MF Global: Fraud, Incompetence, or a Bit of Both?

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In the wake of its futures-market-rattling bankruptcy, there is a huge shortage of client funds at MF Global (OTC: MFGLQ). But when we look back at what led to the broker's collapse, one thing is clear: There's no shortage of incompetence.

Sure, the question of fraud is what has grabbed much of the headlines, but even if there was bona fide fraud, it was served up with a hefty helping of poor judgment, miscalculation, and a seeming inability to learn from even the very recent past.

At this point, the one thing that we can say for sure in the case of futures broker is that it is an epic disaster. A brokerage that traces its roots back to 1783 is now bankrupt and liquidating, billions of dollars of supposedly safe customer money has been frozen, more than $1 billion of it appears to be missing, and there're no shortage of calls for the head of former CEO Jon Corzine.

But what was actually fraudulent here and what was just plain dumb?

Man was that stupid!
Chief among the incompetence offenders here is Corzine, who set an ambitious strategy to turn the futures broker into an investment bank that would compete with the likes of Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) . One of Corzine's primary steps in this direction was building a principal-trading operation within MF Global that risked the firm's own capital.

What Corzine didn't do, however, was put the company in a position where it could safely make such a transition. MF Global was already highly levered when Corzine took over, but he kept the massive leverage -- 30-to-1 as of Sept. 30 -- even as he ratcheted up trading risk. This gave MF Global and its fledgling principal strategy desk precious little room for error without blowing up the entire company. Leverage at that level was what sunk Lehman and Bear Stearns and put all the other big banks at risk in 2008. That Corzine somehow missed that boggles the mind.

Then, of course, there was the huge bet on European debt that played a major role in sinking MF Global. Along with the hefty leverage, avoiding concentrated bets was another lesson that any reasonably informed average Joe could have learned from the financial crisis that took place a mere three years ago.

Even if Corzine Rip Van Winkled his way through the recent financial meltdown, he should know plenty about the dangers of making big bets while being highly leveraged. When he was the co-CEO of Goldman Sachs, he took part in the bailout of the overly leveraged Long-Term Capital Management. LTCM failed after large, concentrated bets it made went the wrong way.

Of course, Corzine wasn't alone in this disaster. MF Global had a chief risk officer, Michael Stockman, who presumably should have had something to say about the crazy risk profile at MF Global. To be sure, Stockman said the right words when it came to the issues that caused the 2008 financial crisis. He co-wrote a research paper, "The-100 Year Flood," about the meltdown and helped design a course at Dartmouth's business school that -- according to his MF Global bio -- focused on "risk management insights."

And yet Stockman seemed to bring none of this insight to MF Global. A candidate for the foot-in-mouth Hall of Fame, Stockman was quoted by as recently as March as saying, "I would suggest we are not taking enough risk."

And while those may be some of the most glaring examples of idiocy at MF Global, it really only scratches the surface, as we could also potentially include the current CFO, the former CFO, and the traders on the prop desk, among many others.

Limber up for the perp walk
For better or for worse, CEOs and other executives can make certain stupid decisions and not be jailed for it. The extent of MF Global's leverage was a secret to no one. And though there are some folks complaining that the company didn't disclose enough about its bet on European debt, its annual report -- which was released in May -- makes it pretty clear that the company had huge exposure:

At March 31, 2011, securities sold under agreements to repurchase of $14,520,341, at contract value, were de-recognized, of which 52.6% were collateralized with European sovereign debt. [Author's note: Dollars in thousands.]

But when clearly defined rules are in place, and a company and its executive team violate those rules, it's time to break out the handcuffs.

In MF Global's case, the most glaring issue is the fact that as much as $1.2 billion of customer money is currently missing. Under Commodity Futures Trading Commission rules, customer money can be invested in certain ways to earn money for the brokerage, but it cannot, under any circumstances, be used by the company to fund itself or its own trades.

The question of what happened to that money is still under investigation, but many -- including CFTC Commissioner Bart Chilton and accounting expert and Forbes columnist Francine McKenna -- think that foul play is involved.

