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MF Global Update: The Black Hole in a Dark Cave

Posted by Larry Doyle on April 11, 2012 7:56 AM |

In a day and age when money transfers on Wall Street are processed and tracked with tremendous precision, the MF Global back office operations might only be compared to a caveman enterprise during the Dark Ages.

How might a firm such as MF Global, taking risks that literally brought the house down, have such inadequate back office capabilities? Great question, but for further ‘enlightenment’ on this dark and murky topic, let’s review a recently released CFO report, Lax Treasury Practices Aided MF Global Fall, Experts Say:

Poor accounting of the movement of funds between bank accounts and outdated treasury systems contributed to the chaos of the final days of securities dealer MF Global — and ultimately to the loss of $1.6 billion in customer funds. 

According to corporate treasury experts, the congressional testimony of key executives at MF Global shows that the commodities firm’s treasury department was poorly organized and insufficiently automated — and that those flaws as much as anything may have led to the improper transfer of money out of so-called customer-segregated accounts.

The defects in MF Global’s treasury operations were exposed when, in the company’s final week, margin calls from futures clearinghouses, customer demands for withdrawals, and requests from counterparties for added collateral sparked a frantic hunt for liquidity.

Federal officials are investigating how a series of money transfers among MF Global’s different bank accounts at JP Morgan & Co. and between subsidiaries of MF Global’s holding company may have caused the “loss” of customer funds. The theory is that someone at the firm overrode internal controls that safeguarded customer funds and transferred money that was designated as belonging to customers — with a few of those transactions exceeding $100 million.

But MF Global, it appears, lacked sufficient documentation and proper accounting for the movement of money in and out of customer accounts.

“It’s pretty clear that MF Global did not have a treasury workstation — they were keeping track of fund transfers on a spreadsheet and using e-mails and phone calls,” says Bruce Lynn, a managing partner at The Financial Executives Consulting Group. “They were in the 1980s.”

For example, when money is transferred from a bank account, there should be a contemporaneous entry on the books of the corporation, says Lynn, or at least that is best practice. MF Global may have been transferring the money but then not reconciling or accounting for the transfer until nearly a month later. “There is a black hole for days and weeks, and that is just sloppy,” says Lynn.

That careless recordkeeping around MF Global’s bank accounts could also have contributed to executives’ delayed realization that customer-segregated accounts were actually underfunded and not misreported.

Lynn doubts the wire transfers that tapped customer-segregated funds stemmed from a mixup of the accounts, as recent media reports suggest. MF Global was probably using a web-based system provided by JP Morgan & Co. called JP Morgan ACCESS to manage its accounts, he says.  In such a system, semirepetitive payments — like the wiring of money to an account overseas — would  already be set up and a transfer would just require filling in an amount and pushing a button. “It’s highly unlikely the wrong account numbers were used,” says Lynn.

While investigators may yet find that there were criminal or civil violations by top executives at the firm, Lynn says that the misuse of customer funds probably didn’t happen the way some members of Congress think it did. “[In hearings], congressmen made it sound like [CEO Jon] Corzine sneaked in in the middle of the night and flipped a switch and overrode some internal controls, but that’s not the way it happened,” he says. More likely, the company’s culture didn’t place a high value on internal compliance. “Did [Corzine] create an atmosphere where people paid attention to these things? I don’t think so,” Lynn says.

“I swear [Edith O’Brien] has an e-mail in her back pocket — an explicit acknowledgement that it was OK to send the money out,” says Lynn. “Even if it wasn’t policy, self-preservation would make any treasury professional get an executive [to sign off].”

Are shoddy operations, much like ignorance, an excuse for financial impropriety? Perhaps only in an incestuous world of crony capitalism. Whom can we count on to shed some light on the MF Global cave?

I am all for granting Ms. O’ Brien immunity so we can learn more about the interaction between those in the front office — especially Mr. Corzine — and those occupying the cave in back.

Is it just me, or do you notice a striking similarity between the two individuals pictured in my commentary?

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 so that investor confidence and investor protection can be achieved.

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