Vaporized! The Halloween horror story of MF Global
It's ten years today, but a story like this one sticks with you. Maybe because the mystery of the missing customer millions was never really solved?
Chicago. Halloween morning, 2011.
It was a bit chilly as the sun came up at 7:21 a.m. Traders in the futures and options pits at the Chicago Board of Trade arrive early since they’re always an hour behind New York.
In 2011 the CBOT live trading floors, like newsrooms, were full of Bloomberg terminals and thousands of computer monitors, ticking off the news updates, and tuned to cable news channels like CNBC for the latest business updates and gossip. Traders love the adage, “Buy the rumor, sell the fact.” Rumors about almost anything, from interest rates to war to Presidential deaths, move markets.
Despite traders’ natural affinity for professional sports, and betting on them, few in the CBOT trading pits were paying attention October 31, 2011 to the news that Tony La Russa, who had managed the Chicago White Sox from 1979 to 1986, was announcing his retirement as manager of the St. Louis Cardinals, only three days after Cardinals won the World Series in dramatic fashion in Game 7.
No one on the CBOT floor, a commodity futures exchange owned and operated by CME Group of Chicago, was talking about Kim Kardashian either, for a change, even though she had suddenly filed for divorce from professional basketball player Kris Humphries on October 31 after only 72 days of marriage.
Instead the floor was spooked by the news, in the rumor mill for weeks, that MF Global would file for bankruptcy. The news of an impending bankruptcy was already rampant in Asia when New York traders wandered in, before dawn, at the New York Mercantile Exchange, also owned and operated by CME Group of Chicago. The Singapore Exchange had already told the traders that MF Global agreed to cease entering into new transactions on Monday. When Australian customers woke up they found their accounts frozen.
Given MF Global’s huge presence in the open outcry trading pits of exchanges all over the world, every MF Global employee and customer on a global basis soon found themselves cut off from access to the futures exchanges. Most were already on the Chicago trading floors when the news that MF Global Holdings shares had been halted since about 6 am eastern time came over the wires. The Federal Reserve Bank of New York had announced earlier that morning that the firm was suspended from its role as a primary dealer, one of 22 firms allowed to make a market in Treasury securities and trade directly with the Fed.
MF Global employees who attempted to enter the CBOT trading floors after 7:00am were blocked — security badges didn’t work and electronic access to the CME's Globex trading software had been cut off. MF Global employees already on the trading floor attempted to conduct business as usual but were soon escorted off the trading floor by exchange security personnel.
In New York, the InterContinental Exchange ordered MF Global employees to leave the trading floor and began limiting trading by the firm’s customers to liquidation transactions only. Outside of NYMEX in downtown Manhattan, the mood among traders and floor employees was also grim. "Everybody's running for the door," one trader who had previously been clearing through MF Global told a reporter. Floor traders rushed to find new clearinghouses. "A lot of guys left, cleared out," a reporter quoted one natural gas trader remarking. They left in fear of a major whiplash market move as a result of the bankruptcy news.
An unintentional loss of connection to the CME Globex trading software is called an "ungraceful disconnect."Active orders are canceled and the exchange freezes your trading positions. It was a nightmare, one veteran trader wrote a few years later, calling that what happened on Halloween morning a "disgraceful disconnect."
Bryan Durkin, CME Group’s COO, was the only official exchange presence that morning. He walked around the CBOT’s fourth floor lobby talking to the swarm of traders milling around because they were suddenly barred from the trading floor and locked out of Globex, the exchange’s trading software.
By mid-morning in New York it was all over: MF Global Holdings Ltd., the largest non-bank Futures Commission Merchant in the U.S., had collapsed and filed bankruptcy in a U.S. court in Manhattan.
What really scared the living daylights out of everyone, however, didn’t happen until later that evening. At 6pm Eastern Time The New York Times reported that $1.6 billion of MF Global customer money was missing from accounts that were, by law, supposed to be protected from pillage by the company and its executives.
Imagine going to your local bank to withdraw some cash for the week and the teller says, “It’s gone.”
That’s exactly what MF Global clients all over the world were told 10 years ago today, Monday morning, Halloween 2011, when MF Global filed for bankruptcy.
