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Subcommittee Says Corzine Led MF Global Into Bankruptcy; Also Cites CFTC, SEC Errors

Friday, December 21, 2012
By Richard Hill

A House subcommittee report issued Nov. 15 said former senator and New Jersey governor Jon Corzine caused the bankruptcy of futures commission merchant MF Global Inc. and that financial regulators compounded his mistakes by failing to share critical information as the firm floundered.

The report by the Financial Services Oversight and Investigations Subcommittee also implicated two credit ratings agencies for allegedly failing to do due diligence on the firm as it engaged in riskier activities.

The subcommittee said Corzine “made several fateful decisions” during his 20-month tenure as chief executive officer of the 230-year-old firm, “the cumulative effects of which caused MF Global's bankruptcy and jeopardized customer funds.” Those decisions included taking risky bets on European sovereign debt and negating the firm's traditional risk-management regime by “sideline[ing]” its chief risk officer.

The firm filed for bankruptcy protection Oct. 31, 2011, telling its regulators that several hundred million dollars in customer funds were unaccounted for (23 BBLR 1365, 11/3/11).


Regulatory Silence
In addition to Corzine, the subcommittee singled out the Commodity Futures Trading Commission and the Securities and Exchange Commission for failing to share critical information as they oversaw MF Global's operations. The firm was registered with the SEC as a broker-dealer and with the CFTC as an FCM.

Specifically, the panel said that the SEC did not include the CFTC or futures self-regulators in a meeting it held with MF Global in June 2011 that was prompted by the firm's continued losses and changes in business strategy. It also allegedly did not include the CFTC in discussions with the Financial Industry Regulatory Authority about a capital charge FINRA imposed on MF Global that eventually affected the firm's capital requirements under CFTC rules.

The CFTC, the report said, failed to inform the SEC that MF Global was using an alternative method to calculate its obligations to commodities customers trading on foreign exchanges, a move that could have affected its broker-dealer operations.

A CFTC spokesman declined to comment on the report and its findings. An SEC spokesman, meanwhile, rejected the assertion that the agency failed to share information about the FINRA action with the CFTC. John Nester told BNA in an email that “the report neglects to note that our staff in fact informed the CFTC staff of these charges at that time, a fact confirmed by CFTC's general counsel in testimony before the subcommittee.”

The subcommittee report said that even when the SEC and CFTC began communicating during the last week of the firm's existence, “the agencies often worked at cross-purposes.” In one supposed instance, the agencies clashed about how the firm should use an excess $220 million that it had set aside for broker-dealer customers.

The subcommittee concluded that had the agencies better coordinated their oversight of MF Global, “they might have gained a more complete understanding of the company's deteriorating financial health, and they might have taken action to better protect the company's customers and investors before it collapsed.”

It recommended that the agencies either streamline their operations, or that Congress explore merging them into a single body. Nester said the SEC was reviewing the report and would “consider carefully” the recommendations that are within the agency's jurisdiction.


CRAs
The subcommittee also was critical of the role credit ratings agencies played in the demise of MF Global. It said that while Moody's and Standard & Poor's both were aware that the firm had increased its risk profile, neither was diligent in following up. Specifically, the report noted that despite knowing for five months that the firm had increased its exposure to risky European sovereign debt, the CRAs did not factor the investments into their ratings of MF Global until one week before its liquidation.

The report also charged that the CRAs either “did not understand” MF Global's investments, or that their understanding “was inconsistent with MF Global's public filings.” It said Moody's and S&P's actions “suggest an absence of due diligence” on their part, and that the Financial Services Committee should consider requiring the SEC to establish periodic public monitoring of CRAs.

Moody's did not return a call seeking comment Nov. 15. Meanwhile, S&P spokesman David Wargin told BNA Nov. 15 that the agency “monitored MF Global's creditworthiness and took ratings action as events warranted based on a review of available information.”

Regarding the subcommittee's recommendation for CRAs, Wargin said S&P “conducts surveillance on an ongoing basis and did so here, consistent with our goal of producing forward-looking, timely, and credible credit rating opinions. We do not believe that government-mandated surveillance would add to the quality of our ratings.”

Also spotlighted by the subcommittee was the New York Federal Reserve Bank and its decision to grant MF Global “primary dealer” status. The designation allowed the firm to act as a counterparty to open market operations executed by the New York Fed and gave it an air of government approval, according to the panel. The subcommittee urged the New York Fed to examine its “primary dealer” selection process to see if it is adequately scrutinizing potential participants.

Meanwhile, the report painted Corzine as an authoritarian whose insular leadership style and trading decisions sank the firm. Corzine joined the firm in March 2010 and resigned several days after it filed for bankruptcy protection.

The subcommittee pointed to Corzine's decisions “to chart a radically different course for MF Global” as an investment bank--“a mini Goldman Sachs,” subcommittee Chairman Randy Neugerbauer (R-Texas) called it at a press conference Nov. 15--rather than a commodities broker as the root cause of the firm's bankruptcy.

The report said Corzine “fail[ed] to maintain the systems and controls necessary to protect customer funds,” and concluded that those actions “represent a dereliction of his duty.”

The subcommittee, however, did not make a recommendation about whether Corzine, the firm, or others should face prosecution.

Corzine himself told the House Agriculture Committee and other congressional panels in December 2011 that MF Global was in a weak financial position when he took it over, and that he “saw the possibility of taking part in the transformation of a challenged company by restructuring existing businesses and capturing opportunities available in the post-2008 financial environment” (23 BBLR 1582, 12/22/11).

The subcommittee, however, said that Corzine's actions exposed the firm to risks it could not afford.

A spokesman for Corzine could not be reached for comment Nov. 15.


European Debt
The report observed that Corzine began investing heavily in the sovereign debt of struggling European countries, a fact that Corzine also discussed in his congressional testimony. The strategy, however, contained inordinate risk, which Corzine successfully shielded the firm's board from knowing. At the same time, the “authoritarian atmosphere” he allegedly instilled at the firm discouraged subordinates from second guessing him, the subcommittee said.

Adding to the gathering risk crisis, according to the panel, was the fact that Corzine allegedly kept many of the sovereign debt transactions off the books, meaning shareholders, depositors, and the firm's counterparties were blindsided when CRAs and the press began reporting the firm's outsized risk profile in late October 2011.

According to the subcommittee, as staff grasped to identify unallocated company funds to fend off the liquidity crisis, they inadvertently drew upon the customers' assets as well as the firm's. In that vein, the subcommittee concluded that Corzine “failed to integrate systems and controls for managing the company's liquidity and protecting customer funds, [and] the company could not fully assess and anticipate its liquidity needs during the crisis, nor could it coordinate its cash management, liquidity monitoring and regulatory compliance functions.”

Neugerbauer and Financial Services Chairman Spencer Bachus (R-Ala.) declined to say specifically Nov. 15 that Corzine was involved directly with transferring the customer funds for the firm's use.

By Richard Hill

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