The House Financial Services Oversight and Investigations Subcommittee released its report on the MF Global bankruptcy on November 15, 2012. The report was scathing of Corzine saying he created an “authoritarian atmosphere”, “insulated trading activity from review process”, and was responsible for “dereliction of duty…to maintain the systems and controls necessary to protect customer funds.”
It seems every few months the restoration of confidence in the financial markets is set back by another enormous ethical failure. In this case, not only does MF Global, a major investment firm, collapse and declare bankruptcy, but billions of dollars from customer accounts are also missing. What happened at MF Global and what were its ethical failures?
The Players and Events
Former Goldman Sachs CEO and New Jersey Governor Jon Corzine is hired as CEO of MF Global in March 2010. When Corzine takes over, MF Global is a less-than-profitable commodities and futures trading firm with customers largely comprising Mid-Western farmers and ranchers. At the time, MF Global’s commissions from trades are not enough to cover expenses. Corzine, whose aggressive investment practices had been extremely profitable at Goldman Sachs, is expected to make MF Global profitable again.
MF Global is a small firm when Corzine takes over. In order to net large returns with little initial investment, Corzine initiates a bold strategy that bets heavily on long odds. As the Eurozone sinks deeper and deeper into its own financial crisis, European government bonds are readily available on the cheap. MF Global buys up these bonds betting they improve or are bailed out and consequently giving MF Global a substantial profit at little cost. The strategy is known as “repo to maturity” trades. The risk is that European economies can sink further in debt or fail completely.
Corzine continues betting, forcing MF Global to become more dependent on faltering European economies. Despite warnings, Corzine increases the firm’s exposure to Eurozone government bonds. Some of the money is borrowed internally from other parts of MF Global in a move known as “internal-repo,” and some of the funds are from loans with the Eurozone bonds leveraged as collateral. The investment is risky, given the nature of European economies at the time, and it is unclear whether customers or shareholders know of the strategy. Eventually, more than $6 billion is bet on European government bonds before others at MF Global, uncomfortable about building upon such an unstable foundation, force Corzine to stop,.
Problems arise not abroad, but at home. When news breaks that MF Global has invested $6 billion in unpredictable European bonds, pandemonium strikes.
- Creditors demand more liquid collateral to ensure their loans are safe.
- Shareholders sell what they can as MF Global stock prices plummeted.
- Customers try retrieving their money but their demands are lost in the chaos.
When Corzine tries finding a buyer for MF Global in a final attempt to save the company, it becomes clear that money is missing from customer accounts. On Oct. 30, 2011, MF Global declares bankruptcy.
The Big Problem
The MF Global story is another scandal in the history of Wall Street. It is a familiar tale of personal hubris driving a company to seek large, short-term gains by betting big on long odds. When the bet fails the company collapses. A major ethical failure of MF Global is in its inability to account for customer money. Billions of dollars of customer money vanish in the chaos of MF Global’s final days. The money is supposed to be separated from the firm’s own accounts.
Tampering with customer funds is a crime under the Commodity Exchange Act of 1936, because customer money must be segregated from firm money. Customer money at MF Global is missing. Where this money went, and where it is, remains unclear. MF Global is a small firm spending beyond its limits and it is eminently possible the company uses customer money to keep the firm afloat in its final days. There are several transfers of money to creditors, including $200 million to JP Morgan, just before MF Global declares bankruptcy.
MF Global is currently under investigation by the Commodities and Futures Trading Commission, Securities and Exchange Commission, FBI, and Justice Departments in Chicago and New York. If customer money is not segregated, there can be criminal charges. Jon Corzine denies knowing anything, especially the whereabouts of these funds. A bankruptcy trustee charged with recouping lost money for the broker’s clients is already suing Jon Corzine and other MF Global executives in a class action suit that accuses them of breach of fiduciary duty and negligence.
In a scathing report on MF Global’s collapse, a House financial services committee’s investigation panel says the broker misled regulators over the size of its Eurozone bond bets. The report states that Jon Corzine and former chief financial officer Henri Steenkamp were not “forthright” about the company’s liquidity difficulties in the months before the broker’s collapse.
While civil charges against MF Global executives are likely, there is no indication prosecutors will bring criminal charges related to the firm’s demise.
The MF Global case presents three instances of ethical failures:
1. Failure in Duty as a Fiduciary
Customer funds are supposed to be segregated and invested, and firm money is to be used for the firm (payroll, debt payment, etc.). Instead, MF Global appears to commingle customer money into firm accounts to pay off the firm’s debts. This act represents an ethical failure by the leaders of MF Global, who have a fiduciary relationship with their clients based on trust and mutual understanding of investment policy. The firm’s decision to ignore standard investment practice lost clients billions of dollars. Under Kantian deontological or duty-based ethics, MF Global failed as an investment firm to carry out its fiduciary duty to clients. Instead MF Global focused on its corporate interests ahead of clients’ interests. Although $3.9 billion has been returned in the seven months since the firm’s collapse, $1.6 billion is still missing. This severe blow to the firm’s clients, largely Mid-Western farmers and ranchers, cannot be understated.
2. Failure of Disclosure and Transparency
MF Global took a big risk investing in European bonds. MF Global failed because customers and creditors were uncomfortable with the investment strategy. Their decision to leave MF Global ultimately caused the firm’s sudden collapse, but that is not to say customers or creditors are at fault. As with the status of customer funds, it also is unclear whether MF Global was upfront about its investment strategy. Did customers and shareholders know MF Global was buying Euro bonds? Were they clear about the complex leveraging of internal-repos? If the leadership at MF Global had been completely transparent about their strategy, investors may have backed out much earlier, thereby not allowing MF Global to leverage itself into such a position. Creditors, too, may have been unwilling to offer loans based on unstable collateral. The broker did not acknowledge its exposure to troubled Eurozone debt when questioned by regulators. In addition, the broker did not clearly describe the size and nature of its portfolio to the public in the company’s regulatory filings. MF Global’s investments, accounts, and transactions lacked full disclosure and transparency.
3. Failure in Utilitarian Terms
Utilitarian ethical theory proposes actions that produce the greatest good for the greatest number of people. MF Global’s investment strategy was an unarguable utilitarian failure because the company’s mismanagement negatively affected the financial sector economically and in terms of reputation. Few benefitted but a great many suffered as a consequence of MF Global’s actions. Ethical failures like MF Global’s continue to sow seeds of distrust in the financial sector. What is needed for a vibrant US economy is confidence: that investments are secure and that customer accounts will not be mismanaged or misused illegally. Wary investors will be unwilling to reenter a market marred by fiduciary breaches.
By: Preston Bukaty
Photo: Flickr, DominusVobiscum