The MF Global You Don't Know but Probably Should

This is a story about Refco, a troubled but once high-flying futures brokerage firm that ultimately became part of MF Global. Special thanks to Forbes contributor Francine McKenna, who also keeps the excellent blog re: The Auditors. Not only has she done the smartest work we've seen on the connections between Refco and MF Global, but she also spent time giving us ideas for how to pursue this story, and in the process provided insights that proved crucial in our reporting.

Most accounts characterize him as an impressive CEO.

Well-educated with a track record for making fistfuls of money, he knew the risks created by the sometimes-outlandish behavior of traders and sought to moderate it at the futures and commodities brokering firm he led. Or so it seemed.

We recognized that this sort of egocentric trader personality was simply not going to survive. ... The firm had to change its image, its posture and its general approach to the market. We had to become professional.

You think that quote is from Jon Corzine, the former New Jersey governor and U.S. senator who's become the face of a multibillion-dollar failure at futures firm MF Global? Wrong. That's Phillip Bennett, a mysterious Englishman speaking about Refco in a 1987 interview with Forbes.

Eighteen years later -- and three years before the collapse of Lehman Brothers and Bear Stearns -- Refco revealed that Bennett had hidden $430 million in bad debts from, well, everyone. Creditors panicked, liquidity evaporated, and Refco, already leveraged at a rate of more than 350-to-1 as of May 2005, filed for bankruptcy that October, just two months after what had been a successful IPO.

Today, as regulators weigh whether to bring charges in the MF Global case, Bennett is serving out a 16-year term in prison for securities fraud.

Looking back, and seeing connections
But back in the late fall of 2005, as Refco was falling apart, an investor group led by J. Christopher Flowers, a Corzine friend and former colleague at Goldman Sachs (NYSE: GS  ) , swept in to offer $768 million for the futures business. An initial agreement would be abandoned as other bidders emerged.

Flowers would re-enter the story in a similar fashion two and a half years later, but Refco would first have to be sold to Man Financial of the United Kingdom. The firm announced its bid on Nov. 13 and within two weeks terms of the $282 million deal were finalized.

Within two years, in July 2007, Man Financial would spin off its brokerage operations into what we now know as MF Global. Former Refco employees followed, including assistant general counsel Dennis Klejna and Steve Grady, who as of this June led MF Global's prime services business.

Yet trouble persisted. In February of 2009, a broker named Evan Dooley made what MF Global said were unauthorized trades in wheat futures resulting in $141.5 million in losses. The stock fell 28% the next day, destroying precious equity in the process. Futures firms tend to use equity and debt to raise capital when bets go bad.

The Dooley case left MF Global looking for more capital, and that left an opening for Flowers. His firm pledged up to $300 million in fresh capital in May 2008 in exchange for a board seat and convertible preferred shares yielding 10.725% in annual dividend payments.

If that sounds familiar, it should. Warren Buffett extracted similarly generous dividend payments on behalf of Berkshire Hathaway shareholders as conditions of big investments in Goldman Sachs and General Electric. The difference, of course, is that neither Goldman nor GE is staring down the long barrel of a bankruptcy filing.

Two failures, much like the other
There isn't now and may never be a verifiable direct connection between the failures of Refco and MF Global, but the head-shaking similarities between these two firms -- which are now conjoined because of the Man buyout -- are startling.

First and most obvious is missing money. Bennett hid Refco debts; MF Global is accused of comingling client funds in order to remain solvent. Roughly $600 million is still unaccounted for. We can't be sure criminal malfeasance is involved, but the Commodity Futures Trading Commission has launched a formal investigation.

Billions of dollars in trading capital has been frozen in the meantime. CME Group (NYSE: CME  ) has confirmed it has $2.5 billion in MF Global client funds on deposit. InterContinentalExchange (NYSE: ICE  ) is also limiting trades.

