April 20, 2012 |
Only on Wall Street can you bankrupt a
company; misplace $1.6 billion of customers’ money; lose 75 percent of
shareholders’ money in two weeks; speed dial a high priced criminal
attorney and get a court to authorize the payment of your multi-million
dollar legal tab from the failed company’s insurance policies; have
regulators waive your requirements to take licensing exams required to
work in the securities and commodities industry; have your Board of
Directors waive your loyalty to the firm; run a bucket shop out of the
UK; and still have the word “Honorable” affixed to your name in a
Congressional investigations hearing.
This is not a flashback to the rotting financial carcasses
of 2008. This putrid saga has been playing out in five Congressional
hearings since December with the next episode scheduled for Tuesday,
April 24, before the Senate Banking Committee under the auspicious
title: “The Collapse of MF Global: Lessons Learned and Policy
Implications.” (The title might more appropriately be, “MF Global:
Lessons
Never Learned and Policy Implications of a Wild West Financial System Just One TradeAway from the Next Taxpayer Bailout.”)
There are
plenty
of lessons to be learned from MF Global and heart-pounding policy
implications; all of which we can count on Congress to ignore at the
behest of the Wall Street money and lobby machine until the next epic
financial crisis – an eventuality that is growing more likely each
day as Congress refuses to restore the Glass-Steagall Act, the
depression era legislation that bars Wall Street securities firms from
owning banks holding insured deposits.
MF Global, the eighth largest bankruptcy in U.S. history, held 36,000
customer accounts in the U.S., over 5,000 in the U.K., and an unknown
number in Japan, Australia, and Hong Kong. It’s a forensic accounting
mess. Can you imagine what it would be like if one of the major Wall
Street firms failed with more than 3 million customer accounts?
MF Global filed for Chapter 11 bankruptcy in the U.S. on October 31,
2011 because of off balance sheet transactions and proprietary
trading – a quaint name for betting the house with other people’s
money – resulting in a downgrade of their credit rating to junk and a
resulting collapse in liquidity.
In MF Global’s unique world of risk controls, the CEO of the firm was
doing the proprietary trading. Off balance sheet transactions blew up
Citigroup in 2008, requiring hundreds of billions in taxpayer funds and
guarantees to shore it up. Proprietary trading, of the heads we win,
tails you lose kind, has cost Goldman Sachs and Citigroup serious
reputational damage with customers. And yet, no lessons have been
learned. Off balance sheet bombs are still lurking all over Wall Street
and the SEC continues to stall on outlawing proprietary trading at
securities firms holding customer accounts.
The CEO of MF Global when it disintegrated was Jon Corzine, the
former New Jersey Senator and Governor and former co-head of Goldman
Sachs & Co. Corzine took the reins of MF Global in March 2010.
Conflicts abounded with the knowledge and rubber stamp of the Board of
Directors. Corzine was not just Chairman and CEO, he was the firm’s top
trader of volatile European BIIPS debt – Belgium, Italy, Ireland,
Portugal and Spain. Corzine took the firm’s position from approximately $500 million when he was
hired to $8.1 billion (including Greece and France) in the 19 months it
took him to blow up the firm. (How does the CEO of a financial firm
police a cowboy trader when he’s the same individual?) When the Chief
Risk Officer of the firm, Michael Roseman, raised warnings about the
risk with the Board of Directors, Rosemanwas asked to leave and replaced
with a new Chief Risk Officer acceptable to Corzine, according to
Congressional testimony given by Roseman and Corzine.
But wearing the three incompatible hats was not the only fatal flaw
in Corzine’s management model: he contractually did not owe his total
loyalty to MF Global. The August 11, 2011 proxy issued to shareholders
and filed with the SEC carried this caveat:
“During the term of Mr. Corzine’s employment agreement with the
Company, Mr. Corzine will spend substantially all of his business time
and attention on Company matters, except that he may serve as an
operating partner of J.C. Flowers. Pursuant to his contract with J.C.
