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The securities dealer's finance department and its regulators were busy looking for a mysterious reporting glitch during the company's final days – one they never found.
Vincent Ryan, CFO.com | US
April 3, 2012
While securities dealer MF Global was melting down financially, the company's finance and treasury departments - in conjunction with futures-market regulators - were on the hunt for the accounting error that wasn't.
MF Global's general counsel and the CFO of its broker-dealer unit appear to never have had any evidence that faulty reporting had caused a deficit in customer-segregated accounts. But they persisted in their belief for as long as three days, according to a time line of the firm's final days constructed by the Chicago Mercantile Exchange. The reason? The amount was so large "it was too big to be anything else."
In turn, early on, the CME and the Commodity Futures Trading Commission were prevented from conducting a full audit of customer-account statements because they didn't have all the necessary documentation from MF Global. The three-day delay in confirming the customer-account shortfalls combined with the inability of regulators to get timely information from MF Global personnel may have contributed to the "loss" of $1.6 billion in customer funds and the firm's eventual demise.
The bankruptcy has stirred up a firestorm in the securities industry and among regulators because many of the customers who lost money were farmers and ranchers who used futures in nonspeculative ways to hedge against price volatility. The firm went from reporting a $192 million quarterly loss on October 24, 2011, to filing Chapter 11 on October 31.
The theory is that someone at the firm overrode internal controls that safeguarded customer funds and transferred money out of them to sure up the company's global liquidity position. Congress and federal investigators are particularly focused on the role of Jon Corzine, the former CEO of Goldman Sachs and governor of New Jersey, and whether he purposely directed his treasury department to use customer funds.
Futures brokers such as MF Global have to keep customer funds segregated from the firm's own, but they are permitted to commingle money to create a buffer in case any one customer incurs substantial trading losses. The broker can withdraw some funds from those accounts for operational uses, but has to keep a certain cushion in the accounts, and any shortfalls have to be reported to the Commodity Futures Trading Commission.
The events of MF Global's final days, gleaned from the CME time line and reconstructed from the recent testimony of two of the firm's CFOs and its general counsel, show a firm in chaos. MF Global was in a frantic search for liquidity as it faced margin calls from futures clearinghouses, customer demands for withdrawals, and requests from counterparties for additional collateral. Executives were also trying to negotiate a sale of the company to Interactive Brokers, a Greenwich, Connecticut-based broker-dealer and proprietary trading firm. But the sale was derailed after the search for the accounting error ended.
Here's how the notion of a reporting glitch developed: The daily closing report of MF Global's customer-account balances first showed a deficit on Wednesday, October 26, according to the testimony of Christine Serwinski, former CFO of the North American broker-dealer unit of MF Global. But it wasn't until 1 a.m. on Monday, October 31, according to the CME, that Serwinski and assistant treasurer Edith O'Brien confirmed that the deficit was real and told Mike Procajilo, a CME auditor, such.
That's because they first believed that it was the reporting that was at fault. The possibility of an accounting error was first discussed on October 29. On that day, MF Global's treasury department reported to Serwinski that the previous day's accounting showed a shortfall in customer-segregated accounts. But the staffers told her it reflected "reconciliation errors" and that the account was not really "under-segregated."
The search for the accounting glitch began in earnest the next day, October 30, when a CFTC official saw a draft of the October 28 customer-account report. That kicked off a series of telephone calls among Procajilo, MF Global's general counsel, Laurie Ferber, and its assistant controller, Mike Bolan. Serwinski and others still believed the report was the result of an accounting error. The shortfall was "inconceivable to me," said Serwinski in her congressional testimony.
The CME time line says "at some point" that day MF Global representatives told the CME that they found the error. Later on, Bolan reportedly informed the CME that the error was a "mis-posting" in the amount of $450 million. But the CME's Procajilo, meanwhile, was getting conflicting reports from his auditors at MF Global's Chicago offices. They were telling Procajilo that despite an exhaustive review, no one had found any accounting errors.
When Serwinski and assistant treasurer Edith O'Brien confirmed that the deficit was real and told the CME, they then scrambled to secure cash to "top up" the segregated accounts. But MF Global failed to find any available funds and the Interactive Brokers deal collapsed.
Could regulators have acted sooner and saved the company, or at least protected customer funds? The CME says it was worried about MF Global's liquidity as early as October 25, in the wake of a credit-rating downgrade by Moody's. Procajilo says he asked assistant controller Bolan for a liquidity analysis of the broker-dealer side of the business as early as the morning of Thursday, October 27. Although Bolan told Procajilo the analysis would be ready later that day, Procajilo never received it, says the CME.
On October 27, CME auditors arrived at the Chicago offices of MF Global to examine the statement of customer-segregated funds for the close of business on October 26. According to the CME, though, its auditors never completed the analysis because they didn't have all the documents they needed from the company to perform the audit.
As of October 28, based on their review of the documents they did receive, the CME auditors had no reason to believe the segregated account was out of compliance on October 26. On October 30, the day before MF Global's filing of Chapter 11, the CME auditors received a disc from CFTC officials containing the missing documents from October 26. But by then the auditors were swept up in the pursuit of the accounting error.