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MF Global: The Accounting Error That Wasn’t

Posted by Larry Doyle on April 4, 2012 12:24 PM |

What really transpired in the offices of MF Global over that last fateful week?

On October 24th, the firm was downgraded by Moody’s. A week later, the once venerable house known as MF Global declared bankruptcy. Who knew what, and when did they know it? How did hundreds of millions of dollars of customer funds go missing? The best accounting and “follow the money” reporting I have seen to date is provided by a Sense on Cents favorite, CFO, which writes:

While securities dealer MF Global was melting down financially, the company’s finance and treasury departments — in conjunction with futures-market regulators — were on the hunt for the accounting error that wasn’t. 

MF Global’s general counsel and the CFO of its broker-dealer unit appear to never have had any evidence that faulty reporting had caused a deficit in customer-segregated accounts. But they persisted in their belief for as long as three days, according to a time line of the firm’s final days constructed by the Chicago Mercantile Exchange. The reason? The amount was so large “it was too big to be anything else.”

In turn, early on, the CME and the Commodity Futures Trading Commission were prevented from conducting a full audit of customer-account statements because they didn’t have all the necessary documentation from MF Global. The three-day delay in confirming the customer-account shortfalls combined with the inability of regulators to get timely information from MF Global personnel may have contributed to the “loss” of $1.6 billion in customer funds and the firm’s eventual demise.

The bankruptcy has stirred up a firestorm in the securities industry and among regulators because many of the customers who lost money were farmers and ranchers who used futures in nonspeculative ways to hedge against price volatility. The firm went from reporting a $192 million quarterly loss on October 24, 2011, to filing Chapter 11 on October 31.

The theory is that someone at the firm overrode internal controls that safeguarded customer funds and transferred money out of them to sure up the company’s global liquidity position. Congress and federal investigators are particularly focused on the role of Jon Corzine, the former CEO of Goldman Sachs and governor of New Jersey, and whether he purposely directed his treasury department to use customer funds.

Futures brokers such as MF Global have to keep customer funds segregated from the firm’s own, but they are permitted to commingle money to create a buffer in case any one customer incurs substantial trading losses. The broker can withdraw some funds from those accounts for operational uses, but has to keep a certain cushion in the accounts, and any shortfalls have to be reported to the Commodity Futures Trading Commission.

The events of MF Global’s final days, gleaned from the CME time line and reconstructed from the recent testimony of two of the firm’s CFOs and its general counsel, show a firm in chaos.

Here’s how the notion of a reporting glitch developed: The daily closing report of MF Global’s customer-account balances first showed a deficit on Wednesday, October 26, according to the testimony of Christine Serwinski, former CFO of the North American broker-dealer unit of MF Global. But it wasn’t until 1 a.m. on Monday, October 31, according to the CME, that Serwinski and assistant treasurer Edith O’Brien confirmed that the deficit was real and told Mike Procajilo, a CME auditor, such.

That’s because they first believed that it was the reporting that was at fault. The possibility of an accounting error was first discussed on October 29. On that day, MF Global’s treasury department reported to Serwinski that the previous day’s accounting showed a shortfall in customer-segregated accounts. But the staffers told her it reflected “reconciliation errors” and that the account was not really “under-segregated.”

The failures to perform in this fiasco are almost too many to count. From controls, compliance, accounting, treasury, and basic corporate governance, MF Global was a mess. That said, being a mess is no excuse and certainly not a legal defense. America knows that. Does Washington? Who has the balls in our nation’s capital to make the legal case that the senior management of this firm failed to perform and protect its customers? Only the integrity of our markets — along with hundreds of millions of dollars — lies in the balance.

Read all the details of this financial folly at MF Global’s Inscrutable Accounting Error.

Larry Doyle

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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.

  • Peter S.

    Purposely overriding internal controls safegaurding segregated customer funds reeks of collusion. Internal controls are in place for a reason – so no “accounting accident” can occur. Maybe it’s the reason for the “cat that ate the canary” smirk on Ms. O”Brien’s face as she repeatedly invoked the fifth.

  • Mark J. Novitsky

    The “failure” of the FCIC to recognize the “cause & effect” that the strategic elimination of Glass-Steagall being at the heart of the 2008+++ “crisis”…and the failure to immediately restore Glass-Steagall (not some watered-down Volker Act) — lets everyone know who congress and “regulators” really work for and who they represent.

  • Mark J. Novitsky

    Corzine & MF-Global…The equivalent of someone walking into a bank with a gun w/o a mask…robbing it in full view of numerous video cameras…leaving abundant undeniable fingerprints and DNA evidence…getting caught…lie to congress…and walking away scot-free. Madoff to MF…what has changed???

  • Mark J. Novitsky

    Sorry for redundancy…JPM “fined” $20 M by CFTC for “UNLAWFULLY MISMANAGED CUSTOMER FUNDS”(LEH not MF Global)…implies that LAWS were BROKEN…WHO pays the “price” / FINE? The shareholders of course…the ones that got RIPPED OFF!!! And Dimon pockets another $23 MILLION BONUS!!! – As always…when the incentives for lawbreaking FAR outweigh any RISK of justifiable accountability…repeat…crash…”outrage” / nobody could have anticipated…repeat…crash…”outrage” / nobody could have anticipated…over and over and over.

  • LD

    A JPMorgan spokeswoman declined to comment.

    As MF Global’s main bank, JPMorgan was heavily involved in the brokerage firm’s final days last October. It helped the firm sell off assets and process a flurry of transactions in an effort to stave off collapse.

    It also received hundreds of millions of dollars in MF Global’s customer money, according to people briefed on the matter. One significant misuse of customer money came on Oct. 28, MF Global’s last day of business, after the firm overdrew an account at JPMorgan in London. When MF Global learned of the overdraft, it transferred $175 million in customer money, perhaps inadvertently, to patch the hole.

    Authorities investigating the collapse of MF Global also suspect that JPMorgan received customer assets as it helped MF Global sell commercial paper and other securities to an array of other Wall Street firms.

    But there is some dispute over how much money JPMorgan must return to customers. The bank is a leading creditor in MF Global’s bankruptcy, and it is itself owed tens of millions of dollars. It is unclear how much customer money remains at the bank.

    The missing money belongs to clients who traded in the futures market — investors like farmers and hedge funds. The trustee has returned about 72 percent of their money.

    Money from customer trading in futures accounts went to a number of other destinations, aside from JPMorgan, including clearinghouses and MF Global’s securities customers, the people briefed on the matter have said. About $700 million is also trapped overseas.

    JP Morgan in Talks Over Missing MF Global Customer Money

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