As a commodity trading advisor (CTA) you constantly take risks and try to manage those risks. One thing that you don't want to manage is the risk of your client’s futures commission merchant (FCM) failing. This is what happened on Oct. 31, 2011 when MF Global melted down. Here is what it's like to be a CTA when you're FCM melts down.
On Wednesday, Oct. 26, I got a call from a competing FCM; “Hi Robb, I know you have some business over at MF global. You may have heard that they have been having some problems. We’d certainly like your business. You might want to consider what is happening over there and we’d be happy to help.”
I hadn't really thought that much about MF Global’s credit rating being downgraded that week because that shouldn’t affect the futures division; all customer accounts are segregated. I didn't think much of the call because as a CTA I constantly have brokers and FCM's that want me to just move all my business over to their company with all kinds the promises of glory and how much money they can raise for me or how much better or cheaper they’ll do executions.
People in the industry get confused with the difference between a commodity pool operator (CPO) and CTA. With a CPO, all the money is pooled together into one or more accounts. This gives the CPO a lot of authority and power as to where it places the funds.
In the past, one of the dangers of having money pooled together was a Bernie Madoff type scandal. I remember decades ago a CPO manager telling me that he had so much control over the “account” that he could write a check and leave the country; that it would be a while before anybody knew what happened. The industry has learned from these mistakes and now implement many more safe guards, such as the use of an administrator and outside accounting firms.
To move accounts, the CPO can sign one set of paperwork and then inform the investors of the change in a timely manner.
A CTA doesn’t get to pool money, they manage each account individually. Each client would have to make this decision and then re-paper the account at the new FCM if the client decided to move their money there. This can create fear, uncertainty and doubt. Clients will wonder what the problem is. It’s just not worth it.
So when I got the call from the competing FCM, I didn’t think of it beyond just another competitor wanting my clients’ business. There was no reason, based upon rumor and innuendo, to cease my five-year relationship with MF Global, liquidate all positions, and have my clients re-paper their accounts. This also would delay any trading and create opportunity costs.
There was nothing to worry about. All the client funds are “segregated,” meaning that the firm could lose every dime, but those client funds are in separate accounts and not used for the FCM’s business operations. These segregated funds are sacrosanct to the industry. They provide a level of protection for all clients.
The futures industry is a relatively small industry. Especially because the Mecca is Chicago and many industry people have been in the business two to four decades. Reputation permeates the business. If somebody does something wrong, it will follow them.
I had a very good brokerage group at MF Global; I had no reason to change ships. Plus, many other CTA and CPO operations had long-standing business with them. The group I dealt with handled 24-hour trades through their Chicago and London desks. Sometimes I would put option trades on overnight. They handled them with total professionalism. When they made a mistake, which was rare, they paid for it without argument. I had a very good situation at MF Global.
Oct. 31 truly was a Halloween for the industry and for MF Global customers. Between 6:00-6:30 a.m. I received a call from the broker. Rarely did I ever get calls from the broker this early unless there was an issue, and that issue usually was an option that needed to be bought back because we couldn’t get an ask price on. This morning was a lot different. The broker's first words out of his mouth where “Robb, MF Global is going bankrupt, everything is falling apart.”
I had options and futures positions on, so it was decision time. I had several paths I could take: Path 1 was to do nothing, let the course of action work itself out; path 2 was to liquidate everything.
I contacted my compliance consultant and accounting firm. The compliance person assured me that all customer funds were segregated. This was a major assurance in the industry. I wanted to make sure, as I always have, that every decision was made within the regulations. With the CPA firm I discussed previous situations like Refco and others, getting advice on the best course of action. The compliance person was at least half right – the clients monies were supposed to be segregated. With client funds I only have power of attorney to trade the account. Not the power to wire money anywhere.
Between 7:00 and 8:00 a.m. the broker had informed me that all my stops were cancelled. Stops are used to manage risk. I had dozens of option straddle positions on with stops in the underlying futures markets. I also had futures positions on. Now I had no stops; total exposure. Then the broker informed me that he had no ability to place any orders. No stops and no way to liquidate. Now we’re just rearranging the deck chairs on the Titanic, or as another CTA put it, we had 0% of the equity and 100% of the risk. I couldn’t trade. Later that morning the broker informed me that I could place orders with FCM Rosenthal Collins Group (RCG). I’ve had a relationship with them for several years. I called over there and they knew nothing of the arrangement, at least the person I talked to knew nothing about it. There was much confusion that morning. The S.S. Californian also was supposed to be there for the Titanic, but that night the wireless radio operator was sent to bed early and missed the Titanic’s distress call by 25 minutes.