Rules? Who says we need rules?
Refco and MF Global also share a penchant for attracting the eyes of regulators. According to data provided by the National Futures Association, MF Global and Refco have paid millions more in fines than their most direct peers:


NFA Actions


CFTC Actions (fines)

Exchange Actions


Total Fined

Bank of America Merrill Lynch


2 ($185,000)

16 ($345,500)


Goldman Sachs



30 ($217,500)


JPMorgan Chase (NYSE: JPM  )


3 ($410,000)

4 ($3,000)


Lehman Brothers


3 ($385,000)

34 ($306,940)


MF Global


1 ($10,000,000)

12 ($90,000)


Morgan Stanley (NYSE: MS  )



27 ($219,450)




9 ($9,234,000)

136 ($2,228,375)




1 ($200,000)

19 ($149,850)


Source: National Futures Association data.

MF Global may have suffered just one CFTC citation in its brief history as a publicly traded futures operator, but the text of the complaint is particularly troubling given the events of the past two weeks.

"The CFTC order finds that, from 2003 to 2008, MF Global failed in four separate instances to ensure that its risk management, supervision and compliance programs comported with its obligations to supervise diligently its business as a CFTC registrant," the order states. The commission imposed a $10 million civil penalty as a result of the infractions.

It's a good bet the CFTC team now investigating MF Global will refer back to this case. Just don't expect it to influence the outcome. History would call such hope wishful thinking. After all, Refco went bust just shortly after coming public.

Months of due diligence conducted by auditors and bankers yielded no warning signs, and that's despite the extraordinary leverage ratio that was hiding in plain sight. (Refco had been leveraged at a Lehman-like 26-to-1 as far back as 2003, according to data supplied by S&P Capital IQ.) IPO underwriters at Goldman, Bank of America, and Credit Suisse (NYSE: CS  ) , among others, simply cashed in and moved on.

Six years later, $600 million is missing at MF Global. Nothing's changed. And nothing will change until boards of directors, ratings agencies, investors, and regulators choose -- actively choose -- to demand more of the people running this industry.

Don't hold your breath waiting.

Have a different view of the MF Global bankruptcy? Please weigh in using the comments box below. You can also help us report the full version of this story by sending scoops to

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Berkshire Hathaway at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

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Read/Post Comments (7) | Recommend This Article (25)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 15, 2011, at 4:34 PM, prginww wrote:

    Does anyone wonder whether the CFTC or CME were concerned about the $325m bond issue that MFG placed in August this year ? You could say that debt wasn't worth the paper it was printed on. If any of the regulators had suspicions that something wasn't quite right before August then both they and MFG have a lot of questions to answer even if the "missing" money does come to light.

  • Report this Comment On November 15, 2011, at 11:45 PM, prginww wrote:

    Character, integrity, honestly are not written about in our modern media. However those characteristics and values will outperform all the regulators in the world.

  • Report this Comment On November 16, 2011, at 8:51 AM, prginww wrote:

    The Refco connection has always been the poison in the well at MF Global. The baffling decision to allow an operator like Steven Grady to manage anything at MF has always been a source of bewilderment to employees and others in the business.His unethical careless behavior and bullying ways are well known. He could be the most hated man, next to Corzine of course. Its time they investigate Grady and how he always seems to be wherever there is a major failure.

  • Report this Comment On November 16, 2011, at 10:42 AM, prginww wrote:

    The deceit, conspiracy and complicity amongst these traders, the banks and the accounting/auditing "professionals" keeps surfacing as more of these scam businesses go down.

    It's clear that the professional conduct and duty of care notions we think exist in the accounting and auditing community are just that; notions. The reality is that too many of these people use their positions to exploit those who should be able to trust them. And that other people in these "professions" fail to act against their bad eggs to keep their reputation clean and respectable.

