According to a report released today by the House Financial Service’s Subcommittee on Oversight and Investigations, the ultimate onus for MF Global’s bankruptcy and missing customer funds rests squarely on Jon Corzine, the firm’s former CEO. “During his nineteen-month tenure as Chairman and CEO of MF Global, Jon Corzine made several fateful decisions, the cumulative effects of which caused MF Global’s bankruptcy and jeopardized customer funds,” the report says.
The Committee conducted more than 50 interviews and held three hearings at which it considered the testimony of 19 witnesses, including MF Global’s former senior managers and its principal regulators, and examined documents from a number of sources in its investigation. Released just over a year after MF Global declared bankruptcy, the Committee explains it has three reasons from conducting the investigation: “First, MF Global’s customers deserve to know how and why their funds went missing; second, market participants deserve to know whether regulatory lapses have been identified and corrected; and third, taxpayers deserve to know that regulators have been held accountable so that similar losses may be prevented from occurring in the future,” the report says.
The 100-page report details the history of the firm to show how Corzine’s decisions over 19 months led to the downfall of a firm that could trace its lineage back 230 years. Although the report places the responsibility squarely on Corzine, it first lists the details of the firm’s recent history including an unauthorized wheat trader in 2008 that lost the company $141.5 million and shattered confidence among some customers regarding the firm’s risk controls.
Corzine succeeded Bernie Dan as Chairman and CEO in March 2010. According to the report, “Securing an executive with Corzine’s reputation and experience was viewed as a potential coup for MF Global. After a 23-year career at Goldman Sachs in which he rose from a bond trading desk to become the company’s Chairman, Corzine served five years as a U.S. Senator and then four years as New Jersey’s Governor.”
When Corzine joined the firm in 2010, he widely publicized the fact that he intended to transform the firm into a full-service investment bank — a Goldman Sachs-mini. But that transformation would require capital. To fund his vision for the firm, Corzine personally took on the role of head-trader and began taking positions in European sovereign debt. “Because of this risk to the company’s income statement and the time it would take to realize gains, a direct investment in the bonds themselves would not achieve Corzine’s objectives. However, the company discovered that it could book quick profits by purchasing the bonds and then using them as collateral in a transaction known as a repurchase-to-maturity (RTM) agreement,” the report says.
In addition to this expansion into new revenue streams, Corzine created an authoritarian atmosphere at MF Global in which his decisions were not to be questioned. The report notes that when Michael Roseman, MF Global’s chief risk officer, argued against expanding the limit on the sovereign debt positions in September 2010, Corzine began looking to replace him.
In November, the board approved expanding the European RTM portfolio to $4.75 billion and Corzine informed Roseman that he would no longer report to the board but to COO Bradley Abelow. Abelow had been Corzine’s chief of staff when he was Governor of New Jersey. In January 2011, Corzine dismissed Roseman and replaced him with a new chief risk officer, Michael Stockman.
By August 2011, these RTMs were coming to light at regulators, and the Financial Regulatory Authority (FINRA) made demands that MF Global begin taking haircuts on these positions. As these positions came to light to credit rating agencies, the firm began to face a liquidity crisis as its credit rating was put on negative outlook.
Although FINRA’s charges against MF Global were filed on Sept. 1, they didn’t really come to the public’s attention until an Oct. 17 story by the Wall Street Journal. The timing proved to be fateful because the firm was to release its worst ever quarterly earnings report on Oct. 27, which would announce a loss of $191.6 million.
To try and head-off some concerns, Corzine moved the company’s earnings call up to Oct. 25. During the earnings call, Corzine and CFO Henri Steenkamp tried to assure investors that the firm was in the best financial situation it had ever been in. According to the report, “Corzine also sought to clear up ‘clouded perceptions’ about the company’s European RTM portfolio, asserting that the trades had ‘relatively little underlying principal risk’ and had realized ‘zero’ loss. ‘On a personal note,’ Corzine added, ‘our positions and the judgment about risk mitigation steps are my personal responsibility and a prime focus of my attention.’”
The call did little calm customers’ anxieties, and as credit rating agencies cut the firm’s rating to junk status, customers and counterparties sought to distance themselves from the firm. “MF Global’s customers and counterparties also reacted to the earnings news, and as the crisis deepened, MF Global faced a liquidity drain of crisis proportions…One counterparty, HSBC pulled MF Global’s line of credit and ordered the company to wind up its business with the bank by the end of the year,” the report says.
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.
Based on the evidence, the report ultimately lays the fault for the firm’s demise on Corzine for his ambitious plans for the company, but failure to put adequate risk controls into place. “By expanding MF Global into new business lines without first returning its core commodities business to profitability, Corzine ensured that the company would face enormous resource demands and exposed it to new risks that it was ill-equipped to handle,” the report says.
This expansion into new business lines, the authoritarian atmosphere that Corzine created and a failure to ensure proper bookkeeping led to the misuse of customer funds in the firm’s final days. “As the company struggled to find additional liquidity, company employees identified excess company funds held in customer accounts. However, because they did not have an accurate accounting of the amount of customer funds the company held, they withdrew customer funds as well as company funds.”
MF Global currently is the subject of multiple civil and criminal investigations in jurisdictions around the world. Prosecutors and MF Global’s regulators will determine whether the company or its employees violated laws or regulations.
Responding to the briefing of the report released yesterday, Steven Goldberg, partner at RLM Finsbury and spokesman for Corzine, said, "[T]he Subcommittee makes a number of assertions as to Mr. Corzine’s 'failures' in managing MF Global. When Mr. Corzine joined MF Global he was tasked with quickly turning around a failing business, shoring up internal processes and controls, and, most importantly, immediately returning MF Global to profitability. He set a new strategy for the firm after extensive discussions with the Board, the senior management team and well respected outside consultants. At all times Mr. Corzine acted in good faith and did what he believed was necessary to turn around MF Global."
In the end, the report finds that Corzine ultimately is accountable for what happened at MF Global. “The responsibility for failing to maintain the systems and controls necessary to protect customer funds rests with Corzine. This failure represented a dereliction of his duty as MF Global’s Chairman and CEO.”