Putting the puzzle pieces together.
A version of this article originally appeared on our US site, Fool.com.
Cast of main characters:
Jon Corzine, CEO of MF Global Holdings
Henri Steenkamp, CFO of MF Global Holdings
Edith O'Brien, assistant treasurer of MF Global, the broker-dealer subsidiary of MF Global Holdings
Laurie Ferber, general counsel for MF Global Holdings
T minus seven days: Monday, October 24 2011
Following a meeting with MF Global management the previous Friday, Moody's (NYSE: MCO.US) downgrades the broker to Baa3 -- the lowest investment-grade rating. Worse still, Moody's places MF Global on review for a possible further downgrade. Moody's announcement has lit a fuse; Corzine and his cadre of executives are now in crisis-management mode. They urgently need to shore up confidence if they are to avert a collapse.
Richard Repetto, a brokerage industry analyst at Sandler O'Neill & Partners, suggests that Jon Corzine may be the only thing keeping the firm together, telling Bloomberg: "If he's gone, forget about it. Customers flee and it's even worse."
In response to the downgrade, MF Global moves its earnings announcement to the following morning -- two days earlier than planned. In order to try to reassure clients and stave off defections, the firm sends clients a letter signed by CFO Henri Steenkamp. Admitting it is "disappointed" by the downgrade, MF Global nonetheless tries to put a brave face on things: "We believe it bears no implications for our clients or the strategic direction of MF Global." In a precursor to the now-infamous statement Steenkamp makes during the next day's earnings call, the letter goes on to state that "MF Global's financial position is strong; the firm remains a well-capitalised counterparty with a strong liquidity position".
One of the factors that drove the decision to downgrade: in the Friday meeting, Moody's learns that MF Global's European sovereign debt positions are the firm's own bets -- there are no clients behind them. Moody's isn't alone in its concern; as Macquarie Group analyst Ed Ditmire tells Bloomberg, "This European sovereign exposure has cut [the] support [the company's book value provides to the stock price]; it makes people think that book value isn't as certain as they thought".
The bond market is equally concerned. A $325 million MF Global bond issue with a 6.25% coupon, maturing in August 2016, closes at just $0.638 on the dollar. At that price, the bonds are yielding 17.8%, or nearly 17 percentage points over the yield on same-maturity Treasuries. Per bond-market convention, MF Global's bonds are now "distressed" (a label given to bonds offering a spread of at least 10 points over Treasuries). Diana DeSocio, a spokeswoman for MF Global, says the firm has a policy of not commenting on its bond prices.
T minus six days: Tuesday, October 25
In a morning conference call with analysts and investors, MF Global announces a wider-than-expected loss for its fiscal second quarter ending September 30. Although they did not contribute to the loss, Corzine addresses the European sovereign debt trades head-on in his opening remarks: "Our positions and the judgment about risk mitigation steps are my personal responsibility and a prime focus of my attention." Despite this, analysts will pepper him with questions on the trades during the question-and-answer session.
Not to be outdone, CFO Henri Steenkamp tells investors he is "proud to say that our capital structure has never been stronger".
The stock market isn't buying it. In fact, investors sell the stock mercilessly, sending the price down 48% to close under $2.
T minus five days: Wednesday, October 26
At 11:12 a.m., Bloomberg reports that mergers and acquisitions advisor Evercore Partners is working with MF Global. According to an unnamed source, the broker is "exploring strategic options", including selling itself. DeSocio refuses to comment on "rumours or speculation." In fact, MF Global had begun discussions with Evercore the previous day regarding a partial or complete sale but waited until Wednesday evening to formally retain the advisor's services.
"It appears that there's been a dramatic loss of investor confidence," Repetto tells The New York Times. "This is Corzine's legacy ... he needs to step in and reinvigorate the business and reassure investors and clients."
Five-year bonds issued by MF Global in August fall as low as $0.45 on the dollar intraday but recover and trade up to $0.67 late in the day. Still, the cost of insuring against a default by the broker has exploded: To insure $10 million in face amount of bonds for five years, the up-front payment is $4.7 million, with annual payments of $500,000.
