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Will MF Global Customer Interests Be Crushed by Big Banks?

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I'm not a lawyer. I don't even play one on TV. As a result, one of the most difficult aspects of breaking down the MF Global (OTC: MFGLQ) case has been trying to understand how the legal system works in this kind of situation.

At this point, my nagging suspicion is that it simply doesn't work. Or at the very least, a quagmire of overlapping rules and regulations has created a labyrinth that not even some of the sharpest legal minds (or at least some of the most well-paid legal minds) seem to be able to navigate.

Not that the legal issues are the only maze that those working on MF Global have had to navigate.

This just in
In an update released Monday, James Giddens, the trustee for the MF Global brokerage subsidiary, said that at this point the small army that's been picking apart the broker's books has a decent picture of where money was moved in the final days of MF Global's solvency. In short, it's not a pretty picture.

The numbers that Giddens included in his press release back up his familiar refrain that tracking down the $1.2 billion of missing customer money would be difficult because of the frenetic final days at MF Global. Here are a few of the pertinent numbers from the release:

  • Cash transactions at the broker totaled more than $105 billion in the final week.
  • There was an additional $100 billion in securities transactions.
  • In all of October 2011, the trustee examined 840 individual transactions that exceeded $10 million, for a total transaction value of $327 billion.
  • The large cash transactions include 47 bank accounts across eight financial institutions.
  • In the final five days of solvency, MF Global was hit with margin calls totaling $554 million.

To put the magnitude of these numbers in perspective, MF Global's -- the holding company -- final earnings release reported total assets of $41 billion as of Sept. 30, 2011. Shareholder equity at that date was put at $1.2 billion. That means that in the course of one week, the broker's cash transactions alone were a multiple of the company's total assets, while margin calls were nearly half of the company's total previously reported book value.

In other words, that was indeed an incredibly hectic week.

The same old story
Of course while the new numbers may be fascinating, they still leave the same nagging question: Will customers that had segregated accounts at MF Global be made whole?

The answer is still unclear, and if it is going to happen, the road to 100% appears to be a long one. While it certainly helps that the trustee now has a good idea of where all of MF Global's money went, reclaiming it is hardly an easy matter. Since these transactions involved MF Global sending money to parties that it rightfully owed money to, Giddens said he's forced to "investigate the complex factual and legal questions" that might allow him to pursue claims against some of the recipients.

But to the non-lawyer in me, this all seems hopelessly and needlessly convoluted. The bottom line is that if MF Global pulled money from customer accounts -- without replacing the funds with certain allowed assets -- to meet other obligations, then it did so illegally. In that case, the customers should be made whole from the general assets of the broker or even the holding company if necessary.

And it appears that the latter scenario is exactly what happened. Giddens wrote:

The investigation to date has found that transactions regularly moved between accounts and that funds believed to be in excess of segregation requirements were used to fund other daily activities of MF Global. In the past, such transfers were in amounts of less than $50 million, but as liquidity demands increased and could not be met from internal sources, much larger amounts were used. ... [T]he 4(d) U.S. segregated commodity customer account appears to have reached a deficit condition on Wednesday, October 26 that continued through to MF Global's bankruptcy.

Unfortunately for the customers that are still out roughly a third of their MF Global accounts, recovering the property pits them against some of the most powerful financial bodies in the world, including MF Global Holdings' two top creditors, JPMorgan Chase (NYSE: JPM  ) and Deutsche Bank (NYSE: DB  ) . And thus far, it seems that these "too big to fail" banks have a strong ally in Louis Freeh, the trustee for MF Global Holdings. The Commodity Futures Trading Commission has already blasted Freeh's views on handling the case, writing in January:

The brief of the Chapter 11 Trustee contains errors and misstatements of law that, if accepted, may inhibit commodity customers from recovering their property. ... If, contrary to the language of the statute, the Chapter 11 Trustee were correct, the senseless result would be to render inapplicable the key regulations of the Commodity Futures Trading Commission in the largest commodity broker bankruptcy in U.S. history, and to strip of a remedy all MFGI commodity customers who entrusted their property to MFGI in reliance on applicable segregation requirements, based solely on the happenstance that the commodity broker also operated a much smaller securities business ... that is not the law.

