(Originally written on December 5, 2011. Some updates added.)
Are the Trustees handling the MF Global bankruptcy case breaking the law? Commodity Futures Trading Commission Chairman Gary Gensler implicated that very thing when, on December 1, 2011, he testified at a Senate Agricultural Committee hearing regarding Commodity Law and the MF Global situation. The transcript of Mr. Gensler’s testimony is as follows:
Mr. GENSLER: “The Rules are very clear, and it’s actually right in the Congressional Statute and…associated Rules. Customer Funds are to be segregated at all times of the day. It’s not just at the end of the day. There’s a once-a-day calculation at the end of the day…but no one should confuse that once-a-day calculation. At all times of the day, the money is to be segregated in bank accounts or in various security accounts.” (exact quote, emphasis added…video link below)
(Here we must assume that Mr. Gensler means a “100% Net Asset Value (NAV) calculation” that must be segregated at all times. He was likely referring to CFTC Regulation 1.20 and/or the Commodity Exchange Act, Sec. 4[d])
At all times. At all times. No ambiguity there from Mr. Gensler.
Normally, MF Global’s responsibilities were to keep the books on two types of segregated accounts. There are the Individual Customer Segregated Accounts (CSA’s) and also the MF Global Master Segregated Account (MFSA). The CSA’s consist of open contract and option positions, cash, T-Bills, property receipts, etc…and the MFSA includes a pooling of assets borrowed from the CSA’s. MF Global was allowed under CFTC Reg. 1.25 to invest these MFSA funds in various instruments (Sovereign and Corporate bonds, etc.), but since the value of those investments would fluctuate, they were also responsible for reconciling the NAV of the MFSA to match the 100% NAV of the sum of the CSA’s. This is the “once-a-day calculation” to which Mr. Gensler referred. At the end of each day, this reconciliation is made and is supposedly audited by the self-regulating Exchange, the CME in this case. However, as Mr. Gensler stated, these totals must actually match at all times of the day, even though it is perhaps only checked by the CME at the end of the day.
This ongoing account-matching calculation is made with sophisticated computer programs and if the NAV of the MFSA is greater than the sum total of the CSA’s…then MF Global pockets the difference as profit — as per their business model, and as allowed by law. However, if the NAV of the MFSA falls below the sum total of the CSA’s…then MF Global is required by law to replace those assets from other, non-segregated assets of the Company in order to reconcile the segregated accounting AT ALL TIMES, including for the “once-a-day” audit.
MF Global failed to maintain, at all times, a 100% NAV in the MFSA. And that broke the law. They were required by law to replace the MFSA deficit from other MF Global assets on a moment-to-moment basis. Period. The fact that segregated funds were co-mingled or withdrawn is a sideshow, a distraction.
Here’s how the Segregated Funds should have been immediately replaced:
A) Normally, the replacement funds might come from non-segregated accounts at MF Global, Inc., the brokerage (MFGI).
B) If the non-seg MFGI funds were insufficient, they had a bank credit line of at least $300 million from which to draw.
C) If that wasn’t sufficient, and all non-segregated sources of capital within MFGI were exhausted, then MF Global Holdings (MFGH), as the parent company, was responsible for replacement.
D) We know that MFGH is legally responsible for replacing funds at the broker because just two months earlier, on 9/1/11, the SEC (through FINRA) invoked SEC Rule 15c3-1 to require MFGH to “top up” the collateral requirements at MFGI, and bring MFGI Accounts into regulatory compliance…which MFGH (grudgingly) did. (see Abelow Declaration of 10/31, Par. 33…link below)
E) If the SEC and FINRA says MFGH is responsible for boosting funds at MFGI to maintain regulatory compliance — that’s good enough for us!
F) Therefore, MFGH was clearly responsible AT ALL TIMES to make sure that MFGI complied with the law, even if – and especially if – an asset transfer was required. They couldn’t just let MFGI be willfully and knowingly non-compliant.
G) Also, MFGI had a $300 million line of credit with JPM (and other banks) that had an explicit “Parental Guarantee” clause in it. (see Abelow Declaration, par. 27 and 28, link below). If MFGI could not repay JPM the $300 million then, the parent company MFGH was obligated to make good the funds.
