Following nearly three hours of not answering Senate Agriculture Committee questions on Tuesday, a trio of MF Global (http://en.wikipedia.org/wiki/MF_Global) executives may have thought they’d slipped the noose. In the face of increasingly exasperated committee member questions, the executives – responsible for the eighth-largest bankruptcy in U.S. history and the odd, potentially criminal, loss of an estimated $1.2 billion in customer funds – exhibited amnesia symptoms, reciting a wide range of variations on “I don’t recall.”
But immediately after the executives were dismissed, the CME Group’s (http://en.wikipedia.org/wiki/CME_Group) Terrance Duffy gave testimony under oath that contradicted former MF Global head Jon Corzine’s (http://en.wikipedia.org/wiki/Jon_Corzine) claims of ignorance regarding the disappearance of customer funds.
In the days just prior to MF Global’s demise, CME – tasked with auditing MF Global’s futures business – had auditors reviewing the firm’s segregation reports. The Oct. 26 and Oct. 27 reports, said Duffy, showed the firm in full compliance.
In fact, the Oct. 27 report “showed the firm held $200 million in excess segregated funds.”
Then, on Oct. 30, “the CFTC informed us they were aware of a draft segregation report for the close of business on Friday, Oct. 28, which showed more than a $900 million shortfall in required segregation,” testified Duffy, CME Group Executive Chairman.
For more coverage of Duffy’s testimony, see here.
“CFTC and CME staff and auditors returned to the firm on Sunday, Oct. 30, and were informed by this discrepancy was caused by ‘an accounting error.’ Our auditors, working with the CFTC, devoted the rest of the day and night, to find the so-called ‘accounting error.’ No such error was found.
“Instead, at about 2 a.m. Monday morning, Oct. 31, MF Global informed both the CFTC and CME that the shortfall was real and that customer segregated funds had been transferred out of segregation to the firm’s broker dealer accounts.
“After receiving this information, CME remained at MF Global while (the firm) attempted to identify funds that could be transferred into segregation to reduce or eliminate the discrepancy.”
Duffy then spiked Corzine’s credibility. “A CME auditor also participated in a phone call with senior MF Global employees, wherein one employee indicated that Mr. Corzine knew about the loans made from the segregated accounts.”
On Monday, Oct. 31, continued Duffy “MF Global revised its segregation report for Thursday, Oct. 27, indicating that the alleged $200 million in excess segregated funds should have been reported as a deficiency of $200 million. This shortfall on segregation on Thursday, Oct. 27, was hidden by the inaccurate report, a telling sign to keep regulators in the dark.
“It remains to be seen whether this failure to disclose permitted additional segregated funds to be improperly transferred.
“Throughout this time, the firm and its employees were under the direction and control of MF Global management. Transfers of customer funds effectuated by MF Global for the benefit (of the firm) constitute very serious violations of our rules and of CFTC regulations.”
Duffy’s claims came after his earlier testimony before the House Agriculture Committee on Dec. 8 where he didn’t mention the allegation. “This leaves us wondering why you’re sharing it now,” said Michigan Sen. Debbie Stabenow, committee chairman, following Duffy’s opening statement.
Duffy said the information was “not made available to me prior” to the House hearing. “I received this information (on Dec. 10) from an e-mail and phone call from our lawyers. They informed me of what they’d found out in their investigation” but hadn’t shared previously.
Regarding ongoing MF Global bankruptcy proceedings, Duffy backed those calling for customers to be made whole first. Such clients “should be first in line in front of all other participants, including bond-holders and everyone else.”
Duffy stuck another thumb in Corzine’s eye. In the wake of MF Global’s collapse, Duffy doesn’t believe the regulatory system “is broke. I think someone violated the rules.”
Kansas Sen. Pat Roberts rued the fact that Duffy hadn’t been in the panel prior to the MF Global executives. “You have sort of tossed a bomb.”
Undoubtedly, Duffy’s allegations against Corzine will be a key focus of the House Finance Committee’s MF Global hearing on Thursday (Dec. 15).
In the dark
Addressing Corzine (who was joined by the firm’s Chief Financial Officer Henri Steenkamp and Chief Operating Officer Bradley Abelow), North Dakota Sen. Kent Conrad said trying to “pierce the veil” surrounding MF Global was proving “incredibly” difficult. And it quickly became obvious that -- despite hours’ worth of congressional testimony and weeks to consider their past actions -- the firm’s lawyered-up and subpoenaed executives were simply unwilling to help the committee shed light on the situation.
Seeking a “direct answer” Georgia Sen. Saxby Chambliss simply asked Corzine if he knew MF Global was using “customer funds to carry out proprietary transactions?”
Corzine claimed he was unaware of the “misuse” of customer funds, a word he used regularly. “I didn’t authorize it, didn’t intend to have it happen.”
A combative Roberts, ranking member of the committee, asked the panel a series of questions regarding MF Global actions in the days just prior to the discovery of “lost” customer funds. Did the firm receive margin calls “or other requests for liquidity on Oct. 28?”
Corzine: “I believe there were margin calls as there are on almost every day.”
Roberts: “Well, you indicated publically that $4.5 billion went out the door.”