One possibility is that in a fit of desperation as the company was crumbling, Corzine, or somebody else at the top of MF Global, decided that it would be OK if customer funds were used to shore up the company's trading positions. If this turns out to be the case, it's bad news for the execs at MF Global because that's just plain illegal.

It's also possible that something has been fishy at MF Global for a long time and it was only the blaring light of bankruptcy that revealed the company's misuse of customer money. Once again, if this is the case, we'd expect to see somebody end up behind bars. The big question here would be what, as the CEO of the company, Corzine would be on the hook for if he didn't explicitly know what was going on.

Answer: (D) All of the above
The more details that trickle out from the investigators on MF Global, the more it seems like this was a lethal mix of incompetence, hubris, and idiocy along with a nasty dose of fraud.

Of course, to be fair, particularly when it comes to possible incompetence, there's plenty to go around outside of MF Global. Remember, a company like MF Global can't reach untold heights of leverage without the aid of willing lenders like JPMorgan Chase (NYSE: JPM  ) , Bank of America (NYSE: BAC  ) , and Deutsche Bank. Additionally, futures exchanges like CME Group (Nasdaq: CME  ) and IntercontinentalExchange (NYSE: ICE  ) are supposed to keep a close eye on their members and, specifically, the segregated customer assets. It would seem that some less-than-top-notch work from all of the above may have also gone into the MF Global debacle.

Post-implosion, there's still a pressing need to get client funds -- every last penny of them -- back to MF Global's customers. After that, the courts will sort out what's left in the company for its creditors.

But as the picture becomes clearer regarding what precipitated MF Global's failure and how hundreds of millions of dollars of client funds disappeared, it will be imperative that regulators and the legal system sort out where there was fraud and where there was incompetence. Incompetence is obviously not ideal, but it exists, and when investors and creditors back incompetent management, it's reasonable for them to end up on the wrong end of a blowup. Fraud, however, needs to be swiftly and severely punished to show that regulations are to be taken seriously.

Our team here at The Motley Fool is continuing to dig deep into the MF Global mess. If you'd like to share any information with us, you can email us at or call our tip line at 703-254-1546.

If you want to stay up to date on the emerging story at MF Global and Wall Street reform, shoot a blank email to

The Motley Fool owns shares of JPMorgan Chase and Bank of America. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (6) | Recommend This Article (11)

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  • Report this Comment On November 22, 2011, at 8:02 PM, nickjob wrote:

    I agree with most of the premise of your article, with the exception of one. With all due respect, incompetence is not one. It seems to imply that Jon Corzine is stupid. Not so. The facts don't support that reasoning. Over thirty some years in the investment field. Top dog at Goldman Sachs. New Jersey Governor and, until recently Chairman of MF Global. Even Joe Biden gave a sterling opinion of his mental acuity. Substitute for incompetence words like arrogant, egotistical, power hungry and you are getting closer. As a former owner and CEO of a clearing firm, I as well as all the rest of my colleagues in the same position would be embarrassed to use the dumb excuse and say I didn't know the rules and regulations of clearing. Corzine knew for sure that he was dipping into customer funds. Make no mistake about it. Why otherwise was Corzine lobbying Gensler(CFTC Chairman and previous good old boy with Corzine at Goldman) this summer to relax the sacrosanct rules regarding investment of customer funds? He was probably already in trouble. And what role did Gensler play in this whole mess? Was he in cahoots with Corzine? These questions and many more should be asked by a senate agricultural investigating committee? It may turn out that the biggest mistake Corzine (and maybe Gensler) made was ticking off the people of the heartland; a bunch of small and medium-sized farmers, co-ops, grain elevators and trading entrepreneurs who met for over 150 years at the exchange to conduct business in an honest and extremely efficient manner. If they are found guilty, lock them up and throw the key away.

  • Report this Comment On November 22, 2011, at 8:15 PM, TMFKopp wrote:


    "Corzine knew for sure that he was dipping into customer funds."

    Oh no, no, no... that's definitely *not* what I was covering under incompetence. The incompetence covers primarily the lead-up to the company's blow-up and the seeming inability (refusal?) of Corzine and the rest of the execs to learn the lessons of just a few years ago (leverage + concentrated bets).