T minus four days: Thursday, October 27
At 2 p.m., MF Global management and members of the finance team meet with representatives of the US Securities and Exchange Commission and the US Commodity Futures Trading Commission in the broker's New York headquarters. The order of the day is MF Global's funding and its liquidity. When the meeting concludes, a smaller group of MF Global personnel from the legal, compliance and finance functions meet with the SEC to discuss the examination that is to take place the following week.
During market hours, Fitch Ratings becomes the first major rating agency to cut MF Global's credit rating to "junk" status.
At 3:41 p.m., The New York Times reports that, as of Thursday afternoon, the percentage of client assets that have left the firm remains in the low single digits. The same sources indicate that the firm's liquidity is adequate and that it is not considering filing for bankruptcy.
That same afternoon, CME representatives arrive at the firm's Chicago office to perform an audit of the firm's daily segregation report as of the close of the previous business day (Wednesday, October 26).
Late on Thursday, Moody's downgrades MF Global for the second time in four days. MF Global is now a "junk" issuer according to two of the "big three" credit rating agencies.
T minus three days: Friday, October 28
MF Global is preparing to auction off $4.9 billion in government, agency and corporate bonds in order to "get liquid". JPMorgan Chase (NYSE: JPM.US) is facilitating this process and, in order to address MF Global's urgent need for cash, has agreed to provide any funds from the sales to MF Global on a same-day basis. (Such trades typically take one or two days to settle.) However, the bank will only do so if the broker fills overdrafts in clearing accounts MF Global's UK affiliates maintain with JPMorgan.
This issue is raised directly with Jon Corzine on Friday morning. Corzine personally assures JPMorgan that MF Global can and will cover the overdrafts promptly. According to his own testimony, Corzine "contacted the firm's back office in Chicago and others and asked them to resolve this issue, which I understood they did".
In order to address the problem, assistant treasurer Edith O'Brien performs two transfers that morning: a $200 million transfer from a customer segregated-funds account to an MF Global "house" account within the broker-dealer (MF Global), followed by a $175 million transfer from said house account to an MF Global UK account at JPMorgan.
In an email, assistant treasurer O'Brien indicates that the first transfer was made "per JC's [Jon Corzine's] direct instructions". This is not the smoking gun the press has made it out to be. In Congressional testimony last December, Corzine stated: "I never gave any instruction to misuse customer funds."
In a statement in March, Corzine spokesman Steven Goldberg was even more specific: "He never directed Ms O'Brien or anyone else regarding which account should be used to cure the overdrafts, and he never directed that customer funds should be used for that purpose. Nor was he informed that customer funds had been used for that purpose." It is entirely conceivable that Corzine's "direct instructions" were limited to the necessity of filling the overdraft.
Mr Corzine also testified that he received "assurance ... from our back-office people in Chicago" -- including O'Brien -- that the transfer was legitimate. According to The Wall Street Journal, O'Brien disputes having given any such assurance.
It's important to note here that the idea that there is never any comingling of client and house funds is inaccurate; in fact, it's commonplace for a broker to add some of its own funds to client accounts as a form of working capital. As such, it isn't illegal for a broker to draw funds from client accounts as required by the business -- provided it is not withdrawing more than the amount it has previously contributed to the account. The crucial question is, therefore, to what extent had MF Global withdrawn funds from its customer accounts? That's not just a post-mortem question; on that Friday morning, JPMorgan became intensely interested in the answer.
Indeed, by 11 a.m., JPMorgan had confirmed that MF Global had covered the overdrafts. However, due to the depth of the operational ties between the two firms, they could "see" the initial $200 million transfer originating from a customer account. Given the circumstances of MF Global's distress, the bankers naturally thought it prudent to confirm that this transfer complied with CFTC rules regarding customer segregated accounts (i.e., that the funds belonged to MF Global).
