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What Happened to the MF Global Customer Funds?

Posted by Larry Doyle on November 9, 2011 6:59 PM |

How is that $600+ million of customer funds disappears from a bankrupt brokerage firm and it is not THE perpetual lead story in every financial periodical?

I know there is a lot going on in the world but this story blows them all away because it strikes at the very heart of our financial markets.

If customers do not have a deep faith and strong belief that their assets are segregated and protected why would any customer maintain an account with any broker? I wouldn’t. 

The faith and belief of the sanctity of segregated accounts has been shattered by the debacle at MF Global. Yet where is the mainstream financial media to carry this torch?

Perhaps the media and the financial industry itself are running scared that customers are about to learn that regulators and brokers have sold them a bill of goods on the sanctity of segregated accounts just as they sold them a bill of goods on the integrity of the ratings process, the validity of the auction-rate securities market, the value of SIPC insurance, and so much more.

Why are we supposed to believe anything that emanates from our financial regulators or those firms who would want to manage our investment funds?

I want to thank Andy Abraham of Abraham Investment Management who has provided me a number of links which are well worth the time to read and further understand what likely happened with the MF Global customer funds. Much of this you may find disturbing.

After reading these reviews, you will want to call your brokers and financial planners and ascertain that your accounts and funds are fully segregated and protected. You may want to ask those to whom you are speaking to make sure that your conversation is on a taped line.

While we have yet to hear any concrete material explaining what really happened to the customer funds in question, a few business writers offer their take on what went down during those fateful days leading up to MF Global’s demise.

1. Francine McKenna of Forbes writes, MF Global Assets Have Left the Building: How When, Where

When did MF Global exploit the customer segregated accounts and why?  How were the proceeds used to stem the firm’s deepening insolvency?

…., I believe that MF Global transferred  assets, not cash, from customer segregated accounts to a “house” account sometime late Wednesday or early Thursday.

I’ve given those who executed the “nuclear option” to save MF Global the benefit of the doubt. I believe those executives used all available legitimate means to raise cash first, including trying to sell proprietary assets, as CNBC reported, and exhausting existing credit lines. When margin calls on the repurchase agreements and account closure demands from strategically important clients – not the bread and butter individual traders and smaller investors and money managers who got rubber checks – kept coming, they hit the wall.

Why do I believe MF Global executives transferred customer assets not cash to “house” accounts? Because missing cash would be noticed immediately. Their clients were still trading and clearing and cash was required to settle. Securities such as U.S. Treasury Bills, blue-chip equities such as CME Group stock held by many exchange members, and physical assets such as gold, warehouse receipts, and other certificates of title are less active. They would not be missed Thursday through Monday.

2. Francine’s colleague at Forbes Robert Lenzner wrote just yesterday, MF Global May Have Used Customer Funds in the $6.3 Billion Losing Trade Without Informing Clients,

After an intense day of investigation, I have just discovered  that a CFTC rule(1.29) allowed  Jon Corzine’s MF Global to use the margin and cash in customers heretofore segregated accounts to amass a risky $6.3 billion investment in European sovereign debt that backfired. Nor did Corzine have the obligation to  inform any of these customers he was  gambling with their money. Or that he was intending to keep all the profits for himself and  his troubled firm. Nothing for the customers.

The language of Rule1.29 allows  “The investment of customer funds in instruments described in 1.29 shall not prevent the futures commission merchant (MF Global) or clearing organization so investing such funds and retaining as its own any increment or interest resulting therefrom.” Increment refers to any trading profits or gains.

The criminal division of the Justice Department in New York — as well as the SEC and the CFTC and members of Congress– are  investigating whether any laws were violated and if so, whether any criminal charges can be brought. As of 3pm today, there has been no sign of the missing $633 million. My sources believe it was probably grabbed by the institutions that made the margin calls on MF Global as the European bonds sank in value.

This shocking loophole, which is available to all  commodity traders, whether giant ones like Goldman Sachs or members of commodity exchanges,  means that huge risks are being taken with money that does not belong to the trading firms– without the customers having any idea of the danger they are in.  As Andy Abraham, a futures trader in Israel put it to me today;  “this means they can take segregated funds and leverage them to kingdom come. It means nothing is safe.”

Many would maintain that the Fed has plowed excessive liquidity into the system but the simple fact is our banking system remains chock filled with losses and assets that are improperly marked. Liquidity and counterparty credit risks remain a huge ongoing problem.

Regulators are continually showing their inability to protect investors thus investors MUST protect themselves. Call your brokers and financial planners. Question them aggressively as to the sanctity of the segregation of your account.

As Andy Abraham wrote me today,

.. NO ONE KNEW about this. I spoke to scores of people in the industry for 30years +…Everyone was in SHOCK. This must be made public. Even bank accounts and stock accounts could be at risk …

Caveat emptor remains the order of the day. On that note, once again we need to …NAVIGATE ACCORDINGLY!!

For those involved in the MF Global debacle or just merely interested in learning more about this situation, I am happy to provide the following links,

Shepherd, Smith, Edwards, and Kantas

Commodity Trade and Trend Following

Larry Doyle

Isn’t it time to  subscribe to all my work via e-mail, an RSS feed, on Twitter or Facebook? Do your friends, family, and colleagues a favor and get them to do the same. Thanks!!

I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.

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