Regulators, much like the media, tend to overreact to problems when the failure falls at their feet. The media tends to obsess on a story that they initially missed. With regulators, they tend to write proscriptive rules in an attempt to solve a problem that can be partially laid at their doorstep, one in which they missed but in an attempt to deflect blame they create new regulations to prevent the situation from repeating itself.
The MF Global debacle was really a slow motion car crash. There were numerous red flags going back a year and the bottom line is that according to the initial bankruptcy filing, there was capital within MF Global Holdings to cover the shortfall in customer segregated funds but the appropriate regulatory authorities did not demand those assets, instead allowing the main brokerage business unit be split off into a separate Securities Investor Protection Corporation (SIPC) run bankruptcy with the parent allowed to operate in Chapter 11 mode. In fact numerous divisions of the firm weren’t placed into bankruptcy until several weeks later and the parent wasn’t assigned its own trustee until later that month.
In an infamous Nov. 1, 2011 hearing before the bankruptcy judge, an attorney for MF Global flat outright lied to the judge in front of lawyers for the Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC) and Department of Justice, in denying knowledge of the shortfall in customer segregated funds.
In a recent post, I pointed out why it was important to put the blame for the MF Global debacle squarely at the feet of Jon Corzine. I concluded that post with: “Only when a case such as MF Global explodes on the scene does the larger media world take notice… If the appropriate blame is not placed where it belongs then the industry itself will be held solely responsible.”
Some commentators new to the situation may erroneously assume that politics are at play. It is not, or at least it is not why it is important that Corzine is prosecuted or at least clearly held accountable. Yes, Corzine is a prominent Democrat and his connection to the Administration as a prominent bundler of campaign cash may have affected the diligence in which the Justice Department investigated the case. We have pointed out the curious nature of leaks that have appeared to come from the DOJ. But charges of political favoritism changes the focus, which should remain on the seriousness of the crime.
Last summer Congressman Michael Grimm (R-NY) and members of the commodity customer coalition (CCC) called on for an independent counsel to investigate the matter (Grimm letter). I reported this at the time but also noted that the letter did not stay focused on the case at hand but was a political document taking swipes at the administration. Talking with the CCC, who was trying to get Democratic support for an independent counsel, I suggested the letter be amended to focus on the issue at hand and take out references to “Solyndra", “fast and furious” and suggestions of a culture of corruption as I believed those references made it easier for the media and Democratic Congressman to dismiss it as a political attack.
I understand the frustration with what appears to be political favoritism but the important thing from a Futures industry perspective was the violations of the sanctity of customer segregation and not why the DOJ appeared to be dragging its feet.
With the political divide in our country today, as soon as the focus was on suspicions of why the DOJ was not moving, those advocating on behalf of a more vigorous prosecution lost half its audience.
Why do I bring all this up? The CFTC is proposing rules that would significantly change the margining structure of futures brokers. Last week CME Group Executive Chairman Terry Duffy suggested to the Senate Committee on Agriculture, Nutrition and Forestry during a hearing on reauthorizing the CFTC that the rule proposal would prevent end users from using futures markets, the purpose of which is to mitigate risk and price discovery.
Futures Industry Association (FIA) president (and former CFTC Chair) Walt Lukken noted to the committee, “This re-interpretation of the long-standing application of the statute will result in a tremendous drain on liquidity that will make trading significantly more expensive for customers hedging their financial or commercial risks, and will adversely affect the ability of many FCMs to operate effectively.”
When individuals are not held accountable for misdeeds, problems created from those misdeeds are associated with the underlying structure. And in this case, the underlying structure—the regulated futures market with central counterparty clearing and segregated customer funds — has proven itself over the years. As I pointed out before, the futures structure withstood the hurricane winds of the Lehman Brothers failure and was used as the model to regulate swaps. Additional rules changes have been implemented in the wake of MF Global, some of which resulted in another fraud being detected. The industry should continue to improve oversight measures but everyone needs to remember that the MF Global debacle involved a crime not a loophole in regulations.
The end result of the CFTC's proposed residual interest rules will punish the victims in the MF Global debacle. That is what happens when you don't hold the appropriate parties responsible.