Risk Management

Lax Treasury Practices Aided MF Global Fall, Experts Say

Trying to meet frantic demands for cash and collateral from its counterparties, MF Global’s treasury department may have lost track of “whose cash ...
Vincent RyanApril 10, 2012

Poor accounting of the movement of funds between bank accounts and outdated treasury systems contributed to the chaos of the final days of securities dealer MF Global — and ultimately to the loss of $1.6 billion in customer funds.

According to corporate treasury experts, the congressional testimony of key executives at MF Global shows that the commodities firm’s treasury department was poorly organized and insufficiently automated and that those flaws as much as anything may have led to the improper transfer of money out of so-called customer-segregated accounts.

The defects in MF Global’s treasury operations were exposed when, in the company’s final week, margin calls from futures clearinghouses, customer demands for withdrawals, and requests from counterparties for added collateral sparked a frantic hunt for liquidity.

Federal officials are investigating how a series of money transfers among MF Global’s different bank accounts at JP Morgan & Co. and between subsidiaries of MF Global’s holding company may have caused the “loss” of customer funds. The theory is that someone at the firm overrode internal controls that safeguarded customer funds and transferred money that was designated as belonging to customers with a few of those transactions exceeding $100 million.

Commodities houses don’t strictly segment customer cash and the house’s cash, points out Jeff Wallace, a co-founder of Debt Compliance Services. Firms can legally put their own money in the customer account to handle intraday flows and take it out at night. But the firm has to keep a certain cushion in the accounts, and any shortfalls have to be reported to the Commodity Futures Trading Commission.

But MF Global, it appears, lacked sufficient documentation and proper accounting for the movement of money in and out of customer accounts. 

“It’s pretty clear that MF Global did not have a treasury workstation — they were keeping track of fund transfers on a spreadsheet and using e-mails and phone calls,” says Bruce Lynn, a managing partner at The Financial Executives Consulting Group. “They were in the 1980s.”

For example, when money is transferred from a bank account, there should be a contemporaneous entry on the books of the corporation, says Lynn, or at least that is best practice. MF Global may have been transferring the money but then not reconciling or accounting for the transfer until nearly a month later. “There is a black hole for days and weeks, and that is just sloppy,” says Lynn.

That careless recordkeeping around MF Global’s bank accounts could also have contributed to executives’ delayed realization that customer-segregated accounts were actually underfunded and not misreported.

For four days, one of MF Global’s CFOs, Christine Serwinski, and general counsel Laurie Ferber believed a near $1 billion shortfall was due to reconciliation errors. The Chicago Mercantile Exchange and the Commodity Futures Trading Commission also had trouble conducting a full audit of customer-account statements because they didn’t have the necessary documentation from MF Global.

The hectic pace with which the company’s treasury department was processing transactions in the firm’s final days may have also caused treasury staff to delay the reporting of bank transfers.

“I’m willing to believe that the volume of transactions were such that [treasury] wasn’t inputting the trades; they were just opening the JP Morgan account and doing wire transfers directly out of it and they weren’t updating their current records,” says Wallace. “When the volume was growing crazy, they just lost control of whose cash was whose.”

And there was an urgency to complete transactions. When a Wall Street firm is being drained of its cash by margin calls and other demands from counterparties, “to keep up appearances you want to give people the cash as soon as possible,” says Wallace, “If a bank makes a demand for $50 million at eleven-thirty, theoretically you could wait to pay them off at four-thirty, when the Fedwire closes. But when there are real questions about your firm’s liquidity, you don’t want [counterparties] to wait.”

Despite the chaos, though, multimillion-dollar transfers of money would have had to have been approved by a top executive, says Lynn. In other words, MF Global assistant treasurer Edith P. O’Brien, who declined to answer questions from Congress, must have gotten an OK from one of the company’s finance chiefs, the head of treasury, or the chief executive to execute the large transactions that are suspected of being connected with customer funds, says Lynn.

“I swear [O’Brien] has an e-mail in her back pocket — an explicit acknowledgement that it was OK to send the money out,” says Lynn. “Even if it wasn’t policy, self-preservation would make any treasury professional get an executive [to sign off].”

At the same time, says treasury consultant Lynn, a CFO or other top executive would probably not concern himself with the accounting entries surrounding the transaction — which account would be debited and which credited; they would probably leave that to the treasury department.

Lynn doubts the wire transfers that tapped customer-segregated funds stemmed from a mixup of the accounts, as recent media reports suggest. MF Global was probably using a web-based system provided by JP Morgan & Co. called JP Morgan ACCESS to manage its accounts, he says.  In such a system, semirepetitive payments — like the wiring of money to an account overseas — would  already be set up and a transfer would just require filling in an amount and pushing a button. “It’s highly unlikely the wrong account numbers were used,” says Lynn.

While investigators may yet find that there were criminal or civil violations by top executives at the firm, Lynn says that the misuse of customer funds probably didn’t happen the way some members of Congress think it did. “[In hearings], congressmen made it sound like [CEO Jon] Corzine sneaked in in the middle of the night and flipped a switch and overrode some internal controls, but that’s not the way it happened,” he says. More likely, the company’s culture didn’t place a high value on internal compliance. “Did [Corzine] create an atmosphere where people paid attention to these things? I don’t think so,” Lynn says.