Thoughts on the June 4, 2012 report of James Giddens, Trustee for MF Global, Inc.

I have followed closely the aftermath of the MF Global bankruptcy and the failure to meet customer asset custody obligations.  My reaction over time has been generally a cynicism at the ever lengthening course of what appeared to be a very quiet investigation.  I have expressed anger at the various U.S. Attorneys for a prolonged, silent inquiry while assets were being used for trials of John Edwards and Roger Clemens, two figures who were already beyond redemption in the public eye.

I do not have any personal assets at stake in the MF Global matter, however, because of my belief in the system of segregation, I also tweeted my assurance the week before the bankruptcy filing for customers to stay calm because of the protection of the law.  This assurance was based on a 30 plus year career at exchanges and clearinghouses.  I don't know if anyone acted differently because of my tweet, but the outcome of MF Global has forever shattered my trust in the reliability and honesty of any brokerage firm anywhere, and of any size.  To be clear, I still have complete trust in the sanctity of funds on deposit at the major U.S. Clearinghouses because there is no commercial conflict with the Clearinghouse's proprietary interests.  However, funds that are deposited at a broker, but not turned over to a clearinghouse are in my view unprotected until I see reforms to the system, and an accounting of what happened at MFG, before I even begin to approach the level of regard for their safety that I held previously.

I have now read the report of June 4, 2012 by James Giddins, the SIPC Trustee overseeing the bankruptcy and related investigation of MFG.  Clearly, silence has not equaled inactivity.  The Trustee has written a compelling narrative and explanation (although at times the failure to name the counterparty to important emails is frustrating, most likely at the request of U.S. investigators) and answers a number of questions.  Clearly there was confusion in the final 10 days of MFG's existence because of numerous customer redemptions and the insistence of virtually every counterparty for additional cash, which quickly drained liquidity.   Recordkeeping responsibilities for the financial and custodial functions of the firm were divided between MFG's offices in Chicago and New York  A key employee with financial experience was on vacation.  The Treasurer was new.

It is possible that every wrong action occurred without anyone actually knowing for a fact that the action was wrong.  Knowledge, I suppose, is the burden that any criminal investigation would need to meet.

However, the fact that MFG seems to have adopted a policy that allowed for intraday invasions of client funds to meet the firm's myriad obligations in itself to me is wrong, and places what would normally be merely a negligent decision with an unintended outcome in a highly suspicious light.  In other words, funds in trust cannot be invaded, even temporarily, and once a firm decides to ignore that basic rule of a trustee's obligation, any mistake in repaying the funds comes on the heels of knowingly misusing trust funds in advance.

I can now understand why Edith O'Brien is not receiving immunity from prosecution so quickly.  She may indeed be guilty of a crime or crimes.  Others in the "New York Operations" area, as the Trustee calls them, may also have knowingly participated in this breach of trust.  Whether higher level officials knew of the practice to borrow from segregation is unclear, and I'm sure a key topic of the ongoing investigation.

The Trustee also reports on the interactions between the firm and the regulators, including a report that circulated internally that was edited before being shared with regulators, omitting a likely red flag from regulatory review.  Following directives not to transfer segregated funds with regulatory approval, it appears from the Trustee's report that transfers of that kind occurred.  False reporting and misleading regulators are serious, perhaps criminal offenses, and I am also sure they are now the subject of intense scrutiny.

Were the senior officers of the firm knowingly involved in misdeeds?  The report is certainly more exculpatory than indicting - there are no reported smoking guns - but there are several very serious open questions.  Who knew what facts when different facts were being reported to regulators? Who knew that intraday transfers from segregated funds  for the firm's own benefit were fairly routine? And, if someone senior knew, would he have a greater duty to inquire about certain transfers lest he turn a blind eye - also the potential basis for criminal culpability?  These are open and fascinating questions.  My guess is that with this report as a basis for where the investigation sits, we will have the answers to these questions in due course.  I am advising myself: Patience.  This trustee has done commendable work, and we can only wait for the next report or some other action for more answers.