From the November 01, 2012 issue of Futures Magazine • Subscribe!

MF Global’s original sin

Some early moves didn’t seem to make sense, but it would take weeks before critical questions began to be asked. For example, why was the firm’s subsidiary, MF Global Inc., practically a 100% FCM, put into protection under SIPC, which is designed for the securities industry? With only 318 securities accounts, how could the chairman of SIPC, Stephen Harbeck, possibly characterize MF’s securities business as “substantial” to a federal court?

But more importantly, with approximately $5.5 billion in segregated customer assets and an identified $633 million (at the time) shortfall in customer funds, how could MF Global Holdings, a self-identified brokerage firm with the bulk of all earnings from its brokerage unit, rush into a Chapter 11 reorganization and not Chapter 7, which is required for liquidation of brokers? 

A Chapter 11 is used to reorganize an entity, and this provides advantages to creditors. As Anita Krug, assistant professor of law at University of Washington, explains, “A  Chapter 11 proceeding permits the company to keep operating, possibly without a trustee, requires the appointment of a creditors’ committee and permits the estate to pay for the committee’s professionals — obviously good things for creditors. Although Chapter 7 permits a creditors’ committee under limited circumstances, that committee has a restricted role and, importantly, the estate generally does not cover the associated professional fees.”

Securing Chapter 11 could be done only if the brokerage unit was broken off into a separate proceeding. Doing this created not only more confusion and loss of customer priorities, but would foster conflicts between competing trustees. Washington D.C. Bankruptcy Attorney Wendell Webster says, “Allowing Holdings to reorganize under Chapter 11 may have created an inherent conflict between the trustees, precluding adequate protection of the brokerage customers. This potential conflict is disturbing particularly given the disproportionate number of brokerage accounts and customers.”  

And the law may not be absolute that a dually registered brokerage must fall under SIPC liquidation. The guidelines are: “Because stockbroker and commodity broker cases are very rare and can present unusual issues, the United States Trustee should notify and consult with the Office of the General Counsel immediately upon the filing of such a case.” 

All considered, the CFTC logically should have been guided by the overwhelming weight of commodity customers and futures market protection instead of abdicating its Congressional mandate to the SEC to put MF Global Inc. under the protection of SIPC.  

As the SIPC actions kicked in on Monday afternoon, not only were titled assets frozen, but liquidation of open positions became practically impossible under a court order granted in deference to the SIPC trustee who had never before handled commodity brokerage liquidation. 

With the brokerage now separated from the parent company, Holdings was free of customer protection rules under the Commodity Exchange Act and Bankruptcy Code (see “A distinction without a difference”).

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