What we know. Not a whole lot
MF Global can
trace its roots to the sugar trading business started by James Man in England
in 1783. Jon Corzine took over MF Global Ltd. in March 2010 with the hopes of turning
the Company into a formidable Wall Street firm. But in little over one and a half years the
dream crumbled and the Firm filed for bankruptcy. As usual in these cases, the death Knell of
the Firm was caused by a lack of confidence and liquidity. A 228 year old firm
wiped off the map in the blink of an eye because of bad senior management, risk
controls and an overleveraged portfolio.
But as you know that is not the worst of it. This time-honored Firm is mired in an
investigation that it misappropriated customer funds. The entire outside board
resigned on December 2.
During the
last week of October, the rating agencies downgraded the firms rating twice. The
impetuous for this action was MF Global’s $6.3 billion exposure to European
sovereign debt, growing losses and concerns with risk management. MF Global
tapped credit lines for over a billion dollars, presumably to meet the growing
margin calls. We cannot be sure what the
mark to market loss is/were, however as indicated on the June 30, 2011
quarterly SEC filing we know that the equity was only $1.4 billion. As every Monday morning pundit has indicated,
this was a risky bet under most circumstances.
Where was Risk Management?
Michael
Stockman the Chief Risk officer (“CRO”) at MF Global has 25 years of risk
experience and co-authored a paper on the credit crisis that included risk
management insights and recommendations to avoid the next crisis. Here is a seasoned expert who understands
risks in a crisis market and yet MF still managed to fall apart directly related
to being long in a crisis market. What did
Michael Stockman really mean when during a March 31, 2011 interview with Risk Magazine,
he said, “We are going to be actively and aggressively seeking to take risks in
a broad fashion. In our client-facing businesses – this is no surprise as we
build out – I would suggest we are not taking enough risk,”
In the MF’s
public filings, the Company states “ The Company’s Board-approved risk appetite
and strategic objectives translate to defined risk tolerances and oversight
processes and, subsequently, strictly enforced delegations of authority and
concomitant controls, which are designed to ensure its operation within those
risk tolerances. The CRO, who reports to the Company’s President and Chief
Operating Officer (Bradley Abelow), leads the Risk department and is delegated
certain authorities from the Board. The CRO reports and advises on market,
credit, issuer and operational risk matters. The CRO and senior management
promote company wide compliance to its enterprise risk management framework”.
Did MF Senior
Management ignore the warning signs and how much did risk management push back? We will find out the answers as this case
evolves.
Why was there a breakdown in Controls?
The most
fundamental mantra at a broker dealer is to protect their customer’s assets
(currency and securities). It is the
first and most important lesson you learn when starting in an operations or
finance department. All licensed individuals
in this industry know that you do not compromise the integrity of the customer’s
well-being. Every day at a regulated
entity, the operations department ensures that the firm has possession or
control of customer assets. At least
once a week, the Finance department will ensure that the firm has sufficiently
segregated cash in a Special reserve bank account for the exclusive benefit of
its customers. The Finance department acts in an independent manner to ensure
that customer funds were not used by the Firm for Firm business. The SEC and the CFTC are of one mind on this
issue, the customer comes first and foremost.
I had been a
financial principal for a broker dealer for over 20 years. This means that I had the responsibility to
sign off on certain regulatory reports.
Every time I signed, I would review every amount and investigate any
anomaly. My license and reputation and the reputation of the firm were always
the first and last thought as pen met paper.
Certainly small mistakes were made over the years, but when the
regulators reviewed the work papers and the calculations, the information I
provided would be clear, concise and transparent. I might sound self-serving, but I am not
unique in how I approached my responsibilities.
I learned this from my predecessors and passed these lessons to my own
staff. I also worked in the Operations
department during part of my career. I
assure you the head of operations had a similar approach in ensuring that the customer
was protected.
As of today, a
team of regulators and consultants are trying to find the $1.2 billion of
customer funds. This should not be such a
difficult task, especially if the customer funds were transferred out of
customer accounts over a period of a day or two. However, Scott D. O’Malia, a commissioner at
the Commodity Futures Trading Commission, the agency leading the investigation
of the firm, recently said that MF Global’s records were “a disaster.” Between not being able to easily follow the
money and an indication that the records are a disaster, the likelihood that
the alleged misappropriation of customer funds has been going on for a longer
period of time than first believed.
So, how could
the CFO, (Henri J. Steenkamp 35 years of
age assuming the role of CFO in April 2011) or the Head of Operations (David
Simmons, started with MF on July 05, 2011) allegedly allow the most fundamental
rule of a commodities broker dealer to be ignored and how could those who
should have stood as the stewards of the firm break the customers trust?
It will be
interesting when the investigation is concluded who gave the orders, who pulled
the trigger and who had a lapse of conscience?
