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MF Global Didn’t Segregate Client Collateral: CME

MF Global Holdings Ltd. (MF), under investigation by U.S. regulators after filing for bankruptcy protection, violated requirements that it keep clients’ collateral separate from its own accounts, the head of the world’s largest futures exchange said.

Craig Donohue, CME Group’s chief executive officer, said on a conference call with analysts today that MF Global isn’t in compliance with the rules of the exchange and the Commodity Futures Trading Commission.

“While we are unable to determine the precise scope of the firm’s violation at this time, we are investigating the circumstances of the firm’s failure,” Donohue said.

MF Global, the holding company for the futures broker run by former New Jersey Governor and ex-Goldman Sachs Group Inc. Co-Chairman Jon Corzine, is being investigated by regulators for hundreds of millions of dollars that may be missing from client accounts, according to two people with knowledge of the matter.

CME Group’s Chicago Mercantile Exchange is the designated self-regulatory organization for MF Global, meaning it audits and monitors the firm’s positions on a regular basis, said Laurie Bischel, a CME Group spokeswoman.

MF Global told regulators yesterday about deficiencies in accounts that it managed for clients in the futures market, the CFTC and Securities and Exchange Commission said in an e-mailed statement. MF Global was ordered by the CFTC’s enforcement division to preserve records for the review, said one of the people, who spoke on condition of anonymity because the probe isn’t public.

$6.3 Billion Wager

Corzine, 64, now faces a regulatory probe as well as a bankruptcy. He wagered $6.3 billion of the firm’s own money on sovereign European debt in a bid to increase profits. Instead, the firm reported a $191.6 million quarterly loss on Oct. 25 as Europe’s debt crisis led to demands from regulators to boost capital, as well as credit downgrades and margin calls, MF Global President Bradley Abelow said.

BlackRock Solutions, a unit of BlackRock Inc., was called in on Oct. 28 to examine MF Global’s balance sheet and determine if some assets could be sold, according to a person briefed on the discussions. BlackRock ended its review when it became clear the firm wouldn’t find buyers and that there were shortfalls in client accounts, said the person, who spoke on condition of anonymity because the talks were private.

Bobbie Collins, a spokeswoman for BlackRock, declined to comment.

Corzine and Diana Desocio, an MF Global spokeswoman, didn’t respond to e-mails or phone messages seeking comment.

$7.3 Billion

Under the regulations, futures brokers that trade on exchanges are required to keep their clients’ collateral, often cash or securities, separate from their own accounts. The segregated collateral is meant to reduce risk in futures trades. MF Global had almost $7.3 billion in customer funds in segregated accounts as of Aug. 31, according to the most recent CFTC data.

“It’s kind of considered the third rail of the brokerage industry that when you’re holding your customers’ funds in their names, you don’t touch them — even in an emergency situation when you’re running short of cash,” Darrell Duffie, a professor at Stanford University’s Graduate School of Business, said in a telephone interview.

“The fact that the CME has stated that customer funds have been mishandled increases the likelihood that this is not just a simple accounting error or IT glitch,” he said. “The CME obviously has access to its own clearing account records and would probably have based its statement on a review of those records.”

‘Prudent’

The regulators said in their statement yesterday that they advised bankruptcy as the “safest and most prudent course of action to protect customer accounts and assets.”

The missing funds were reported yesterday by the New York Times. As much as $950 million was thought to be missing at first, and that figure fell to less than $700 million as the firm reviewed its accounting, the Times said today, citing people briefed on the matter. More funds may show up in coming days, the report said.

MF Global listed debt of $39.7 billion and assets of $41 billion in Chapter 11 papers filed in U.S. Bankruptcy Court in Manhattan.

Corzine, who won the top job at Goldman Sachs by leading the firm’s fixed-income unit, was recruited to the firm in 1975 as a trainee on the government bond desk. He graduated in 1969 from the University of Illinois at Urbana-Champaign, served in the Marine Corps Reserve and received his master’s degree in business administration from the University of Chicago in 1973.

Senate

Corzine, a Democrat, was elected to the U.S. Senate a year after he left Goldman Sachs in 1999 with an estimated $400 million as the firm went public. He became governor in 2006 and was defeated in November 2009 by Republican Chris Christie.

MF Global’s board met through the weekend to consider options including a sale, a person with direct knowledge of the situation said. The firm was in discussions with five potential buyers for all or parts of the company, including banks, private-equity firms and brokers, a person with knowledge of the matter said on Oct. 28.

Interactive Brokers Group Inc. was still considering a rescue early yesterday, but pulled out after the discrepancy surfaced in customer accounts, The Wall Street Journal reported yesterday, citing unidentified sources.

Thomas Peterffy, Interactive Brokers’ chief executive officer, didn’t respond to a request for comment.

“The first thing you do in any liquidation is go through the accounts and figure out what’s in there and whether they’ve been properly credited,” said Peter Henning, a law professor at Wayne State University in Detroit. “If they say it’s been credited and in fact they’re not there, then you have some very major problems.”

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