At some point in the early to mid afternoon, JPMorgan's chief risk officer, Barry Zubrow, broaches the matter directly with Jon Corzine during a phone call and requests written assurances. (Zubrow is a former Goldman Sachs (NYSE: GS.US) partner and a former advisor to Corzine when he was governor of New Jersey.) The fact that the bank chose to speak to Corzine underscores the level of its concern regarding this matter. Corzine tells Zubrow that he understands the request and will ask someone under him to review it.
JPMorgan then emails Jon Corzine a compliance letter requiring O'Brien to attest that the transfers made from customer segregated accounts were compliant with all applicable rules concerning segregation, which he then asks MF Global general counsel Laurie Ferber to review. The scope of the letter is very broad, covering all transfers from MF Global past and future. Ferber demurs on the grounds that no single employee can offer such a guarantee without having personally overseen every such past transfer -- to say nothing of the open-ended liability linked to guarantees regarding future actions.
Ferber contacts a counterpart at JPMorgan to try and gain a better understanding of its requirements. Naturally, JPMorgan's overriding concern is with the two transactions that occurred that morning. Ferber voices her objections to the language in the initial certificate; her counterpart indicates JPMorgan is prepared to narrow it down. Ferber then calls O'Brien to update her on the conversation she's just had. When Ferber hangs up, she's under the impression that O'Brien is ready to sign the letter if it refers only to the two transactions in question.
At this stage, either there was an internal miscommunication at JPMorgan or there is a discrepancy between the testimonies of Ferber and Diane Genova, the deputy general counsel of JPMorgan Chase's investment bank. According to the latter, the bank becomes impatient that it has not received the signed letter and contacts Ferber's office. Ferber is unavailable, so the bank speaks to her deputy, Dennis Klejna, instead.
Lucky for them, Klejna -- a former head of the enforcement division of the CFTC -- understands the issue well. According to Genova's testimony, Klejna verbally assures them that the initial transfer out of the customer segregated account was compliant with CFTC rules and represented excess funds belonging to MF Global. This is contradicted by a Wall Street Journal source, according to whom Klejna disagrees that he made such representations, because he was not in any position to do so.
However, there is no reason to doubt Genova's testimony that Klejna expressed the same reservations as Ferber and requested a revised letter that focuses strictly on transfers made that day. According to Genova, at approximately 6:30 p.m. JPMorgan emails Klejna a revised letter "focusing only, as Mr Klejna had suggested, on the transfers from October 28". On this point, Genova's testimony is again inconsistent with Ferber's (if we discard the possibility that several parties at JPMorgan were working independently on two sets of drafts without the knowledge of the other parties).
Indeed, Ferber told Congress she received a second draft of the letter from JPMorgan that evening. Unfortunately, the language remained too broad for her liking: Instead of focusing on the two transactions they had discussed, JPMorgan's revised draft refers to (emphasis mine), "all transfers or withdrawals made on or after October 28". Because Ferber provided verbatim quotes from the second and third drafts of the letter, I favour her recollection of events over Genova's.
T minus two days: Saturday, October 29
At about 2:30 p.m., Ferber and Klejna speak with lawyers from JPMorgan concerning the letter, informing them that the second draft remains too broad. She reiterates that the funds withdrawn from the customer segregated account were MF Global's and tells JPMorgan's lawyers she thinks she can get them a signed letter if they restrict it to the two transactions that occurred on Friday.
Genova herself testified that part of this conversation was "about how we could more specifically focus the draft letter on the series of transfers on the morning of Friday, October 28 that had initially triggered J.P. Morgan's request for assurances from MF Global" -- which casts a doubt on her characterisation of the draft sent to Klejna the previous day.
A little after 5 p.m., JPMorgan sends a third, and final, draft to Ferber and Klejna (who was also interacting with O'Brien). The final draft refers to "the transfer and withdrawal made on October 28, 2011 in the amount of $200,000,000 ... out of such Customer Segregated Account to a proprietary account of MF Global and the subsequent transfer to the MF Global UK Ltd. Account ... for the purpose of covering overdraft amounts in accounts with J.P. Morgan." You can read the full letter draft here (link opens PDF file).