The chapters still to come
The MF Global debacle is far from over. If controls at the broker weren't enough to keep the company from raiding customer accounts in those final days, CEO Jon Corzine may be on the hook because of assurances he made under Sarbanes-Oxley provisions. While CME Group (NYSE: CME  ) created a $100 million fund to protect farmers and ranchers in future cases like this, that exchange operator still remains under a cloud and realistically will probably have to do much more. The U.S. government and regulatory bodies have also been considering changes in how they handle this industry moving forward.

But most notable may be the showdown between the large, big-money interests such as JPMorgan and Deutsche which took legitimate risk in lending money to MF Global, and the diverse group of smaller customer interests that held the belief that their supposedly segregated accounts at MF Global were a risk-free proposition.

As I said at the beginning, I'm no lawyer, but in this case it doesn't take a legal degree to see what's right.

The Motley Fool owns shares of JPMorgan Chase. 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 does not have a financial interest in any of the 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 (7) | Recommend This Article (12)

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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 February 08, 2012, at 4:30 PM, DJDynamicNC wrote:

    Of course, if I walked into a bank and took somebody's "segregated account" money and spent it on bills I legitimately owed, I'd quite clearly (and legitimately) be accused of stealing, and be forced to reimburse the victim and would probably spend time in jail.

    Unfortunately, such common sense laws do not apply to our mighty Wall Street overlords, who are far too important to be bothered with such trivial concerns.

  • Report this Comment On February 08, 2012, at 8:10 PM, milfalcon wrote:

    I'm not a lawyer either, but it seems to me that if it's proven that MF Global took money from the segregated funds (ie stole it) and used it to pay back loans to JP Morgan and Deutsche (a big if, obviously), then those entities in turn are now in possession of stolen goods, and should be obligated to return those funds. Note that neither JP Morgan and Deutsche have necessarily done anything illegal or even wrong to this point (they had no reason at the time to suspect the funds MF was sending them were stolen), but if that does prove to be the case I don't see how the laws would protect them from having to return the money.

  • Report this Comment On February 08, 2012, at 9:22 PM, venturen wrote:

    This is just a clearer picture of what wall street does every day to pensions, individuals, companies. They make up very complex rules and then steal your money. They no longer loan money or invest in compainies. The spin the money. they are a multihead hydra that does high frequency trading usless except to push the market up and down while taking the cream. Think nothing of stealing people's life saving...all the better for that big bonus. They are never on the hook for a penny. They outright lie in IPO and bond quaint to be a trusted would have to be a moron to trust these crooks! SAdly they are running the country into the ground and Benny boy gives them unlimited 0% money. But unfortunately that is the end of the game...I give it 5 years and then a real depression with hyperinflation...and yes they are opposites.

  • Report this Comment On February 09, 2012, at 1:47 AM, BBLBBD wrote:

    This is more a picture of what the political class (the left-leaning class) does to every citizen. They steal our money to fund their lavish and super rich "world citizen" lifestyle. Cf. Gore, Clinton, Corzine, Daschel, Geitner, Reich, Pelosi, Reid, Sommers, ad infinitum, ad naseum. How does a system designed for citizen legislatures make so many of them so rich ? Think of Martha Stewart, or Conrad Black. Did they do any worse >

  • Report this Comment On February 09, 2012, at 11:48 AM, DJDynamicNC wrote:

    @Venturen - in the interest of accountability, would you like to make a bet on that?

    Five years from now will be February 9th, 2017.

    If by noon on February 9th, 2017, the United States is experiencing hyperinflation (say, 20% annually or higher) I'll forward to you 1 pound (sixteen ounces) of silver. If annual inflation as calculated on that date is lower, you can forward to me the equivalent in good old fashioned US Dollars (at 2017 rates of exchange).

    I'm a big fan of accountability.

  • Report this Comment On February 09, 2012, at 11:51 AM, DJDynamicNC wrote:

    @BBLBBD - lolol

  • Report this Comment On February 09, 2012, at 3:02 PM, devoish wrote:

    New Year, New Words;

    By way of background, hypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is “hypothetically” controlled by the creditor, who has a right to seize possession if the borrower defaults.


    Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal.

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