Before most of the world knew MF Global (OTC: MFGLQ) was preparing to file for bankruptcy, regulators knew that customer money had been moved. Much of it, an estimated $1.2 billion at last count, is still missing.

Former MF Global CEO Jon Corzine has sworn before Congress that he doesn't know where the missing money is. At least one regulator is now challenging that story.

In explosive testimony during the House Agriculture Committee hearings on MF Global last week, CME Group (NYSE: CME) Executive Chairman Terry Duffy said that at roughly 2 a.m. on the morning MF Global declared bankruptcy, the company told representatives of the U.S. Commodity Futures Trading Commission and CME that "customer money had been transferred out of segregation to firm accounts."

In similar testimony before the Senate on Dec. 13, Duffy said an agency auditor participated in a phone call where an MF Global employee indicated Corzine knew the firm had loaned customer cash to a European affiliate.

Unnamed sources pointed to missing customer funds as early as two weeks after the bankruptcy, but Duffy's testimony represents the first time a high-level executive had gone on record to state definitively that MF Global had commingled accounts. More damaging? The CME knew about it.

But who knew what, and when, goes far beyond executives in a hearing. Customers, introducing brokers, and MF Global traders paint a picture of warning signs and weak-kneed regulators who failed to take action in the days, weeks, and years leading up to MF Global's death. This is a closer look at what they witnessed.

Something wicked this way comes
Rich Ilczyszyn, a former MF Global trader who now runs, arrived for work at the Chicago office at 6 a.m. that Halloween morning. From the outset, he was told that "offset only" trades were being allowed that day; brokers could only exit positions on behalf of their clients. An email from the firm's back office verified the order.

"It was a huge red flag," Ilczyszyn says. He and several colleagues attempted to reach the New York office to get clarification but the phone lines were jammed. A short time later, the computer system went down. "Clients couldn't get out of the market at all," Ilczyszyn says, "which is a dangerous proposition when you're talking about leveraged futures positions that can skyrocket or collapse within minutes."

Until arriving at the office that morning, Ilczyszyn wasn't especially concerned about the bankruptcy rumors he'd heard over the weekend. "We'd seen this sort of thing before."

Ilczyszyn was in a good position to know. He had been a trader with Lind-Waldock since 2002, then went to Refco when the latter bought the first. But then Refco went bankrupt and was swept up by MF Global. Ilczyszyn was unaffected because Lind-Waldock remained its own operation, with its own CEO.

Corzine changed that by putting the MF Global brand on every business unit. It would be the first of many changes in the new regime. "I felt the difference right away," Ilczyszyn says, but he also never saw any signs that MF Global was about to implode. "I can't even imagine how something like this could happen."

Congress, critics, and cuts
Fingers are quick to point at Corzine. His testimony on Dec. 8 in front of the House Committee on Agriculture didn't help his case much; Corzine gave vague, generic answers that came just shy of taking Fifth Amendment protection against self-incrimination.

Yet he also has supporters. Says one former trader for the principal strategies desk: "Beyond everything that happened, [Corzine] was the guy who knew everyone's names, he was walking around, smiling, saying hello to people ... I mean, he was like the dear leader."

He says this without irony, not realizing it's a name most often applied to North Korea's Kim Jong Il.

For all the praise, there were criticisms of Corzine as well, many of which centered on his restructuring of the firm. By all accounts, MF Global was a company with many silos. Michael Fitzpatrick, a former MF Global oil trader, notes this isn't unusual in older commodities firms. "Cocoa, metal, wheat ... all are their own little fiefdoms."

A series of mass hirings and firings over the past two years had only exacerbated the problem. In 2009, MF Global had expanded its fixed income team and created a new institutional sales team, both of which brought on a slew of new hires. The company had three chief financial officers in four years.

Upon his arrival in March 2010, Corzine continued to restructure the company and made several of what multiple insiders describe as questionable hires. "When I got the chance to see Corzine and his people, I was not impressed," says Ilczyszyn. "These were the same people you always see who were 'good on paper.'"

The illusion of small
For customers, blame isn't as important as restitution. Steve Meyers, owner of Grainbelt Commodities, tried to get his business out of MF Global the Friday before the bankruptcy. "I ordered a bunch of wires sent out. They got back to me when it was too late to do anything and claimed they couldn't find wiring instructions for my account," he says.

Later, instead of receiving the wire transfers he had requested, Meyers received approximately $500,000 in checks by mail, one of which was for $350,000. "Nobody in their right mind would send out a check," Meyers says. "In fact, if I had ever ordered one, they wouldn't have done it."

The checks bounced.

There were other warning signs. In the weeks leading up to the bankruptcy, MF Global instituted what appears to have been a crackdown on margin calls. "I generally don't have margin calls but when I did, I'd get a call immediately," Meyers recounts. "They started to require 100% margin up at all times, even for day trading. It was a telltale sign that they were either really cutting back on risk or something's going on here."

Others say MF Global had been changing for a while. In 2008 and 2009, Jeff Malec, CEO and founding partner of Attain Capital, says MF Global staff became more difficult to work with; there was more paperwork and red tape with opening accounts. Commission payouts were rarely done correctly.

"We had customer assets in the tens of millions with MF Global," Malec says. "So, perhaps not small, but small in comparison to their large business, and most importantly, made to feel small." Attain severed its relationship with MF Global in mid-2009.

But some customers, like Don Miller, didn't notice anything different about the way MF Global was operating. Miller dealt specifically with S&P futures and equities, and maintained an almost entirely cash account at MF Global. He was one of the most affected when excess cash was frozen.