Flowers, Mr. Corzine will not receive any salary from J.C. Flowers as
long as he is serving as Chief Executive Officer of the Company, but he
will have a financial interest as a limited partner in certain of J.C.
Flowers’s investment management entities. Mr. Corzine’s employment
agreement with the Company contains a provision regarding corporate
opportunities. In general, this provision provides that, if Mr. Corzine
acquires knowledge from J.C. Flowers (and not the Company) of a
potential transaction or other business opportunity that may be a
business opportunity for the Company he will have no duty to communicate
or present such opportunity to the Company…”
JC Flowers was the namesake of J. Christopher Flowers, a former
colleague of Corzine’s at Goldman Sachs. Flowers had acquired a stake
in MF Global to help shore it up in 2008 after a trader blew up $141
million of the firm’s money overnight in what the firm called an
unauthorized trade. It was Flowers who invited Corzine to become CEO of
MF Global. Corzine left MF Global on November 4, four days after its
bankruptcy filing, at the request of the Board.
Why Corzine, a man of great wealth and political stature, would join
an obscure brokerage firm is a mystery worthy of pursuit by the FBI,
which is investigating the missing customer funds according to
Congressional sources. One avenue worthy of pursuit according to Wall
Street veterans, is whether Jon Corzine turned MF Global into
a giant parking lot for other Wall Street firms’ bad bets on sovereign
debt. Fueling that speculation is the fact that JPMorgan, Citigroup and
Bank of America were part of a syndicate of 22 banks that provided MF
Global with an unsecured $1.2 billion revolving credit line that
required no posting of collateral, despite the company’sstring of losses
and weak credit rating. The firm heavily tapped this line of credit in
its last days.
The trustee of the Chapter 11 proceeding for the parent holding
company is Louis J. Freeh, a former FBI director. On April 19, Freeh
asked the court for an expedited hearing to grant him the ability to
issue subpoenas to “the Debtors’ affiliates and subsidiaries, the
Debtors’ former employees, current and former officers, directors and
employees of the Debtors’ affiliates and subsidiaries, lenders,
investors, creditors and counterparties to transactions with the
Debtors…”
The court is allowing Freeh’s own firm, Freeh Group International
Solutions, to perform the accounting work. Four docket entries show that
Freeh has asked for and received four extensions by the court to file a
list of assets of the holding company.
Compared to Corzine’s former employer, Goldman Sachs, MF Global was a
flea on an elephant’s back. It had experienced a string of quarterly
losses since 2007, waspredominantly a Futures Commission Merchant (FCM)
holding retail and institutional commodity and futures trading accounts,
and had 80 regulatory actions against it since 1997. It had a
securities brokerage unit with 300 to 400 U.S. accounts according to the
trustee. How big those accounts were is unknown. If they were all
institutional or hedge fund accounts, it could have been a sizeable
operation. One known account, which presciently moved out before the
bankruptcy, belonged to the $100 billion private energy firm, Koch
Industries, majority owned by Charles and David Koch, financial
backers to numerous corporate front groups.
Corzine had no expertise with running a commodities firm. His
trading background at Goldman was in U.S. Government bonds, not
commodities. According to a spokesman for the National Futures
Association, Corzine passed a limited exam called the Series 32 on
August 17, 2010 but never took the full National Commodity Futures Exam,
Series 3, which would be expected of Registered Associated
Persons working for an FCM. The spokesman suggested Corzine may have
been given a waiver.
Corzine testified to Congress that he was trading debt instruments.
That would have required a valid Series 7 securities license. But the
Financial Industry Regulatory Authority (FINRA) shows that Corzine last
took his Series 7 on June 21, 1975 – 37 years ago. Securities rules
require that if one has a gap of more than two years in working for a
securities firm, they must retake the exam. Corzine had a nine year gap
while serving as U.S. Senator and Governor of New Jersey. A FINRA
spokeswoman said Corzine was given a waiver. Corzine would have also
been required to take ongoing continuing education – some of which can
only be administered by the securities firm one works for. Since
Corzine didn’t work for a securities firm for 9 years, it’s difficult to
see how that requirement could be waived.
