Financial Services Subcommittee Report on the MF Bankruptcy (with Lofchie Comment)

After a year-long investigation into MF Global's demise, the House Committee on Financial Services found that a series of decisions by Jon Corzine to turn MF Global into a full-service investment bank led to the company's bankruptcy and jeopardized customer funds. According to the investigative report, Corzine dramatically changed MF Global's business model without fully understanding the risks associated with such a radical transformation. Specifically, by expanding the company into new business lines without first returning its core commodities business to profitability, Corzine ensured that the company would face enormous resource demands. In order to generate the revenue needed to fund MF Global's transformation, Corzine invested heavily in the sovereign debt of struggling European countries. However, Corzine failed to develop a corporate strategy for managing the liquidity risks.

Furthermore, the report states that the risks were exacerbated by an authoritarian atmosphere at the firm in which no one could challenge Corzine's decisions. The report also found that Corzine acted as MF Global's "de facto chief trader" and insulated his trading activities from the company's normal risk management review process. This enabled him to quickly build the company's European bond portfolio "well in excess of prudent limits without effective resistance." As a result, the liquidity crisis prompted withdrawal of customer funds. Although the subcommittee states that it is up to prosecutors and regulators to determine whether MF Global or its employees violated laws or regulations when these withdrawals were made, the "responsibility for failing to maintain the systems and controls necessary to protect customer funds rests with Corzine."&

While Corzine was identified as the chief villain, the Report does criticize others as well. For example, it says that (i) the SEC and CFTC failed to share information with each other; (ii) the credit rating agencies missed the risks in MF Global's business; (iii) the CFTC's segregation regime was materially flawed [note that this problem is being corrected]; and (iv) the NY Fed should not have permitted MF Global to act as a primary dealer in government securities.

Among the subcomittee's recommendations was the suggestion that Congress consider legislation to impose civil liability on the officers and directors of FCMs who sign financial statements or authorize transfers from customer segregated accounts.

Lofchie Comment: The public press's description of the report has, as far as I have seen, focused on the fact that the report largely puts the failure of MF Global on Corzine. But there are a couple of aspects of the report that, though not as significant in terms of placing blame for MF Global's failure, are much more interesting. See, for example, the discussion, beginning on page 79, as to the absence of cooperation between the the SEC and the CFTC, and the suggestion (on page 81) that the CFTC pressured MF Global to move assets from the protected accounts of securities customers to the protected accounts of futures customers. Perhaps even more interesting is the recommendation, beginning on page 81, that merger of the SEC and CFTC should be considered, given the degree to which they currently overlap in their authority (and I note that overlap will become far more pronounced and difficult to deal with as a result of the regulation of security-based swap dealers with the SEC, who will all have to register with the CFTC as well since their securities activities will all inevitably make them swap dealers as well).See, also, the discussion on page 16 of MF Global's business. It's a bit the opposite of too big to fail; rather, too small to succeed.

View report in full here (links externally to Financial Services website).See also: Press Release.