MF Global crisis: no time to dip into excess

April 5, 2012 07:36 PM
Excess funds are placed in segregated accounts for just such a crisis

The key element in the controversy over transfers from MF Global customer segregated accounts to JP Morgan in the final days of MF Global is whether the money transferred was customer segregated money or MF Global money in excess of customer seg held in the account. The difference, perhaps, is five to 10 years in prison for someone.

The reason Futures Commission Merchants hold excess funds in customer segregated accounts however is to ensure that those accounts do not dip below the minimum segregation level. It has been described by many as a buffer. FCMs place excess capital in segregation accounts in case one customer busts out and the account goes negative or when volatile markets cause a great deal of movement of capital in and out of those accounts. If a specific customer account goes negative, firm funds cover this deficit instead of other customer funds. It is appropriate to have this excess particularly in volatile market conditions and times of stress because it is a firm's responsibilities to perform due diligence on its accounts.

When an e-mail from Edith O’Brien stating the transfer was “Per JC’s [Jon Corzine’s] direct instructions” was leaked two weeks ago many thought it provided a smoking gun implicating Corzine in illegal activity.

It created such a stir that the staff of the House Financial Services Committee, where the leak likely originated from, sent out a second memo explaining, “the Hearing memo does not purport to directly link Mr. Corzine to the loss of $200 million in customer funds.”

It goes on to explain that FCMs are permitted to place excess funds in segregated accounts and draw from them so the fact that Corzine directed money be transferred from that account is not necessarily proof of wrong doing.

It is however, an “abrupt change in standard business practices” to have the Chairman and CEO direct such a transfer that can be seen as a “badge of fraud” as explained in a memo by the Commodity Customer Coalition earlier this week.

In last week’s hearing, MF Global Inc. CFO Christine Serwinski, who was on vacation at the time, testified that she would not have permitted the transfer even though it was lawful. Serwinski explained her philosophy in her written testimony: “I had stated clearly and repeatedly that the firm should maintain a positive “firm invested” balance every day in its segregated and secured report. To me, even though the regulations would allow it, I was not comfortable with the firm putting customer funds at risk even just overnight in that manner.”

So everything we have heard as to why an FCM holds excess funds in segregated customer accounts has to deal with a situation like the one confronting MF Global during the last week of October. Customers were pulling money out due to the downgrade and rumors of the imminent demise of the firm. Situations like this are why you have excess capital and not the time you would try and access that money. Serwinski testified that excess capital had already gone negative on Wednesday.

If ever there was a time that you wanted to have an extra buffer to ensure you did not violate regulations it was then. The crisis that was happening is why an FCM puts excess funds in seg accounts. Yet Jon Corzine ordered the transfer according to the O’Brien e-mail. He understood that the company was under stress and that customers were pulling accounts. But obviously the safety of customer funds was not his priority. His priority was to salvage his overleveraged position, which is what caused stress in the first place. Positions he was warned months earlier by regulators and more than a year earlier by his own risk officer, were simply too large.

That is the ugly part of this. The argument over whether Corzine meant to commit a crime or not is irrelevant. His reckless actions caused the shortfall. He was warned about it by in house risk managers and government regulators well in advance of the crisis but stubbornly held on to a trade he should not have made.


About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.