MF Global CEO Jon Corzine and a slew of other MFG executives would later testify before Congress that they had no idea where the money — $1.6 billion of customers’ money — had gone. Three months after the bankruptcy filing The Wall Street Journal acknowledged that we may never see the customers’ money ever again.
Nearly three months after MF Global Holdings Ltd. collapsed, officials hunting for an estimated $1.2 billion in missing customer money increasingly believe that much of it might never be recovered, according to people familiar with the investigation.
As the sprawling probe that includes regulators, criminal and congressional investigators, and court-appointed trustees grinds on, the findings so far suggest that a "significant amount" of the money could have "vaporized" as a result of chaotic trading at MF Global during the week before the company's Oct. 31 bankruptcy filing, said a person close to the investigation.
This was unprecedented and, to this day, represents the largest looting of customer funds by a broker-dealer/futures commission merchant in the history of Wall Street. Whet Moser at Chicago Magazine:
What, exactly, happens when money vaporizes? Does it dry up, like a raisin in the sun? Or does it explode? Water is often used as a metaphor for money—it flows, pools, and dams up. Maybe it can turn into vapor, too!
It would take nearly two years until the farmers, ranchers, traders, independent brokers, and other clients of MF Global would be made whole. “Mission accomplished!” said the bankruptcy Trustees and almost everyone, including the regulators, moved on.
The problem was, and still is, the missing clients’ money had never really been found. Let’s take you back to the week of October 24, 2011 to explain.
Corzine had placed a bet on sovereign debt of some of the developed world’s most troubled economies at the time. In July of 2011 MF Global raised $325 million through an offering of seven-year, 3.375 percent senior convertible notes and in August, the firm launched and priced its first senior unsecured debt offering, issuing $325 million in five-year, 6.25 percent senior notes. MF Global said in its 3rd quarter earnings announced October 25, 2011 that it had used a portion of the net proceeds of these offerings to repurchase its existing 9 percent convertible senior notes due 2038, repaid a portion of its outstanding permanent indebtedness under its $1.2 billion revolving credit facility and used the remainder for general corporate purposes.
By August 2011, MF Global’s repo-to-maturity position had grown to $7.4 billion, compared to nearly zero a year before. I wrote in Forbes in June of 2012:
Jon Corzine got the chief executive job at MF Global in early 2010 for one reason: Chris Flowers bailed the firm out in 2008 after a wheat trader’s shenanigans cost it $140 million. Flowers was growing impatient with constant losses and Corzine was brought in to return the firm to profitability.
MF Global’s core business was losing money, squeezed by a low interest rate environment and declining trading volumes for futures customers. Corzine could return the firm to profitability by shrinking it, expanding it, or choosing Door No. 3 – betting the firm on risky trades in European sovereign debt.
Trades that required lots of liquidity. And careful risk management.
Rather than a reasoned strategy to turn the firm around, Corzine chose chutzpah. He put a perverse twist on the repurchase trade, routinely used in the past to squeeze some additional income out of the Treasury securities that are traditionally on hand as part of normal business operations. Corzine used the repo trade to finance purchases of billions of dollars of volatile European sovereign debt instead, thereby multiplying the liquidity and risk management needed to come out ahead.
However, a source close to what happened at MF Global in those final days told me that MF Global had burned through six months of working capital in five weeks after the debt offerings. Paul E. Peterson, in Choices Magazine in 2013 wrote:
The success of this RTM strategy rested on two important requirements: that the European debt crisis would not worsen, and that MF Global would maintain a stable credit rating. Instead, the European debt situation steadily worsened and bond prices continued to decrease, leading to margin calls from the lenders in the RTM trades. These margin calls were a major factor in the record $191.6 million loss reported by MF Global for the fiscal quarter ending September 2011. This loss led to a downgrade of the company’s credit rating to the lowest level eligible for investment grade, and set off another wave of margin calls on the RTM trades.
Things at MFG were more tense than usual Monday the 24th. The Wall Street Journal had reported Moody’s had cut the firm’s debt rating again to junk. The firm was circling the drain and everyone that worked at the firm — in New York, Chicago, London, Toronto, Hong Kong, Singapore, and Sydney — panicked.
