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Regulatory Insider: How/Why MF Global Failed Recommended

Posted by Larry Doyle on November 16, 2012 9:20 AM |

We all know that MF Global failed because it had put on massive bets on sovereign bonds in the Euro-zone. There has to be more to it than that, though, right? Yes, indeed.

Wasn’t Dodd-Frank passed in mid-2010 supposed to limit the leverage that could be utilized by banks and broker-dealers? How and why was MF Global able to leverage itself upwards of 50 times in bets placed in late 2010 and throughout the better part of 2011?

Let’s navigate and go over the financial regulatory wall to learn the answers to those questions from a regulatory insider. This insider recently wrote to me and offered the following:

I want you to realize that the root of the problem with our financial system is a flaw in the SEC’s Net Capital Rule (15c3-1) which allows large broker-dealers (net capital > $250K) to dodge any leverage restrictions.

Under the Net Capital rule, a broker-dealer’s total aggregate indebtedness (unsecured liabilities) cannot exceed 15X its net capital; however, if the broker-dealer’s net capital is > $250K, it can elect to file under the Alternative Method ratio requirement meaning that its net capital must only adhere to the > 2% of aggregate debit items (customer receivables) restriction.  (This criteria is meaningless from a financial risk perspective as it does not directly measure leverage.)

In 2011, this flaw in the SEC’s net capital rule caused the MF Global debacle as Jon Corzine placed leveraged bets on PIIGS sovereign debt resulting in 50X net capital leverage ratios, the MF Global bankruptcy and $1.2 billion in missing customer funds.  (These speculative bets again breached the SEC’s leverage limit for small broker-dealers of 15X net capital.)

The Lehman and MF Global debacles could have been prevented if large broker-dealers (net capital > $250K) had been forced by the SEC to limit their leverage to 15X net capital (like everybody else).

In my opinion, this flaw is caused by the incestuous relationship between the government regulators and Wall Street. This relationship allows large broker-dealers to borrow unlimited $ amounts to place humongous speculative bets in the market which in turn puts creditors, investors and customers at immense financial risk.

The only purpose this flaw in the SEC’s net capital rule serves is to accommodate the agendas of greedy individuals like Dick Fuld and Jon Corzine whose goal is to get rich using other people’s money.

Unfortunately, our present system allows people like Dick Fuld and Jon Corzine to walk away “scot-free” even after causing tremendous financial pain to countless investors, creditors and customers (in Corzine’s case).

To prevent a re-occurrence of Lehman and MF Global, we need to do “God’s will on earth” and urge the SEC to correct the flaw in its net capital rule which enables large broker-dealers to dodge leverage restrictions.

Financial regulatory reform? In name only. The next time we hear a political hack in Washington or elsewhere reference that our financial industry has been “reformed”, think about this loophole in the SEC’s Net Capital Rule and realize that the crony capitalism in our nation remains firmly in place. Why is that the phonies in Washington allow this sort of corruptible practice to continue?

Remember, the banks and brokers own Washington. The more we “hope” that things might “change” and that our country might be moving “forward”, the more we need to realize that things truly remain very much the same. Does this surprise you?

Any other insiders care to weigh in on this or other issues?

Given the importance of this specific case and this topic at large, I hope readers will spread this commentary far and wide!!

Navigate accordingly.

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.


  • Peter Scannell

    Net Capital Rule is the flaw (a key left in a vault of leverage).

    Isn’t the behavior at MF Global after the seemingly negligence investment strategy downside became a reality the concern?

    Does the Net Capital Rule also allow for a sole instance the use of segregated customer accounts to be used for the sole benefit of the investment firm maintaining the accounts?

  • Small BD

    I seem to recall that the pillars of society (Lehman, Stearns, and a few that are still at large) held meetings with the SEC in order to ‘convince’ (or dictate, if you prefer) staff that a more ‘flexible’ method to calculate net cap was necessary in order to remain competitive globally. I think that the major push dates to 2005 / 2006.

    MF Global- now that’s financial-reform progress for you!

  • Russ

    The real problem is that those who elect politicians are those who are getting free stuff from the government and they are the same people who are unlikely to figure out the games that Wall Street and the government play with each other (behind your back).

    Basically, the less intelligent are picking who runs the country. I know this is politically incorrect to say, but the truth is the truth.

  • GMA

    I must say…articles such as this set my blood to boiling. Why / How in the world have we allowed financial “regulations” to become so complex and convoluted…and for what purpose? Certainly not to promote clarity and support informed decision making. There can be no doubt Washington and Wall Street are wed in an unholy alliance, certainly not intended to benefit the average investor. While we are “reforming” the tax code, let’s just go ahead and reform ALL financial regulations. If operating procedures cannot be clearly understood by the average high school graduate, they should be rewritten / revised until such is the case. Enough of the gobbledy-gook “rules” that permit such unbridled criminality.

  • James


    Even if this flaw were fixed, wouldn’t bad actors circumvent the rule by booking leverage is non-broker/dealer affiliates?

    And wasn’t MF in the CFTC regulatory regime (a joke) rather than the SEC regime?

  • LD


    There will always be bad actors which is why we need good (excellent) regulators. In fact, I am convinced that far more than needing more regulation we simply need a sufficient number of qualified regulators. MF was primarily regulated by the CFTC but I know that FINRA also had some degree of oversight as well.

    When FINRA was investigating Peregrine, they were required to request to look at its books (Peregrine Financial Fraud: What Shocked Me). How does that happen? If a regulator wants to look at the books, then he should show up unannounced and look at the books and they better be in good working order and fully verifiable.

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