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<div class="timestamp">June 8, 2012</div>
<h1>Trustee Sees Customers Trampled at MF Global</h1>
<span><h6 class="byline">By <a rel="author" href="http://topics.nytimes.com/top/reference/timestopics/people/s/james_b_stewart/index.html" title="More Articles by James B. Stewart" class="meta-per">JAMES B. STEWART</a></h6>
</span>
<div id="articleBody">
<p>
If the collapse of the commodities brokerage firm <a href="http://topics.nytimes.com/top/news/business/companies/mf-global-ltd/index.html?inline=nyt-org" title="More information about MF Global" class="meta-org">MF Global</a>
were a murder mystery, the revelation that $1.6 billion of customer
money had disappeared would be the equivalent of finding the corpse.
</p>
<p>
Who did it? And given that customer assets, by law, must be segregated
from a firm’s assets and operations, how could it have happened? </p>
<p>
This week, MF Global’s liquidation trustee, James W. Giddens, went a
long way toward solving the mystery in a 181-page account of MF Global’s
decline and fall. </p>
<p>
Contrary to vague and self-serving assertions that MF Global’s affairs
in its last week were so chaotic that no one really knew what was
happening, some people at the firm obviously knew only too well, and
took desperate measures that ignored clients’ interests. In doing so,
they violated the most basic obligation of any brokerage firm, which is
to protect customers’ assets. </p>
<p>
More broadly, the report makes clear that the notion that customer
assets are safely segregated, at least at commodities brokers, is an
illusion thanks to a lax calculation of customer assets allowed by the
Commodity Futures Trading Commission, which regulates commodities
brokers. </p>
<p>
Mr. Giddens cautioned that his report was by no means complete, and that
he wasn’t in a position to draw conclusions about potential civil and
criminal liability. But it seems clear that serious violations of law
were committed, and the report will surely add to pressure on the
Securities and Exchange Commission, the commodities commission and the
Justice Department — the agencies investigating MF Global for potential
enforcement and criminal proceedings. </p>
<p>
That MF Global was an accident waiting to happen under the leadership of
Jon Corzine, a former Goldman Sachs chief executive, United States
senator and New Jersey governor, is evident from the structure of the
firm. Merely describing lines of authority requires a chart that
resembles a convoluted family tree. </p>
<p>
Responsibility for accessing funds in segregated customer accounts and
transferring them elsewhere rested with one employee, Edith O’Brien, an
assistant treasurer in Chicago who reported to the firm’s treasurer in
New York, who in turn reported to the chief financial officer, Henri
Steenkamp. The treasury division’s main responsibility was meeting Mr.
Corzine’s increasingly frantic demands for liquidity to support his
high-risk and ultimately disastrous bet on the debt of shaky European
nations. </p>
<p>
Regulatory compliance — making sure that customer funds were safe — was
the responsibility of the financial regulatory group, which reported to
Christine Serwinski, the North American chief financial officer, who
also reported to Mr. Steenkamp as well as an executive based in London.
Ms. Serwinski was responsible for daily reports on segregated customer
funds to the commodities commission and weekly reports to the S.E.C. Mr.
Steenkamp, in turn, reported to Mr. Corzine. </p>
<p>
It’s apparent from Mr. Giddens’s report that as MF Global’s financial
woes deepened last summer and fall, protecting customer assets was among
the least of Mr. Corzine’s priorities. Mr. Corzine testified to
Congress that he never knowingly asked anyone to break the law, and
nothing in the report explicitly contradicts that. At the same time, he
made demands for cash that appear to have left employees no alternative
but to divert customer assets. </p>
<p>
None of this would have been possible if regulators actually required
firms like MF Global to keep customer funds safe. Instead, the
commodities commission allows firms to use an alternative method for
calculating customer funds in foreign accounts that vastly understates
what belongs to customers. Cash, for example, doesn’t count. The
difference between what MF Global actually owed its customers and what
it needed to segregate under the alternative method was calculated at
the firm on a daily basis and often exceeded $1 billion. Although MF
Global reported only the alternative calculation to regulators, it
prepared its own segregation report every day that showed the true
extent of its liabilities. </p>
<p>
MF Global, like most brokerage firms, also kept a surplus in the
segregated funds to make sure that it never ran short. This was
available to the firm for other purposes, although in practice it was
rarely used. But as the <a href="http://topics.nytimes.com/top/reference/timestopics/subjects/e/european_sovereign_debt_crisis/index.html?inline=nyt-classifier" title="More articles about the European sovereign debt crisis." class="meta-classifier">European debt crisis</a>
escalated last summer and demands for greater liquidity intensified,
the firm proposed to tap the surplus and borrow funds overnight from
segregated customer accounts, which prompted a worried response from Ms.
Serwinski, according to the report. </p>
<p>
“Client assets may be put at risk even if for overnight,” she warned,
and then asked whether, in the event of “financial crisis,” there was
any guarantee that the firm would be able to repay its customers.