H) Normally, a parent company guarantee is explicit in writing. However, there must be some sort of implicit parent company guarantee if the Failure to Guarantee results in breaking the law. No client (customer) would ever willingly agree to a contract, a Customer Account Agreement, that would allow MF Global to break the law. That’s why the oft-cited Section 7 of the Customer Account Agreement that Customers signed when they opened their accounts (the obscure fine print) can NEVER impart any permission for MF Global to do all those crazy investment schemes, if doing so results in breaking the law.
So, there must be some sort of implicit parent company guarantee, otherwise laws are broken.
I) So, before the October 31 bankruptcies were ever allowed to be filed, all required funds should have been immediately moved from the Holding Co. into the brokerage Customer Segregated accounts to maintain legal compliance…and then the Chapter 11 filed. Why this has still not yet happened, more than two months later, is beyond belief…and here’s why:
Back to Mr. Gensler’s testimony…
“At all times,” stated Mr. Gensler. Since “at all times” certainly includes “now”, this ironclad 100% Segregated Funds requirement must still apply, even now!
MF Global, though in bankruptcy, still now exists. The Segregated Accounts still now exist. Therefore, according to Commodity Law, those Segregated Accounts must still now, and at all times, be maintained at 100% NAV. Otherwise there is a violation of that law.
Since the Trustees are now responsible for MF Global affairs, they are still now responsible for complying with the law and for maintaining 100% NAV of the Segregated Accounts at all times. They obviously have not done so.
What about “AT ALL TIMES” don’t the Trustees understand? The Trustees have the power and the means to comply with the law and to immediately restore the Segregated Accounts to 100% NAV through the appropriation and substitution of other MF Global Assets. If the non-segregated MF Global assets were required by law to be used in this way before the bankruptcy, they should still now be required to be used in this way. The Trustees’ refusal to use the assets in this way is clearly flouting the law. (Perhaps if there were a discovered “shortfall” that is actually greater than all other assets of the holding company [reportedly $41 Billion] – a true debacle – then they might reasonably claim an inability to comply with the law. This is clearly not the situation, however – the “shortfall” is only $1.2 Billion or less.)
Therefore, the Trustees are willfully failing to AT ALL TIMES maintain the Segregated Accounts to 100% NAV and are currently guilty of violating Commodity Law as CFTC Chairman Gensler stated was the law.
Remedy: The Trustees must be compelled by the Court (or the CFTC or SEC) to immediately restore the Segregated Accounts to 100% NAV for immediate distribution to Customers…or the Trustees should be criminally prosecuted for violation of the law…or both…just as the person(s) responsible at MF Global will be criminally prosecuted for the same transgressions of failing to maintain the Segregated Accounts to 100% NAV, at all times.
The CFTC must also act aggressively to enforce this law. If there is any person or entity that is in violation of this law – or if there is any person or entity that is obstructing compliance with the law (possibly even the Court, if they don’t compel) – the CFTC must use the full capacity of their enforcement powers….and quickly! AT ALL TIMES means NOW!
Actually, the CFTC and/or the SEC may also be guilty of violating this AT ALL TIMES principle. According to reports (ed. note: Congressional testimony has now confirmed) the CFTC was notified before the bankruptcy filing that there was a “shortfall”. They should never have allowed MF Global to file for bankruptcy before determining that the Segregated Accounts were not only accounted for 100% NAV at all times…but were also properly transferred to the new Future’s Commission Merchants (FCM’s). There is plenty of precedent. When an FCM has filed for bankruptcy in the past – in virtually every single instance – the Customer’s segregated accounts were first transferred IN FULL to the new FCM’s. Then the Bankruptcy Court takes over jurisdiction. There is a good reason that this procedural mechanism is in place…so that all market participants may continue their trading activities uninterrupted.
So, Congress must also act aggressively — through their Oversight Committees — to determine who at the CFTC or the SEC was responsible for allowing the bankruptcy filing to occur before ensuring compliance with the 100% NAV at all times requirement in their own Commodity Law.
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** Video Link of Senate Hearing (Gensler testimony at ~ 75-minute marker, response to Sen. Nelson):
** Abelow Declaration – Establishing Holding Company responsibility for replacing Brokerage funding obligations. LINK:
http://online.wsj.com/public/resources/documents/MFGlobalBankruptcyDeclaration.pdf
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