    Since they clearly can't overcome their personal greed to self-regulate, it's time to license the money traders, bankers, accountants and auditors. Airline pilots, truck drivers, doctors and others are licensed, and their license can be withdrawn for malpractice. That's what is normally done with professionals who are doing jobs that can damage others' well-being. It's clear that unethical accountants, auditors, bankers and traders can have equal or greeter impacts on the lives and future of their clients.

    It might be OK to allow "three strikes and your out" in baseball, but managing pensions, savings and the nation's accumulated wealth is not a game. The people associated with these corrupt businesses seem to have taken multiple strikes and continued doing their thing - raking in a personal fortune while deliberately deceiving and stealing from depositors and investors.

    One strike should be enough to pull the personal license and impose a lifetime ban on doing business in banking, finance, accounting/auditing or trading again.

    Investors and depositors need that protection, and so does the national economy.

    Most other critical jobs have mechanisms to protect the welfare of the people they serve. There are entry requirements and routine re-examination and evaluation tests to renew the license.

    It's very clear that banking, finance, accounting, auditing and trading seriously lack these consumer protections. Therefore they seem to have become the haunt of scammers, snake oil salesmen and con artists who could not gain or keep a license elsewhere - for example as a truck driver. It appears likely the garbage rejected from respectable vocations has slithered into the finance sector because filth, slime and blood sucking aren't tolerated elsewhere.

    We need some personal license protection for the people who have no choice but to use this industry. One strike and you're out, forever.

    History shows It's too costly for the economy and too damaging to honest and hardworking people if these garbage are allowed to continue gambling with our future and our money.

  • Report this Comment On November 16, 2011, at 1:36 PM, prginww wrote:

    Tiingall, accountants and auditors are certified and licensed already. First, they have to pass a standardized and rigorous exam on technical accounting knowledge. After passing that, they have to meet licensing criteria imposed by the state in which they practice. Most states include an ethics exam. Of course, knowing the right answers and following the rules aren't necessarily the same thing, but every year there are CPAs who are sanctioned for ethics violations.

    However, auditing standards have never held auditors responsible for detecting deliberate fraud by management. Even internal controls testing can be foxed, and it's impossible to test every transaction.

    As a working CPA, believe me when I say that no auditor in his right mind wants to sign his name to financial statements that turn out to be materially misleading. Professional reputation is worth more than the fees from one client: quite apart from the prospect of lawsuits and regulatory investigations, what client will want you if your name is tainted?

    That said, I agree that the people who actually perpetrate such fraud and failures of fiduciary duty should be banned from the industry.

  • Report this Comment On November 18, 2011, at 3:22 PM, prginww wrote:

    There were many quality people picked up from Refco but agree on the comments about Steve Grady as no one who has worked with or for him can believe he was given such responsibility at MF Global. Other than laying down a sharp axe on staff with relish at both Refco and MF Global(I would estimate he made redundant at least several thousand people at both firms) he tended to manage by intimidation and calling him a operator would be kind. It will be interesting if he escapes full scrutiny this time!

  • Report this Comment On December 24, 2011, at 9:24 AM, prginww wrote:

    What was the issue Jim Rogers had with Refco?

    Wasn't it that he had a CFTC ringfenced exchanged traded futured account, and a separate margin like account which was for bilateral OTC deals with Refco. Refco could legally use any collateral in that account, indeed would need to to be able to execute and hedge trades for clients. However when they went BK Rogers found that some of the money in his CFTC account had been transferred to the margin accoint without his authorisation, and was therefore mired in the bankruptcy whereas the CFTC ringfenced money was cleanly transferred to Man Financial. Lots of fun for lawyers ensued, but not for Rogers. Can he claim it back in total immediately or is he now just one of many creditors ... ???

    I confess can pick 'em ... had an account with Refco at the point it went under ... but came out clean thanks to Man ... and I had an account at Bear Stearns when they went under ... but came out clean when JPM.Fed rescued them. Whew! I exited Man when market interest rates were 5% yet they refused to pay anything even on substantial balances. Whew! again.

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