As all the clients found out - any attempt to wire out funds was stopped by the bankruptcy filing. The monies and positions were stuck for the time being.
The broker then informs me around 9:30 a.m. that other firms might execute the liquidation. Soon after I was called by a firm that said they could liquidate all my positions. I had met the fellow a year before at another firm he was working for at the time. I told him it was a timely call and that “yes I wanted to liquidate all client positions as soon as possible.” I would have to email them the list of positions and accounts, and where they should be given up.
This was an unusual arrangement. I had no paper with this firm, no history and no money! Yet they claimed they were willing to execute these positions. If they weren’t able to reconcile with the accounts at MF global, even though these were offsetting positions and technically flat, I’d really have opposite positions at two different firms and might have to place equal margin there. Yet there was no way to wire/transfer money to that firm from MF Global.
All the while I was getting the email together of all positions and account numbers, and like Santa Claus, I was checking the list twice. At this point I knew which firms were being naughty and who were being nice, and MF Global was not on the nice list.
As I was getting this list together, my miracle happened. My MF Global broker called me; “Robb, they’ve let us back in the system, I can execute trades right at this moment.” It wasn’t clear if he could do give-ups. I figured that if I could at least exit out of all MF Global account positions, then I could call the various FCM’s that the other accounts were at and have them exit the positions. I told the broker, “Hell yes, get me out of all positions.” Minutes later he informs me that he was not only able to exit out of all MF Global trades, but was able to do the give-ups to the other FCMs for all the accounts that I manage All accounts that I managed were totally flat.
That window of opportunity closed one hour later. MFG brokers could no longer make trades. I had jumped through the window at the right time. Having a good relationship with a gifted broker really paid off.
My poor broker. I’ve worked with this guy for over two years. We talk nearly every day. He understands all my trading needs and always goes the extra mile. He was a VP at MF Global who worked his way up the ladder. He’s invested over a decade of his life with his IB at MF Global. Now everything he’s worked for is gone. He doesn’t know his future, he won’t be receiving any commission or pay checks from MF Global, but worked diligently to help his clients. He showed a lot a character throughout this situation.
In exiting all these positions, many brokers would just put in market orders. With futures, especially in liquid markets, that’s not necessarily a bad thing, but with options, it could be lethal. What is one person’s catastrophe is another person’s opportunity. There were a lot of attorneys that made money on Enron demise. There were traders that were getting some bargains that day. Fortunately for me, none of the markets I was trading in were having big moves, the damage would be contained. The broker carefully worked out of each position, and there were dozens of them, to the benefit of the accounts that I manage. He didn’t panic.
Now the information starts coming out that that there is approximately $600 million in segregated funds that are missing, and that is why the last minute sale of the firm fell through.
MF Global Chairman and CEO Jon Corzine, who made the Eurobond bet that created this whole mess, was trying to sell the futures unit over the weekend. The deal apparently fell through when Interactive Brokers’ accountants found the discrepancy in seg funds.
By Tuesday, Nov. 1, all my accounts are sitting in cash or were being settled up from the previous days activity. Those customers that didn’t exit out on Halloween were now stuck with no stops. A week later, those accounts that had positions on were moved to random FCM’s with about 60% of the funds to cover the positions. If the client couldn’t add monies to these new accounts, then those positions might be exited. What about those accounts that went negative during this time because the stops were cancelled? I’ll bet none of them are going to write a check to MF Global to cover those losses.
The most logical thing that could have been done on Monday, Oct. 31, was to just instigate a mass liquidation throughout the day. It’s not like everybody was sitting on just one side of each market. Probably would have been a wash and would have left everybody in a cash position at the end of the month. This would have created a clear line of demarcation and would have avoided the messes that occurred later in the week with some accounts, those with open positions, to be moved to other FCMs by the CFTC.
In the future I’d make these suggestions:
- Suggest to clients to place money at FCMs that only do execution. Not firms trying to build the next Goldman Sachs.
- If the firm does go through a REFCO/MF Global type of bankruptcy situation – if possible, liquidate all positions immediately.
- Suggest that all client monies get wired out at the earliest possible moment.
- Have relationships with other FCMs. Diversification in FCM contacts is a good thing. You just might need them on short notice should another meltdown occur.
Hopefully we’ll learn and the necessary lessons from this debacle. Obviously the goal is to avoid being in this situation in the future.
Robb Ross runs White Indian Trading Co., and developed its Stairs trading program (see "Ross: White Indian and rubber chickens," August 2010). He is an experienced programmer and system developer, having worked at both Microsoft and NASA.