfer addresses certain customers, many other had only minimal positions and still have 80%, 90% or 95% of their accounts frozen. Today the trustee noted that there will be another interim distribution that would attempt to get all customers 60% of their assets returned.

Former MF Introducing broker Sean McGillivray just wrote, “The impact on investors have been well documented. Inconsistent and unequal treatment of differing accounts by regulators as well as the exchanges has eroded confidence in the system. It has also forced unnecessary client liquidation losses. Our firm now holds unsecured debits on the books at our new FCM, because of the CME’s (half hearted and really half thought out) transfer plan.” McGillivray went on, “The majority of our client accounts remain frozen with little hope of a speedy resolution. The industry must step up to restore confidence. The CME is one of the few entities capable of guaranteeing any shortfall, effectively allowing for the immediate release of client funds.” 

This is one of many notes we have received detailing the frustration with a broken process and a disconnect between customers and businesses under stress  and those responsible for resolving a problem that was not supposed to happen and has not been well managed.

So lets recap. Tomorrow will be three weeks since MFGI went under. The trustee completed it initial transfer that returned positions and $1.5 billion in customer margin money last week to 14,500 accounts. It has pledged a second distribution of 60%, about $520 million, of the capital in cash only accounts. The second distribution is said to have begun but is not complete. When that is complete it would mean that just over $2 billion of $5.4 billion would have been returned to customers in just under a month. That is a little more than 35% of customer money that was never supposed to be at risk, even in a bankruptcy.

That is not a give job. Not by the trustee and not by the folks who should be looking out for their customers or the folks who are charged with keeping an orderly marketplace.

Throughout the process the language of the trustee appears to confuse the distinction between customer segregated money and general claims in a bankruptcy. Nothing has angered former MFGI customers more than the term “claims process.” They reply that they have segregated accounts. It is their money that by law is kept apart from the funds of the broker. They don’t want to make a claim, they want their money back. And they should have gotten it back by now, or at least what is left of it and they should be first in line for anything that is left.

It was no secret that the two Republican members of the commission, Jill Sommers and Scott O’Malia, would oppose the position limit rule and Commissioner Dunn was highly skeptical of its efficacy. Speaking to me at the Futures Industry Association Expo last week, Dunn acknowledged that lack of position limits where not impactful on the financial crisis and the agency needed to concentrate its efforts on things that would make the industry safer.

In several stories he has called positions limits a sideshow and his comment from a previous hearing — “With such a lack of concrete economic evidence, my fear is that, at best, position limits are a cure for a disease that does not exist or at worst, a placebo for one that does,”  — has gone viral.  

Dunn addressed Gensler directly asking him to give assurances that the agency would examine the impact of the rules after it became effective. You almost expected Dunn to ask Gensler to put his hand on a bible before responding to direct questions on the purpose of the rule and the role of the Commission. It made you wonder why he didn’t just vote against it. Perhaps approving a rule was the easiest way to move forward.

Dunn also expressed publicly and privately his frustration that they are still waiting on further definitions of swaps, which must be set before the rule becomes active.

What was clear from Tuesday’s meeting is that there was a myriad of compromises on the initial proposal to get the measure passed. What wasn’t so clear was why it was necessary. Those who believe speculation caused the run-up in energy prices in 2007 will not be satisfied nor will those opposed who will bear the cost of compliance, which is expected to run over $100 million.

The chairman and each of the commissioners separately made the point that the Commission was not a price setting agency. In fact, that was one of the questions Dunn asked directly to Gensler and he waited for the chairman to affirm that the agency was not in the business of setting price. The problem is that those advocates who most passionately have been pushing for positions limits believe that that is the role of the Commission or at least believe that if limits were in place the price of many commodities would have been lower in recent years.  

In fact U.S. Senator Bernie Sanders (I-Vt.) may have committed a crime in his fervor to castigate speculators by leaking non-public crude oil position data to the press and a  recent United Nations report flat out recommended affirmative government action in the markets to “correct” price.

Several panelists at the recent FIA Expo in Chicago made the point that often the loudest supporters of certain reforms be it transaction taxes or position limits are the most ill informed.

So we have a rule the necessity and value of whch three commissioners are uncertain of though there seems to be certainty on the cost, at least $100 million to the industry according to the CFTC, making it a major rule.

Dunn asked Gensler, “How will this rule impact disruptive trading practices and market manipulation and the resources at the Commission’s expense to combat them.”

Gensler said, “this rule is another tool to protect price discovery and promote fair and open and competitive markets, it helps protect against parties having excessive market powers therefore protects against corners squeezes and other manipulative schemes.”

There was more regarding large position reporting, information the Commission already receives, but $100 million seems like a large burden for just another tool. The cost estimate would seem to require the Commission to make a stronger case for the necessity of this rule.

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.

Why must politicians journey to D.C. to conduct business? Is it that they cannot master the laptop? Do they need to use sign language to communicate.

No, it is because they need a special place, away from constituents, where they can conduct “business” below the public radar.

Send them home! Let their neighbors see the taxpayer-funded limo in their driveways. Let the local press cover their airport departure on a “fact-finding” mission to Bora Bora. Let them experience constituents’ complaints each morning as they retrieve the newspaper.

Washington (a lovely city where we lived happily for nearly a generation) has become a secret society for politicians who do not “return” there to conduct the nation’s business but to carry out very private agendas that are remote from constituent needs.

Stay in place. Debate and decide via a plethora of electronic media as managers of multinational corporations do every day. Why, most of the work conducted by the Securities and Exchange Commission’s many offices is done this way, as is also true at the Commodity Futures Trading Commision’s fewer but busy locations.

Imagine the relief for Washingtonians! No more traffic snarls from endless motorcades blocking the streets for hours on end. No more “reserved” parking at Reagan and Dulles airports for the political class. No more confusion among tourists about when and how they can visit the great monuments and museums.

Centralized government has become an unaccountable zone. If you don’t believe me, just wait.

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.