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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.

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