Gary Gensler, the former chairman of the United States Commodity Futures Trading Commission (CFTC), from May 26, 2009, to January 3, 2014 was selected by President elect Biden to head the Federal Reserve, Banking and Securities Regulators review group. Gensler’s tenure at the CFTC was marked by the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 and the investigation and prosecution of JPMorgan, Citibank, Bank of America, HSBC, and Barclays for manipulation of Libor, the London interbank offered rate. Gensler acquired a reputation as a tough and effective regulator.
But Chairman Gensler also oversaw a watershed moment in the futures industry and one that is often left out of discussions of his tenure. He oversaw the largest bankruptcy at the time after the fall of Lehman, the collapse of MF Global. This article revisits this story, after first writing about it 9 years ago.
The collapse of MF Global was an unfortunate event for the futures industry because up to that point they had been the most liquid, transparent and crisis free markets in the world. Unlike the larger equity markets, the futures markets had been remarkably free from any systemic financial crisis. . .with the exception of a salad oil scandal (almost 50 years ago).
This all changed when a former CEO of Goldman Sachs, Jon Corzine, took it over with the intention of making the venerated brokerage house more into a trading operation. With Corzine’s takeover and bankruptcy of what had been one of the largest and oldest commodity trading firms in the world, the crisis-free reputation of the futures industry forever changed.
It is axiomatic in the futures industry that customer funds are to be segregated from the funds of a futures commission merchant (FCM) and not to be commingled with other funds. Corzine and MF Global went into customer funds to cover margin on the firm’s trading position in sovereign debt and caused the largest bankruptcy in the futures industry. This article revisits how it unfolded.
Here is a timeline:
- October 24, 2011– The CME Group, Inc (“CME”) initiated a heightened scrutiny of the segregated customer fund reporting of MF Global as a result of MF Global’s market risk. Beginning on October 24, 2011, the CME’s daily audits verified that customer funds were on deposit at the bank(s) where MF Global represented that they were and in the amount that they were supposed to be
- October 25, 2011 -MF Global reported a substantial quarterly loss due to having leverage of 40:1 on its exposure to European sovereign debt. Predictably, MF Global’s stock collapsed and it its bonds began to trade at distressed levels. Corzine utilized all MF Global’s credit lines and tried to secure a sale of the firm to Interactive Brokers.
- October 26, 2011- The Chicago Mercantile Exchange (“CME”) performed a spot audit on MF Global. This audit merely verified that customer funds were on deposit at the bank(s) where MF Global represented that they were and in the amount that they were supposed to be.
- October 31, 2011 -MF Global filed for bankruptcy. Even at this time, there had been no reason to think that any customer funds, which are supposed to be safeguarded from a futures brokerage going bankrupt by virtue of their being completely segregated, would be in jeopardy.
- October 31, 2011- Interactive Brokers announced they are walking away from a purchase of MF Global due to accounting discrepancies.
- November 1, 2011 -After MF Global denied any customer funds were missing, it admitted that there were shortfalls in customer accounts.
- November 2, 2011– The CME announced that MF Global may have transferred money “in a manner that may have been designed to avoid detection insofar as MF Global did not disclose or report such transfers to the CFTC or CME until early morning on Monday, October 31, 2011.” (https://www.timelyobjections.com/corzine-testimony-about-mf-global-truthful/)
- December 8, 2011 -Corzine testifying that he remembers nothing.
- December 13, 2011 -Corzine testifies that he does specifically remember not directing any of his employees to transfer any money, “I never directed anyone at MF Global to misuse customer funds. I never intended to. And, as far as I am concerned, I never gave instructions that anybody could misconstrue.” Id.
- December 13, 2011– Terrance Duffy, the Chairman of the CME, testified before the Senate Agriculture Committee. In Mr. Duffy’s testimony he said that the CME has been conducting their own ongoing investigation of MF Global and discovered on December 10, 2011, after questioning a former MF Global employee who knew about the transfer of $175 of customer funds towards MF Global’s broker dealer operations, that Corzine knew all about the transfers and likely authorized them. Between October 26, 2011 and October 31, 2011, money was moved out of customer segregated accounts in the amount of what is now considered to be well over a $1.2 billion shortfall, or the money was lost in trading losses and positions in sovereign debt. For a more detailed discussion see: (https://www.timelyobjections.com/why-mf-globals-last-days-may-have-been-criminal/)
In 2017, Corzine, signed a consent order with the CFTC agreeing that MF Global had violated Section 4d(a)(2) of the Act, 7 U.S.C. § 6d(a)(2), and Regulations 1.20, 1.22, and 1.23, 17 C.F.R. §§ 1.20, 1.22, and 1.23 and that he had personally failed to supervise his employees. He paid a fine of $5 million to the CFTC for losing over a $1 billion in customer funds. He also agreed to a lifetime ban from certain conduct in the futures industry and was not criminally prosecuted. (https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcorzineorder010517.pdf)
There was some discussion at the time, of possible conflicts of interest. Corzine had been one of the largest political bundlers of the then sitting President (hosting fundraisers in his home even after October 31, 2011 and through 2012). Chairman Gensler had worked under him at Goldman.
For a basis of comparison, at the time this all happened, there were similar events in the futures industry, albeit not of the scale of MF Global. In each of these instances, there was a criminal prosecution.
At one time, Refco was the largest futures brokerage at the CME and it also had one of the shortest IPO in history. Refco raised and lost over $1 billion in investor capital August 2005. It went bankrupt in October of 2005.
An internal audit of Refco revealed that Refco’s new CEO, Phillip Bennett had taken $430 million from Refco’s and manipulated Refco’s financials to disguise his theft. Refco’s accounting firm, Grant Thornton after a complete audit, and all the investment banks that handled the IPO, including Goldman Sachs, and Bank of America Corp., after their due diligence, missed the $430 shortfall. Federal authorities were alerted of the missing funds by Refco’s own internal audit. Bennett repaid all of the money but the public had lost faith in the company. Investors sold billions of shares worth of Refco and the resulting liquidity run forced the firm into bankruptcy.
The Justice Department filed criminal charges against Refco principals Phillip R. Bennett, Tone N. Grant, Santo C. Maggio and Robert C. Trosten for fraudulently hiding trading losses of both Refco’s and of its customers, and fraudulently manipulating financial statements to secure a leverage buyout of the firm and subsequent IPO. In addition to obtaining guilty pleas and convictions against all of them, the government recovered obtained over $33,000,000 in forfeiture actions against five other Refco officers, including Tom Dittmer. There were also civil suits and a class action.
As another point of comparison, consider the fate of Jon Corzine and Russell Wasendorf, Sr.-two men engaged in almost identical conduct. The latter was prosecuted by the Justice Department the former was not. It was discovered in June 2012 that Peregrine Financial Group CEO, Russell Wasendorf Sr., like Corzine at MF Global, had tapped into customer segregated funds to the tune of $215 million.
Russell Wasendorf Sr. was arrested and criminally charged later same that month. Same act-missing customer funds that were by law not to touched-but a far disparate prosecution. (https://www.timelyobjections.com/a-tale-of-two-classes-of-defendant-and-lanny-breuer/#more-57)
Perhaps an important point of differentiation with Corzine is that he had good counsel, and as I recall learning at the time, their use of a joint defense agreement that included two of his key employees.