That liquidity crisis proved to be the catalyst that would put customer funds at risk. Above all, it highlighted the lack of risk management procedures and sub-par booking at MF Global.
As the company juggled funds to meet margin calls, it became oblivious to actual account balances. According to the report, significant bookkeeping errors began accumulating on Wednesday, Oct. 26. On that day, the firm reported excess funds of approximately $1 billion in segregated and secured accounts as of the close of business on Tuesday, but the company’s internal records showed that it had only $21.5 million of its own funds in the accounts. On Oct. 26, “Edith O’Brien, the company’s assistant treasurer, authorized $615 million in intraday transfers from the company’s FCM customer accounts. Because these transfers exceeded the amount of MFGI’s ‘Firm Invested in Excess’ funds, the difference came from customer funds,” the report says.
This was exacerbated on Oct. 27 after MF Global’s U.K.-based affiliate (MFGUK) overdrew several of its accounts with JPMorgan Chase by approximately $175 million. Because the bank was helping MF Global shrink its balance sheet and generate liquidity, when it said “they would not engage in those transactions until the overdrafts in London were cleaned up,” Corzine contacted MF Global’s Chicago office and asked them to resolve the overdrafts.
According to the report, “To cover the overdrafts, O’Brien approved and processed a $200 million wire transfer from one of MFGI’s customer segregated accounts to one of the company’s ‘house’ accounts. O’Brien then authorized a $175 million transfer from the same ‘house’ account to an MFGUK account at JPMC in London. O’Brien noted in an e-mail that the $175 million transfer to pay the JPMC overdraft was ‘per [Jon Corzine’s] direct instructions.’ When O’Brien authorized the $200 million wire transfer, she had not yet received the segregation statement detailing customer fund balances for the previous day because Matthew Hughey, MF Global’s Regulatory Capital Controller, was still preparing them.”
When shortfalls finally were discovered in customer funds on Oct. 29, MF Global’s accounting department maintained the shortfalls “must have resulted from reconciliation errors and that the customer accounts were not undersegregated.”
The company maintained that stance while talking to regulators until Oct. 31 when O’Brien provided a document that showed the deficiency to be the result of three types of transactions: “(1) intra-day loans between MF Global’s FCM and its broker-dealer; (2) the funding of client withdrawals from the broker-dealer; and (3) the $175 million transfer to cover MFGUK’s overdrawn JPMC account on October 28.424 Together, these transactions totaled $909 million.”
That revelation essentially sealed any possible acquisition deals for the firm, and it filed for Chapter 11 bankruptcy on Oct. 31.