Ferber considers the language satisfactory, but unfortunately she doesn't follow up after this point, perhaps considering that Klejna has the matter in hand and likely feeling overwhelmed by numerous other items requiring her attention. Edith O'Brien never signs the letter.
At 5:30 p.m., Corzine provides regulators with an update on the firm's asset sale program and negotiations to sell the entire firm. He identifies JPMorgan Chase and Interactive Brokers as the most interested potential acquirers.
T minus one day: Sunday, October 30
At 4 a.m., Ferber informs a member of the CFTC that, beginning at 7:30 a.m. that morning, MF Global will auction off most of the securities remaining on its balance sheet, including the infamous European sovereign repo-to-maturity positions, in order to free up as much cash as possible.
In the afternoon, a member of MF Global's finance team in Chicago sends out an email, according to which the daily summary of the segregated customer account for Friday shows a $952 million deficit. The operating assumption at this stage is that the figure is the result of an accounting error. Members of the finance team, regulators (some of whom are now on site in Chicago), and, ultimately, even a team from prospective acquirer Interactive Brokers work feverishly through the afternoon and the evening to try to resolve the "error."
Monday, October 31: MF Global files for bankruptcy
Between 12 a.m. and 1 a.m., O'Brien hands Christine Serwinski, CFO of MF Global North America, a document that traces the deficit to three types of transactions:
- Intraday loans between MF Global's futures commission merchant (the futures brokerage) and its broker-dealer.
- The funding of outgoing broker-dealer client funds.
- A $175 million transfer to MF Global's London office on October 28.
All told, the transactions add up to $900 million. Serwinski immediately understands that the deficit is genuine and no accounting error.
At 1 a.m., O'Brien and Serwinski tell the CME Group (NYSE: CME.US) there is a genuine deficit in segregated customer funds.
At 2 a.m. a mammoth conference call begins that will run until about 6:30 a.m. On the call are MF Global's senior management, including Ferber and Steenkamp; its board (on and off); its outside counsel; and an alphabet soup of regulators -- the SEC, the CFTC, the CME, our very own FSA and the Federal Reserve Bank of New York. MF Global has the painful task of informing its overlords that it is unable to resolve the deficit, dooming the possibility of a last-minute sale.
At 10:24 a.m., MF Global Holdings' counsel files a petition for protection under Chapter 11 of the Bankruptcy Code in the US Bankruptcy Court for the Southern District of New York.
On April 24, 2012, James Giddens, the trustee overseeing the liquidation of MF Global, told the Senate Banking Committee his team's investigation into the whereabouts of $1.6 billion in missing customer funds was "substantially concluded", and he went on to say that "we can trace where the cash and securities in the firm went, and that we've done". Of the $1.6 billion, roughly $680 million was transferred to financial institutions with which MF Global did business -- including JPMorgan, which had received a large part of the funds. Giddens also said his team had "a solid basis for seeking the recovery of some of the funds that were transferred to JPMorgan", and that he is engaged in discussions with the bank regarding the matter.
In their testimony before Congress on March 28, Ferber, Serwinski and Steenkamp all said they were co-operating with federal authorities' investigations. At the same hearing, O'Brien invoked her right not to testify under the Fifth Amendment. However, The Wall Street Journal has reported that her lawyers offered a "proffer" – the first step in negotiating immunity or leniency in exchange for co-operating with federal investigators.
In my opinion, O'Brien is instrumental in this story, but I see no evidence that Corzine was complicit in, let alone responsible for, the illegal transfer of customer funds. My prediction: Corzine will never be charged or prosecuted by the government in connection with these transfers -- and not because of any conspiracy to protect him.
However, that does not mean he is entirely safe from litigation; in a statement, Giddens said he could pursue claims for "among other things, breach of fiduciary duties owed to both [the MF Global brokerage] and its customers, and violations of the segregation requirements of the Commodity Exchange Act". A spokesperson for Giddens later added that the list of targets could include any officer or director of the company.
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