Large clients were heading for the doors, asking for their accounts to be closed and funds wired immediately. Lenders cancelled credit lines, other firms stopped trading with MF Global, and counterparties slowed or withheld their payments. MF Global was quickly running out of cash.
As the week wore on, the firm dipped further into statutorily protected assets in its client accounts to use to prop up its own proprietary business, and once it started, there was no stopping it. It got so bad the firm was making intra-day borrowings — transferring funds out in the morning and returning them by the end of the trading day when the final numbers were reported to regulators. By the end of the week the firm was borrowing more than it repaid each day and had stopped creating the regulatory reports.
By Friday, Oct. 28, MF Global realized it had a $300 million shortfall in customer segregated funds. MF Global had experienced a run on the bank and needed an infusion of cash, around $400 million, to make it through the weekend, when a sale of the firm would be consummated. This figure was confirmed by new reporting that confirmed JP Morgan asked the Fed to keep the door open until 9pm that night to allow MFG to wire money out of its accounts at the bank.
Interactive Brokers was nosing around doing due diligence. Instead of solving the problem the shortfall grew larger. Interactive Brokers was the only serious interest in the business after the firm’s primary banker, JP Morgan, took a pass.
We know MFG got that cash infusion, because otherwise it would’ve had to declare bankruptcy Friday night. Now Corzine could work on sealing a deal to sell the firm by Sunday.
It wasn’t to be.
As time passed the shortfall in the segregated customer funds accounts had grown larger. Interactive Brokers balked when they saw a huge hole in the firm’s customer accounts, and walked away.
By early Monday morning, the amount of missing segregated funds had reached $900 million for customers trading on U.S. exchanges, and $700 million for customers trading on foreign exchanges. On Monday morning, MFG was forced to declare bankruptcy, sending a shudder through world financial markets.
MFG executives told regulators they didn’t know where the money had gone, and a crack team of forensic accountants was unsuccessful for a long time in solving the mystery. The question remains, “What happened to the $1.6 billion in customer assets?”
A review of hundreds of pages of reports from each of two Bankruptcy Trustees confirms that clients were not made whole because the missing billion dollars was “found,” as media dutifully reported based on press releases from bankruptcy trustees James Giddens and Louis Freeh. MF Global’s customers got their money back via negotiation and threats of lawsuits by two Trustees who squeezed each of MFG’s two biggest banking partners — JPMorgan and Bank of New York Mellon, along with other parties like the firm’s auditor PwC. Indeed, one Trustee report states that clients got their money back via “negotiation and litigation.”
I had a theory about what happened right away, based on my reporting and sources focused on the Chicago FCM and its back office. I published that theory in Forbes a week after the bankruptcy filing.
(An FCM is an individual or organization that (i) solicits or accepts orders to buy or sell futures contracts or options on futures contracts and (ii) accepts money or other assets from customers to support such orders. As such, FCMs are agents or intermediaries for their customers.)
On December 15, 2011, the oversight panel of the House Financial Services Committee released a CME Group document with a detailed log of its contacts with MF Global between October 24, 2011 and October 31, 2011. According to this document, Christine Serwinski, the Chief Financial Officer for North America at MF Global, and its Assistant Treasurer, Edith O’Brien, told Mike Procajlo, a CME Group auditor at 1:00 a.m. on Oct. 31, 2011 that the customer money was transferred on Oct. 27 and Oct. 28 and possibly Oct. 26, 2011.
“About $700 million was moved to the broker-dealer side of the business to meet liquidity issues in a series of transactions on Thursday, Friday and possibly Wednesday,” Serwinski told Procajlo, according to the document, about eight hours before the firm filed for the eighth-largest bankruptcy in United States history.
This additional detail about use of customer assets in the final days is consistent with my original theory. Recently, I’ve refined my theory with the help of more reporting and the assistance of award-winning documentary filmmaker Nick Verbitsky who is working with me to pursue related projects.
Our refined theory revolves around a successful investor who put his old Goldman pal Jon Corzine into MF Global after failing to get his hands on the firm any other way more than a few times and a complex deal structure that boils down to something very simple — a lender gives cash to a borrower, and the borrower offers collateral to the lender. The collateral requirement for the “Hail Mary” loan MF Global needed to make it through the weekend would have been extraordinarily high. That’s because a deal with an insider has to be a secret, is highly risky, and is potentially illegal. What did MF Global give up to get that loan?