Corzine: “I’ve repeatedly said that there was $4.5 billion worth of U.S. government agencies sold on that day. That was a sale designed to produce margin coming back to the firm as opposed to margin going out of the firm.”
Roberts: “We’ve heard a lot of 35-cent words being tossed around. ... We may not understand the ins-and-outs of it, but two things we do understand are margin calls and chain of command.
“We know customer money was accounted for on (Oct. 26). On (Oct. 28), the firm’s cash flow situation was dire and demands for cash kept coming in.”
Roberts asked Abelow and Corzine if it was the case “that MF Global didn’t have enough cash on hand to cover the cash needs that came in late (Oct. 28).”
Corzine: “From all reports that I’d received, to my recollection on that day, we were able to meet our cash demands.”
Abelow again claimed to be in the dark. “I do not recall being made aware of our running out of cash ... and being unable to meet obligations.”
Roberts dug farther, asking about the possibility that “operational money movers ... was told to cover the liquidity needs or margin calls overwhelming the firm’s cash flow by taking money out of the segregated customer accounts?”
Corzine: “I don’t believe anyone would operate that way. We had no experience in the 19 months I’d been there that anyone had overridden those systems. I have no reason to believe that occurred in those last hours.”
Abelow refused to “speculate about conversations I didn’t see or participate in. I can only tell you I don’t recall participating in any conversation about use of customer funds or assets other than for their intended purposes.”
Breaking the glass
Roberts, growing frustrated, made the point that before MF Global’s collapse, CME knew the firm was “attempting to hide something. In fact, didn’t MF Global leadership go so far as to request and receive an actual plan that would ‘break the glass’ and tap into your customers’ segregated accounts?”
Corzine admitted there was such a report, although “it was not ever the intent to recommend tapping into segregated customer funds.”
Despite his placement at the firm’s pinnacle, Abelow again claimed he was not plugged in and had not “reviewed the specific document. My recollection was that the key source of liquidity under that scenario was the use of a revolving credit facility.”
Roberts retorted “you might want to take a look at it” and then laid out a possible explanation for the firm’s actions. “By all accounts, on the Friday before bankruptcy, MF Global thought it had found a buyer to save (the firm). It seems well within the realm of possibility that a classic run on the bank overwhelmed (the firm’s) cash flow. And an executive could have communicated, somehow, an order to use your customer segregated funds to cover the firm’s liquidity thinking, of course, everything would be fine by Monday morning. The company would be bought out and an infusion of money from the new owner could replace the missing customer funds. Is this plausible?”
Corzine paused before answering. “As in a number of questions, being asked to speculate – and I don’t think I should speculate – I had no reason to believe until the evening of Oct. 30 that there was a misuse of customer funds.”
Abelow echoed a common refrain from Mf Global executives, saying he was “shocked” to learn of the customer fund shortfall.
Roberts, in a clipped tone, “well, if this isn’t what happened? What did happen?”
The executives passed on answering.
The search for integrity
That didn’t stop committee members from trying to box the executives in. Barring deliberate transfers, North Dakota Sen. John Hoeven wondered how MF Global’s customer accounts could be short.
“We had customers also withdrawing funds from the firm,” claimed Corzine. “There are all kinds of transactions associated with that. ... There are possibilities in the repurchase agreements – the proper use of Rule 1.25 investments -- between the FCM and broker dealer that could have broken down.”
The customer funds that are short dollars “were either moved out of their accounts for the benefit of the firm,” said Hoeven. “Or, you have an accounting error and you have a responsibility to make sure you have an accounting system that properly segregates those dollars.”
“There could have been breakdowns in those systems,” said Corzine. “We believed we had the people, the procedures, and the policies in place to protect client segregated funds.”
Iowa Sen. Charles Grassley was “baffled” by the inability of the MF Global executives to answer basic questions. The trio’s “supposed lack of knowledge ... is alarming. I want answers and Iowa farmers want answers.”
Grassley then began a series of questions -- asking for names of MF Global employees able to provide answers that the executives wouldn’t -- that was picked up by other committee members. The reluctant executives provided only several names and eventually pointed to the firm’s treasury department.
Roberts loudly wondered how much testimony it would take “before we finally drill down and find someone’s name who knows what the heck is going on?” He suggested Abelow put together a chart of the firm’s hierarchy and employee names “and we’ll finally get down to the custodian.”
Upon learning of the customer fund shortage “what did you say to each other?” asked Conrad. “If it was me, the first thing that would come to my mind is ‘how in the hell did this happen?’ Did you have a theory?”
Corzine said his reaction was to “marshal resources ... and find out where the money is and why we’re out of reconciliation. Then, step back and let the people who know how to read the thousands of pages of records, get on with the business.”
With so much MF Global client money missing, Nebraska Sen. Mike Johanns went looking for “some person who had sufficient integrity to say ‘Oh, my lord. Client money is disappearing and I need to talk to the boss.’ Are you aware of anybody in the organization” who alerted MF Global leaders “something very, very serious is happening?”
There was no such person or warning, Johanns was told. “Do you realize how incredible that sounds to this committee? $1.2 billion – the first time in history it had happened – could get drained away from customers and it doesn’t come to your attention or someone doesn’t seek your authorization? Doesn’t that strike you as incredible?”
For all witnesses’ prepared testimony, see here.