"I've had to shut down my business," he says, echoing Meyers. "I have no capital to work with." His daughter's $30,000 tuition bill is due, and Miller had expected to pull the money from his business. "I'm scrambling now."

Peter Lamoureux, president of Everest Asset Management and trustee for unwinding overseas operations during Refco's scandal-tainted 2005 bankruptcy, states that in the case of MF Global, small is an illusion. "The MF Global failure might look small, but we're still talking about billions in contracts that could have a material impact on certain types of commerce," he says. "Not solving this issue is tantamount to inviting another fiscal crisis."

"Saying MF Global has 'just 30,000 accounts' misses the point that some accounts could have served 1,000 clients," Lamoureux says. "We really don't know the multiplier effect at work here."

War on several fronts
On Friday, Dec. 9, a judge approved a $2.2 billion transfer of funds to MF Global commodities customers. It was the third such distribution since the bankruptcy, and brings the total of returned funds to $4.1 billion. A petition from the early days of the bankruptcy put MF Global's assets at $41 billion.

JPMorgan Chase, (NYSE: JPM) MF Global's primary lender, has filed for "super-priority" creditor status for the $26 million credit line it extended to MF Global Holdings to fund the brokerage's bankruptcy. If granted, funds released in the future would go straight to the bank.

James Koutoulas is CEO of Typhon Capital and lead counsel for the Commodity Customer Coalition, or CCC, which represents more than 8,000 MF Global customers. Koutoulas filed an objection to JPMorgan's request for super-priority status on behalf of the group. "We're simply asserting that if MF Global commingled funds from customer accounts, or cannot properly account for them, JPMorgan can't lay claim to those funds as if they were their own," Koutoulas says.

Several customers also object to MF Global Trustee James Giddens' relationship with the large bank. Giddens, a partner with the law firm Hughes Hubbard & Reed, admits his firm represented JPMorgan Chase in 2009 and 2010 but claims the bank's billings accounted for roughly one-tenth of 1% of the firm's annual revenue.

Though JPMorgan's connection to MF Global is increasingly complex, it is but one of several banks facing lawsuits for its potential role in the brokerage's collapse. Bank of America (NYSE: BAC), Citigroup (NYSE: C), Deutsche Bank (NYSE: DB), Goldman, Jeffries Group, and the Royal Bank of Scotland were also named in a suit alleging the large banks covered up issues that eventually led to MF Global's bankruptcy. HSBC (NYSE: HBC) also finds itself in a tight spot, as it's unable to determine whether a customer or the trustee is the rightful owner of gold bars and silver contracts it is storing for MF Global.

A broken system
Another battle, Miller says, is that the trustee doesn't seem to understand the nature of the case he's working. Meyers agrees, and says working with the trustee's office has been an endless source of frustration: "The claims forms they put together don't even make any sense. It's clear they don't have an understanding of the futures market."

Giddens isn't the only official under fire, and rightfully so. A timeline issued by the CFTC detailing its involvement with the MF Global case offers platitudes, but little in the way of action. CFTC "worked with" the trustee, "addressed questions," "has been in regular contact with," "encouraged," etc. Not the language of a determined regulator demanding customer restitution.

Perhaps it's to be expected. In the wake of MF Global's disastrous quarterly earnings on Oct. 25, CFTC officials spent several days on-site at MF Global specifically to obtain segregated account financials. On Oct. 31, when they learned of the customer funds shortfall, rather than working in tandem with securities regulators, CFTC kicked the MF Global bankruptcy to the SEC and Securities Investor Protection Corporation. The SIPC, in turn, sought Giddens, who had worked with the agency seven times previously -- most recently on efforts to unwind Lehman Brothers. The decision was considered, made, and implemented in less than three hours, from 2:30 a.m. until 5 a.m., according to the timeline.

As the document explains it, CFTC was "unable" to initiate a bankruptcy proceeding for a registered futures clearing merchant such as MF Global. SIPC therefore had to be involved. What isn't clear is why CFTC never asked to be involved in the unwinding and return of futures and commodity customer assets when Giddens, the trustee, was being appointed.

Repeated attempts to get clarification from CFTC officials have thus far been denied. In the meantime, Commission Chairman Gary Gensler has recused himself from the agency's investigation into the MF Global bankruptcy, citing a potential conflict of interest arising from an association with Corzine that dates back to their days working together at Goldman.

Getting back to even
"I'm not special," Meyers says. "I'm not unlike thousands of brokers who are going through the same thing. And we have lost faith in the system because the industry was nowhere for us."

Ilczyszyn understands Meyers' frustrations, and takes his customers' losses personally. "We're all trying to help our clients. We're talking about millions of dollars. It's our reputations on the line. The reach of this thing is amazing."

Fitzpatrick says, "I was always under the impression that the clearinghouse would make everyone whole."

Dean Tofteland, the Minnesota farmer who's still waiting for tens of thousands of dollars to be unfrozen, understands the risk inherent in the business. On balance, he believes business failure is part of the economy and improves the overall system.

"A bankruptcy is a bankruptcy," Tofteland says. "When you fail, that's a fact of life, but there needs to be an efficient outcome for the customer."

"I feel that the industry had a moral obligation to its current and future customers to ensure a process is put in place to make sure that customers are made whole," Miller says. "I ask myself: What's the right thing to do?"

In our concluding chapter, we discuss what we can learn from MF Global. Click here to read all about it.