In what is becoming a semi-regular feature, it is time to educate members of the general business media about the world of futures. Our target today is Bloomberg.com and columnist Jonathan Weil and his recent column: Jon Corzine, the Biggest Little Target the Feds Can Sue.
To be fair we must note that the column came out earlier in the week before the Commodity Futures Trading Commission (CFTC) enforcement action against MF Global, Jon Corzine and Edith O’Brien came out. However, Weil felt compelled to talk about it based on a Bloomberg story citing the expected action that also included a comment from Corzine’s attorney.
The article basically stated that Corzine was targeted because he was a big fish but not too big of a fish and could be used as an example because the regulatory agency couldn’t be proven to be somehow complicit as was the case with Lehman Brothers. We can accept this general premise though we would argue the latter point. Yes, bigger fish had committed greater crimes and have not been prosecuted. So what.
What is bothersome is that Weil felt compelled to write a column even though he didn’t seem to have knowledge of any of the particulars or the role of the CFTC.
The CFTC is not just one of many financial regulators charged with finding financial fraud on big bad Wall Street as indicated in the story. It is charged with overseeing the U.S. Futures markets and enforcing the Commodity Exchange Act (CEA), which regulates trading of commodity futures in the United States and established the statutory framework under which it operates.
One of the core rules within the CEA regards the segregation of customer funds. Every Futures Commission Merchant (FCM), which is the regulatory entity that MF Global operated its futures operation under, must ensure customer funds are safely segregated from firm assets. They must have procedure in place to ensure this. In testimony to Congress CFTC Chairman Gary Gensler confirmed that customer funds must be fully segregated 24 hours a day. This along with central counterparty clearing is such a core element of the futures industry, which worked extremely well in the various shocks of the last decade that much of the design of the Dodd-Frank Act was to bring this safety to the world of swaps. Mr. Weil might find it interesting that no U.S. futures customer lost a dime in the Lehman Brothers bankruptcy because those segregated funds were moved out of the bankruptcy into another FCM.
One heartbreaking element of the MF Global debacle is that the industry felt so secure in customer segregation rules that many brokers did not bother to try and get customers out of MF Global even after a bankruptcy seemed imminent because they were comfortable the funds would simply be moved and they would be available immediately. I have had several brokers tell me this. I also have spoken to customers who held the bulk of their estate with MF Global because they thought it was safer in a Futures segregated account than in a bank where they would only have the limited FDIC guarantee.
Weill wrote, “MF's demise was a major scandal mainly because of Corzine's celebrity.” No it was a scandal because in the long history of Futures trading in the modern era it is the first time customer segregated funds were breached.
Weil may think the CFTC is making an example of Corzine but I can assure him that most people involved in the industry feel the CFTC had dropped the ball and are outraged the Department of Justice has not vigorously pursued this case.
There were more than 50,000 futures accounts at MF Global. Those customers still have not been made whole even though everything told to them by everyone in the industry from brokers to exchanges to regulators is that their funds by law would be safely segregated and not at risk in the event their FCM went bankrupt. Many people from introducing brokers to commodity trading advisors to farmers and ranchers were put out of business because their money was not safely segregated as was required by law.
The bankruptcy was no big deal. The shortfall in customer segregated funds rocked the industry and is still rocking the industry, which is why so many people are angry that Corzine has not to date, been criminally prosecuted.
And remember, Corzine was not just the head of the firm failing to ensure rules were followed. He orchestrated the huge sovereign debt trades that put the firm at risk in the first place. He replaced a chief risk officer who questioned the size of his positions and lobbied regulators to retain certain rules that allowed him to dip into overseas secured funds.
Gensler a former colleague of Corzine from their days at Goldman Sachs felt compelled to recuse himself from the investigation several days after the bankruptcy filing. Gensler, however, didn’t feel compelled to recuse himself when Corzine was lobbying over rule changes.
The first controversy had to do with the CFTC allowing MF Global Inc. to be split off and placed in a Securities Investor Protection Corp. (SIPC) bankruptcy even though the vast amount of accounts (roughly 95%) were futures accounts and the entity was short nearly $1 billion customer segregated funds and MF Global Holdings was allowed to remain intact days after the initial filing. The CFTC has argued that the law required a SIPC led bankruptcy proceeding but not everyone agreed.
It is something worth looking into. As is the fact that an attorney for MF Global told a whopper to the initial bankruptcy judge—stating he was unaware of the shortfall in customer segregated funds. He did this right in front of lawyers for the CFTC, SEC and Justice Department. No one objected even though they had all been informed the night before that there definitely was a shortfall. Who directed that attorney? Corzine and the leadership at parent MF Global Holdings were still in charge at that point.