</p>
<p>
Ms. O’Brien, who had to approve such transfers, was also worried about
the firm’s growing liquidity needs and where the cash would come from.
“Why is it I need to spend hours every day shuffling cash and loans from
entity to entity?” she wrote in an e-mail in August, describing the
process as a “shell game.” </p>
<p>
Mr. Steenkamp, the chief financial officer, assured Ms. Serwinski that
he had “walked” Mr. Corzine through the regulatory requirements. Still,
he stressed that Mr. Corzine wanted the firm to make use of any surplus
in the segregated accounts and “maximize” it through “liquidity
management.” Despite mounting concerns by top officials, loans from
segregated funds to the firm became routine, and some weren’t repaid.
</p>
<p>
On Oct. 26, 2011, Ms. O’Brien approved transfers totaling $615 million
from segregated customer trust accounts at JPMorgan Chase, supposedly
for an intraday loan. The funds weren’t returned by the end of the day,
which caused “panic” in Ms. O’Brien’s operation, according to the
report. Ms. O’Brien demanded, in an e-mail, to know when the funds would
be returned, adding in capital letters: “I need to know now.” But the
money wasn’t returned, and Ms. O’Brien continued to approve such “loans”
in the ensuing days. </p>
<p>
On the morning of Oct. 28, two officials in the financial regulatory
group who were preparing the daily segregation report for the
commodities commission noted a deficit in segregated customer accounts
of about $300 million. Reporting that would have immediately set off
alarms at regulators. But according to Mr. Giddens’s report, two members
of Ms. O’Brien’s staff determined that a $540 million wire transfer
into the segregated accounts the previous day had somehow gone
unrecorded. They simply added $540 million to the segregated funds — in
effect, double-counting the transfer. That resulted in a surplus of more
than $200 million, and the firm reported this number to the commodities
commission. </p>
<p>
The trustee’s report described witness accounts of these events as
“confusing and contradictory,” noting that the firm’s records accurately
reflected the $540 million transfer and that the segregation report was
revised to show a surplus without any backup documentation. Whatever
the reason, the result was that MF Global filed a false segregation
report with regulators. </p>
<p>
That same day, the 28th, Mr. Corzine ordered Ms. O’Brien to transfer
$175 million to JPMorgan to cover a firm overdraft. With no other source
for the cash, Ms. O’Brien approved a transfer of $200 million from a
customer trust account at JPMorgan. When she spoke to a JPMorgan banker
about the transfer, she said she knew the bank had “issues” with that,
according to the report, presumably because the trust account held
segregated funds. After consulting with their lawyers, JPMorgan
officials had a series of phone conversations with Mr. Corzine in which
they demanded assurances that the transfer was lawful. </p>
<p>
Given that this transfer occurred the same day that the firm’s
regulatory group reported the $300 million deficit in segregated
accounts, it’s hard to know how withdrawing another $200 million could
have met regulatory requirements to safeguard customer assets. Ms.
Serwinski was on vacation at the time, but she testified to Congress
that she would not have approved such a transfer. </p>
<p>
Mr. Corzine testified that Ms. O’Brien “explicitly confirmed” that “the funds were properly transferred.” </p>
<p>
But when asked on Oct. 29 for such an assurance in a letter demanded by
JPMorgan, she balked, even after the letter was revised to limit its
scope to just the $200 million and $175 million transfers. Ms. O’Brien
“was subjected to extreme pressure to sign the letter,” the report
states, “but steadfastly refused to sign it.” </p>
<p>
Ms. O’Brien hasn’t given her side of this pivotal story. She invoked the
Fifth Amendment when asked to testify to Congress. A lawyer for Ms.
O’Brien declined to comment. </p>
<p>
The trustee’s report concludes there was a substantial “shortfall” in
customer segregated funds every day from Oct. 26, when $615 million in
loans from customer accounts were not repaid, until MF Global filed for
bankruptcy on Oct. 31. Given the cavalier disregard of customer
interests and the huge transfers from customer assets that week, the
only surprise to Mr. Corzine and others at the firm should have been
that customer losses weren’t even greater than $1.6 billion. </p>
<p>
Mr. Giddens’s report points out the need for some simple regulatory
reforms. The alternative method for calculating customer assets is a
glaring loophole that needs to be closed and should never have existed
to begin with. Any surplus in customer accounts contributed by a firm
should be maintained in a separate account that the firm can draw upon.
Otherwise, segregated funds should be just that — segregated. A
comparatively low-level employee like Ms. O’Brien should never have sole
authority to tap segregated customer accounts. A spokesman for the
commodities commission declined to comment on my proposals. </p>
<p>
Those responsible for the MF Global debacle should be held accountable
to the full extent permitted by law. And the customer losses and
resulting hardships that happened at MF Global should never happen
again. </p>
<div class="articleCorrection">
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