    As far as violating the segregated accounts, however, that has nothing to do with incompetence. If they did dip into those funds, you're exactly right, they knew exactly what they were doing.

    The only way incompetence is involved with the missing funds is if the bookkeeping was really that bad that the money is there and safe, but that it's just been hard to track down. Three weeks into the bankruptcy and the Case of the Missing Funds, that scenario is looking highly unlikely.

    Thanks for the comment! Glad I could clarify that. No way I'm giving them any "I didn't know" pass on stealing customer cash.


  • Report this Comment On November 22, 2011, at 9:03 PM, nickjob wrote:

    "seeming inability for Corzine to learn his lesson." You still seem to be going easy on him. More likely than not, he "threw a shoe" as they say. He made a huge bet with other people's money. If he was right, he'd make a lot of money, the media would glorify him as they always do in these cases and call him a genious. If he was wrong, he would walk away with the little people holding the bag, go into hiding until things blew over, and then be given another CEO job by the good old boys, and do it again. When do we get representatives who will stand up for the good, honest people of this country? Why isn't the mainstream news covering this story? This administration invests in failing solar companies, big good old boy banks, but turns a blind eye to the heartland. Let's watch carefully to see if his political clout keeps him from a just trial.

  • Report this Comment On November 22, 2011, at 11:29 PM, TMFKopp wrote:


    "He made a huge bet with other people's money. If he was right, he'd make a lot of money, the media would glorify him as they always do in these cases and call him a genious. If he was wrong, he would walk away with the little people holding the bag, go into hiding until things blew over, and then be given another CEO job by the good old boys, and do it again."


    1) It's not Corzine's fault that people are willing to give him money to make that bet. From the investors' and bondholders' perspective, what Corzine was doing wasn't a secret -- that is, they knew MF was highly leveraged, they knew Corzine was ratcheting risk, they even knew that he had a massive bet on European debt. I'm not trying to be easy on Corzine here, but wouldn't you take that opportunity if it was available to you?

    2) As far as the press calling people who are successful though big gambles geniuses, well, that's a problem of the press, not Corzine. If you haven't already, you may want to check out "Fooled by Randomness." Taleb has plenty of harsh words for journalists that do exactly that.

    "Let's watch carefully to see if his political clout keeps him from a just trial."

    Yes. If there was fraud involved here and he walks, that would be a very, very distressing outcome. Trust in regulations depends on the idea that when somebody violates them, they will go to jail.

    Bottom line: I don't really care much about Corzine's reputation or politics. What I do care about is whether he was actually involved in a crime here and, if he was, whether he goes to jail. I also wouldn't ever invest in a company that he leads -- he seems to be a pretty inept leader.


  • Report this Comment On November 23, 2011, at 7:18 PM, PoorGamaliel wrote:

    Corzine, 'I neither admit or deny guilt. Please pass me the $300 million fine. Goldman Sachs got this deal and maybe I can get a bridge loan to the same decision. I am a good person.'

    We should survey Harlem to see if they have heard of laws like that for stealing milk or candy bars. I think they get a solid 5 years for that. Besides they are not good people.

  • Report this Comment On December 07, 2011, at 3:53 PM, WhistleBlowhard wrote:

    The title must be a joke "A bit of both". Maybe if we were only talking about a few million, or ten or twenty million dollars, it could be a bit of fraud. Maybe if we were talking about the disputed resolution of a complex business transaction, or a contractual dispute. No, this is an extremely simple case of a banking/investment management institution - MF Global - invading the constructive trust which protected their clients assets. Make no mistake this lawyer invented term "comingle" is double speak for "theft". This is a massive amount of fraud. We should not be surprised that this massive coordinated crime has headed for our corrupt bankruptcy courts. Highly regarded PHd's in the U.S. at UCLA and other institutions have determined that our bankruptcy courts are corrupt. This sort of crime is covered up, executive criminals are protected by a sinister abuse of bankruptcy laws by BigLaw. Read about these scandals at the BankruptcyMisconduct web site.

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