According to FINRA’s rules, “Principal examinations are rarely
waived.” A Principal is the person charged with supervising other
security personnel and requires a Principal’s license. Based on
Corzine’s testimony, he was not only trading debt but
he was
instructing
others to write tickets. Corzine’s Principal license, a Series 24,
would have lapsed when he left Goldman Sachs in 1999. Even though its
own rules say that waving a Principal examination should be a rare
occurrence, FINRA waived that for Jon Corzine as well, according to a
spokeswoman.
Against this backdrop of regulatory and Board waivers, it is painful
to watch 10 hours of Congressional hearing videos and listen to the
Chief Executive Officer, two Chief Financial Officers, Chief Operating
Officer, Chief Risk Officer and General Counsel tell Congress and the
American people they have no idea how $1.6 billion of what should have
been legally segregated funds in customer accounts is missing. Edith
O’Brien, the former assistant treasurer, took the fifth in house
hearings, while smiling like Mona Lisa.
The final meltdown of the firm came during the week of Monday,
October 24 through Monday, October 31, 2011 – the day the firm filed
bankruptcy. On Monday, October 24, according to a Congressional memo,
Michael Stockman, the Chief Risk Officer who had replaced Michael
Roseman, sent an email that listed the firm’s net funded exposure to
European sovereign debt from Greece, Ireland, Italy, Spain and Portugal
at $7.687 billion and $422 million for Belgium and France. On the same
day,the ratings agency, Moody’s, downgraded MF Global to the
lowest investment grade rating, Baa3.
According to an email obtained by Congress, on October 24, Henri
Steenkamp, the CFO of the holding company for MF Global, sent an email
to Standard and Poor’s, writing that MF Global’s “capital and liquidity
has never been stronger…MF Global is in its strongest position ever….”
Mr. Steenkamp is still employed at the firm and is signing financial
documents for the bankruptcy trustee of the holding company.
On Tuesday, October 25, the firm announced the largest quarterly loss
since going public in 2007, a net loss of $191.6 million. Corzine was
on the earnings call with investors and explained his bets on sovereign
debt as follows: “…the structure of the transactions themselves
essentially eliminated market and financing risk.” The stock
price lost 44 percent on the day.
On Wednesday, October 26, Standard and Poor’s issued a Credit Watch
with negative implications, noting that it might soon downgrade the debt
to below investment grade, i.e., junk. On Thursday, October 27,
Moody’s again downgraded the firm’s rating, this time to junk (Ba2),
citing the firm’s “outsized proprietary position.” In the wee hours of
Sunday morning, the firm owned up to customer money missing from the
segregated accounts. A potential sale of the firm was aborted. On
Monday, October 31, MF Global Holdings Ltd., the parent entity, filed
for bankruptcy and the Securities Investor Protection Act (SIPA)
liquidation proceeding was filed for the securities brokerage and Future
Commission Merchant which held the customer accounts.
Eighteen days before the firm failed, the Treasury, Finance Group,
and a Senior risk officer prepared a hypothetical death spiral scenario
for the firm titled “Break the Glass.” Disturbingly, the following
sentence appears in the document:
“How quickly do we want to send cash back to clients, what is the
message if we do not send immediately, what is the strategy if we want
to keep the customer and wait until the storm passes..."
The checks that were mailed to customers who wanted their money out
of MF Global after its credit ratings downgrades and announcement of
a record quarterly lossbounced.
Customers have moved their accounts elsewhere now but the cumulative
total of money missing in the customer accounts is $1.6 billion,
according to the liquidation trustee hired by the Securities Investor
Protection Corporation (SIPC), James W. Giddens of the law firm, Hughes
Hubbard and Reed. Hughes Hubbard has served as bond underwriting
counsel for Citigroup, JPMorgan, and Bank of America on multiple
occasions. These are three of the 22 banks which provided the unsecured
credit facility of $1.2 billion to MF Global. The law firm told the
court it would drop JPMorgan as a client in response to letters of
complaint from customers. The trustee is currently negotiating with
JPMorgan to return money it says belongs to customers. Hughes and
Hubbard’s current relationship with the 21 other banks in the syndicate
is unknown.
