What Happened at MF Global?

In an age of heightened regulation that witnessed rampant bank and market failure, outright fraud, and more prosecutions of insider trading, one would think that the protection of customer funds would be a moot point. But, it wasn’t.

The story of MF Global is just one example of a collapse with ongoing consequences. For Jon Corzine, erstwhile Goldman Sachs chair and New Jersey politico, the undoing of MF Global marks the latest of a series of undertakings with good intentions gone bad. The company declared bankruptcy in 2011 because of the nature of its business. Here’s what happened.

Key Takeaways

• MF Global was a commodities brokerage house that was spun out of Man Financial in 2007.
• The firm offered clearing and execution services but took aggressive risks, which resulted in losses.
• The firm hired former Goldman Sachs chairman and politician Jon Corzine in 2010.
• MF Global’s downfall was the result of what many call a repurchase to maturity trade.
• The company declared bankruptcy in 2011.

MF Global’s Beginnings

MF Global was a commodities brokerage house, also known as a futures commission merchant (FCM). It offered clearing and execution services. The company spun out of Man Financial in 2007 in a less-than-remarkable initial public offering (IPO) at a time when global financial markets were under stress.

It had ambitions to become a financial services firm akin to Goldman Sachs or JPMorgan. Blighted with a bent for aggressive (even excessive) risk-taking, the firm posted a big loss. But it gained a substantial capital infusion from J.C. Flowers, which helped put the firm back on its feet, even if only for a short while. The company was also plagued by a scandal in 2008 involving a rogue trader in Memphis that resulted in a $141 million loss for the firm.

Jon Corzine was hired in 2010 to help turn the firm around. Corzine, who was a former chairman of Goldman Sachs, U.S. Senator, and New Jersey governor, put together a team that would share his ambitions for MF Global, yet with few naysayers on either the management team or the board.

A fatal flaw in the management design and an apparent violation of the canons of enterprise risk management was his assumption of the role of both chief executive officer (CEO) and head trader—two functions that should remain separate. The role and responsibilities of the chief risk officer (CRO) were insufficient.

MF Global’s Downfall

The firm’s undoing resulted from what many call a repurchase to maturity trade, whereby the firm financed its balance sheet by posting collateral to a counterparty that extends the firm credit, then repaid the counterparty when the collateral—in this case, euro-denominated sovereign debt—matured.

Some, however, disagree with this interpretation, calling the firm’s transaction a total return swap, which is a form of credit risk management. In this scenario, MF Global sold protection to buyers long the underlying assets (eurozone sovereign credits) and received both yield and capital gains from them. MF Global sold insurance and purchased price and credit default risk of what were increasingly shaky assets.

As the seller who received the total return on the reference asset, MF Global did not own the reference assets. Rather, it was subject to price and default risk in an off-balance sheet (OBS) transaction, being synthetically long on the assets and their attendant risks.

A drawback of the total return swap is that the underlying assets must be easily tradable, that is, liquid. European sovereigns failed to meet this criterion. Who wanted to conduct business with a firm subject to increasing default and liquidity risk?

MF Global ended up declaring bankruptcy on Oct. 31, 2011. This would be the eighth-largest corporate failure in the United States. According to reports, more than $1.6 billion was missing from the firm’s customer accounts.

Note

So who was affected? MF Global’s collapse impacted smaller clients rather than larger institutions. Those affected included individual investors and small business clients, such as farmers, ranchers, and financial advisors, who used commodities to diversify their portfolios and hedge risk.

The Aftermath

These circumstances ultimately scuppered the firm’s salvation by Interactive Brokers in the 11th hour. The rash of credit downgrades would not exactly enhance the firm’s standing. While no eurozone country defaulted, the perception became the reality, as lenders to the firm issued margin calls, fearing for their safety.

MF Global admitted to accessing what should have been separate client funds to meet its obligations. This latter action would appear to constitute fraud, but investigations by the Securities and Exchange Commission (SEC) and the Department of Justice yielded no criminal charges against MF Global or its officers.

In January 2017, a federal court ordered Corzine to pay a $5 million civil penalty in a suit settled with the Commodity Futures Trading Commission (CFTC). By February 2017, all of the misappropriated funds were restored to customers and creditors from liquidated bankruptcy assets.

Unlike bank deposits or brokerage accounts, futures accounts carry no backstop akin to Federal Deposit Insurance Corporation (FDIC) insurance or Securities Investor Protection Corporation (SIPC) coverage. For this reason, account segregation is deemed sacrosanct.

When Did MF Global Go Under?

MF Global was a commodities future broker that was spun out of Man Financial in 2007. But, aggressive and excessive risk-taking led to the firm’s downfall. The company, which was plagued by losses and a trading scandal, declared bankruptcy in 2011.

How Much Money Did MF Global Customers Get Back?

MF Global customers and creditors were paid back $8.1 billion after the firm declared bankruptcy. This figure included $6.9 billion for customer claimants and $219 million for non-affiliated unsecured general claimants. According to reports, the recovery efforts took more than four years.

Who Is Jon Corzine?

Jon Corzine was the head of MF Global. He was appointed in 2010 until the firm went under when it filed for bankruptcy in 2011. Before this, Corzine worked for Goldman Sachs. He was also a politician, serving as a U.S. Senator between 2001 and 2006, and then as Governor of New Jersey between 2006 and 2010.

The Bottom Line

Since there were no systemic ripple effects, MF Global doesn’t seem to have been too big to fail. The implications for other similar firms aren’t insignificant, though. There’s been discussion to design an insurance system for futures brokers along the lines of a SIPC or FDIC, as existing regulation appeared less than up to the task of protecting clients. The boondoggle visited upon MF Global casts yet another pall on the financial services profession and its trustworthiness.