MF Global, well, Corzine to be specific, had run out of time to sell other assets or borrow from anyone else. He needed cash at the last minute, before a weekend, and wanted to use his customers’ securities as collateral. Tri-party repos can be done anonymously. A bank acts as the middleman. That means the counterparty to the transaction could remain anonymous and would be difficult to trace in the chaos aftermath of the bankruptcy. The customer assets, likely U.S. Treasuries and other fungible assets not tied to a specific customer, are deposited with a custodian. MF Global had an existing relationship, and account, for such transactions at Bank of New York Mellon.
In the event of a default like a bankruptcy the counterparty owns the collateral. As soon as MF Global declared bankruptcy in a New York court and a trustee was assigned on October 31, the counterparty could immediately seize the collateral, in this case MF Global’s customers’ securities.
This is exactly what we think happened at MF Global.
To read more about this case, including the case against MF Global’s auditor PwC, here is a curated selection of the numerous stories I’ve written:
MF Global Assets Have Left The Building: How, When, Where Francine McKenna, Forbes.com, November 9, 2011
When I was growing up on the South Side of Chicago, we used to see the “shell game” guys quite often on the “L” train. One smooth talking guy, three dixie cups and a garbanzo bean. (A garbanzo bean is better than a pea because it doesn't roll off the piece of cardboard resting on his lap as the train rocks and rolls.)
Someone guesses correctly which dixie cup the bean is under and wins $20. The winner is a plant - there to promote false confidence. The mark does not guess correctly. A player not in on the game will eventually get suckered.
Almost everyone wondering where the missing MF Global customer assets have gone thinks they will show up eventually.
I believe the assets are long gone.
BankThink Auditor PwC Should Have Been on Top of MF Global Francine McKenna, American Banker, November 4, 2011
The Neverending MF Global Story: Regulators Block The Truth Francine McKenna, Forbes.com, January 9, 2012
Uncontrolled Risk Taking, Not Bad Accounting, Did MF Global In Francine McKenna, Forbes.com, June 14, 2012
Rather than a reasoned strategy to turn the firm around, Corzine chose chutzpah. He put a perverse twist on the repurchase trade, routinely used in the past to squeeze some additional income out of the Treasury securities that are traditionally on hand as part of normal business operations. Corzine used the repo trade to finance purchases of billions of dollars of volatile European sovereign debt instead, thereby multiplying the liquidity and risk management needed to come out ahead.
It’s not every day the way a trade is accounted for makes such a difference in how investors, and the market in general, eventually view its success or failure. Buried on page 65 of the 180-page report issued by the trustee on June 4 are new details about MF Global’s fatal high-risk repo-to-maturity trades.
Some continue to compare MF Global’s repo-to-maturity trades to Lehman’s Repo 105 trades, also treated as sales. The accounting standards for both these trades and repo-to-maturity trades allowed off-balance-sheet treatment. Lehman’s objective in using repurchase transactions and treating those trades as asset sales was very different than MF Global’s, however.
The MF Global repo-to-maturity trades were intended to juice profitability, not dress up the balance sheet like Lehman Brothers’ infamous Repo 105 transactions. Unlike the opaque Lehman, MF Global fully disclosed the trades and their accounting treatment including the off-balance sheet effect. Treating the trades as sales allowed MF Global to book a profit immediately in its U.S. unit.
PricewaterhouseCoopers approved the accounting treatment.
On Anniversary of MF Global Bankruptcy, Something Still Missing Francine McKenna, reTheAuditors.com, October 31, 2012
PwC Partner At MF Global Has Long, And Mixed, Track Record Francine McKenna, Forbes.com, June 7, 2013
Who Is The PwC Partner Responsible For MF Global? Someone With A Lot of Baggage, Francine McKenna, reTheAuditors.com, June 14, 2013
Limit Up! A Review of “The Futures” by Emily Lambert w/Book TV Link Francine Mckenna reTheAuditors.com, March 5th, 2011
© Francine McKenna, The Digging Company LLC, 2021