Hughes Hubbard and Reed is the same law firm handling the bankruptcy
of Lehman Brothers. After more than three years, customers have yet to
be made whole. There are over 7600 law firms in New York City according
to the legal web site, Martindale.com. Why SIPC has selected the same
firm for two of the largest Wall Street collapses in history is
noteworthy.
Hughes Hubbard and Reed hired the same public relations firm to
handle both the Lehman and MF Global matters, APCO Worldwide. APCO was
originally formed as a subsidiary of Arnold & Porter, the law firm
aligned with spin for Big Tobacco in the 90s.
According to Wendell Potter, an insurance company public relations insider and whistleblower, writing in his book
Deadly Spin, "One
of the deceptive practices of which APCO has a long history is setting
up and running front groups for its clients. In 1993, Philip Morris
hired APCO to organize a front group called the Advancement of Sound
Science Coalition in response to the U.S. Environmental Protection
Agency's ruling that secondhand tobacco smoke was a carcinogen. Philip
Morris also hired APCO to manage what it called a 'massive national
effort aimed at altering the American judicial system to be more hostile
toward product liability suits' and to build a coalition to advocate
for tort reform. According to the Center for Media and Democracy, the
tobacco industry paid APCO almost a million dollars in 1995 to implement
behind-the-scenes tort reform efforts and specifically to create
chapters of 'grassroots' citizens' groups called Citizens Against
Lawsuit Abuse."
Amy Goodman, host of
Democracy Now!, interviewed
Wendell Potter on November 17, 2010. Potter revealed more about APCO
and front groups: “…there was a front group that was set up called
Health Care America, and the sole purpose for it to be set up was to
attack Michael Moore [who was about to release his documentary on health
care,
Sicko] and to attack the notion of a single-payer system
in this country…the media contact for it was a guy named Bill Pierce,
who I had known and worked with in the past...He was listed as a media
contact, and if you called his number, you would have reached him at his
desk at APCO Worldwide… There was an article that the New York
Times wrote as a kind of a review of
Sicko, not really a
review but just a story about the movie actually premiering in the U.S.
in June of 2007. And theNew York Times story quoted the Health Care
America spokesman as saying that this represented a move toward
socialism. And there was not an — apparently not an attempt on the part
of the reporter, or any reporter that I saw, to disclose the fact that
this was funded largely by the insurance industry.”
In the same month that Corzine was hired by MF Global, March
2010, there were confirmed news reports that APCO Worldwide had been
hired by the Financial Services Roundtable, a Wall Street trade group,
to promote the image of Wall Street as trustworthy. An APCO spokeswoman
says they no longer represent the account.
While customers on this side of the pond are left in the dark as to
how the sanctity of segregated accounts was bulldozed at MF Global, a
recent filing by KPMG, the administrator of the bankruptcy proceeding in
the UK of a subsidiary, MF Global UK Limited, provides more fodder for
Congressional hearings. The subsidiary was running an operation in the
UK called spread betting. That practice was known as bucket shops in
the US in the 1920s and is outlawed here. It involves making bets on
the price direction of financial stocks, commodities, indexes, and other
financial derivatives without the trades ever being placed on an
exchange. No security asset is owned by the customer.
Another spread betting firm in the UK, WorldSpreads Group, was put
under an administrator on March 18. Customer accounts were frozen with a
reported £13 million shortfall in client funds.
There is an old saying by Wall Street cynics: “Where are the
customers’ yachts?” Today, the public can’t even find out where are the
customers’ funds.
Copyright Pam Martens
Pam Martens
worked
on Wall Street for 21 years. She spent the last decade of her career
advocating against Wall Street’s private justice system, which keeps its
crimes shielded from public courtrooms. She maintains, along with Russ
Martens, an ongoing archive dedicated to this financial era at www.WallStreetOnParade.com. She has no security position, long or short, in any company mentioned in this article.