Fallout over the late-October bankruptcy of MF Global Holdings Ltd. — the eighth largest in U.S. history — has spawned FBI and Justice Department investigations and left many wondering how, in the wake of supposed Wall Street reforms, government oversight of another financial institution was so lax.
More importantly for the agriculture sector, the bankruptcy and government response has prompted many questions about the safety of futures trading. That’s largely because MF Global  customer accounts have been frozen and the threat of hard-earned farmer/rancher funds may be lost.
MF Global has reportedly “lost” customer funds – frequently cited in the $1.2 billion range – through a suspected series of unusual, perhaps illegal, transactions. Former MF Global Chairman and CEO, Jon Corzine  (once New Jersey governor and senator) has a long list of questions to answer.
Promising vigorous examination of MF Global’s failing, the Senate Agriculture Committee – with oversight jurisdiction on commodity trading and its regulatory agencies – has scheduled hearings on Dec. 1 and Dec. 13.
“The farmers, small business owners and others who trusted this firm are now facing tremendous hardship and may ultimately never recover all of their money,” said Michigan Sen. Debbie Stabenow, Senate Agriculture Committee Chairwoman. “A discovery of this magnitude demonstrates yet again the need for strong oversight and protections for consumers to prevent this sort of abuse from occurring. Anyone engaged in wrongdoing in this matter must be swiftly held accountable, to help bring justice to victims and to prevent further erosion of confidence in the financial system.”
One thing customer advocates learned from the Wall Street collapse and government bailout several years ago is to get involved early. The newly-formed Commodity Customer Coalition  was a quick response to the MF Global bankruptcy.
On Monday, Farm Press spoke with John Roe, who with several others formed the coalition. Roe, a principal at BTR Trading Group , explained the bankruptcy proceedings, questioned the actions of regulators and Corzine, and spoke about how farmers and ranchers have been affected. Among his comments:
On the basic facts of the case…
“In late October, MF Global released its earnings (report). That showed it missed its earnings and posted a fairly large loss of $198 million, or so.
“It was also revealed that it had an enormous exposure to European sovereign debt. That was relatively new and was a proprietary position taken by the firm.
“Jon Corzine was put in charge of MF Global about 18 months ago. He was supposed to reposition the firm not just as a futures-clearing merchant and broker/dealer but as more of an investment bank. In doing that, he began taking proprietary positions for the firm. That added a great deal of risk to the firm – but was also supposed to add a great deal of profit and profitability.
"The reason this really happened is because we’re in a low interest rate environment. FCMs  (Futures Commission Merchant) make most of their money by holding customer collateral and earning interest on it. Well, when real interest rates are really negative, they seek other means to make money. Otherwise, there’s not a lot of opportunity for them.”
During the last week of October “it became clear -- because the stock fell to $1 per share and there was about a 70 percent loss in value a couple of times – MF Global would probably have to seek bankruptcy protection. Over the weekend of October 30, MF Global sought to sell its futures division to someone and put the rest of the entity into Chapter 11 reorganization bankruptcy .
“Sometime in the middle of the night heading into October 31, the CME Group  – the exchange that’s MF Global’s designated self-regulatory organization (with audit authority) – said there was some sort of shortfall in customer funds. They were trying to ascertain why and how large it was.
“MF Global had been negotiating with Interactive Brokers  (another futures commission merchant) to sell the futures division and move out the accounts. If they’d done that, there wouldn’t have been an interruption in trading and frozen accounts. The commodity accounts would have moved over to Interactive Brokers and MF Global would have gone into bankruptcy.
“But the shortfall in funds was noticed and Interactive Brokers balked. They said ‘we’re walking away.’ That’s when all hell broke loose.
“For an hour, the CME shut off all trading on MF Global. That caused enormous problems and then they went to liquidation only.”
CFTC, Corzine, Coalition
On the CFTC and Corzine…
“Due to the relationship the Commodity Futures Trading Commission (CFTC) head, Gary Gensler , had with Corzine – they were colleagues at Goldman Sachs  and remain friends to this day – Gensler recused himself. The CFTC advised that SIPC (Security Investors Protection Corporation) handle the liquidation of MF Global.
“Then, (Security Investors Protection Corporation) began a ‘SIPA  (Security Investors Protection Act)’ liquidation of MF Global. They planned to marshal all the assets of MF Global, sell off what they could, and deal with creditor claims.
“Well, that’s very bad for commodities customers since they have no protection under the (Security Investors Protection Act) regulations. Those are for securities accounts. We don’t have any insurance – we have customer-segregated funds.
“So, all assets were frozen and nobody knew what the heck was going on.”
On the formation of the customer coalition…
“I’ve talked to people all over the country who have been affected by this: farmers, ranchers, oil and gas guys, and guys in hedge funds. Everyone’s money was frozen and no one could do anything.
“As this dragged out through the first week, it became clear that the shortfall had dropped. I believe it’s about $600 million and no one is really sure why it happened yet. Is it a trading loss? Did they move customer collateral to cover a house trade? Is there even a shortfall?
“Regardless, during that week, I got together with a couple of others through social networking. We were very concerned that no one appeared to advocating for customers as this unfolded. All the agencies that are supposed to protect customers had totally failed. The National Futures Association was doing nothing. The CFTC had basically abdicated its responsibility and authority to (the Security Investors Protection Corporation).
“The CME Group’s actions have been inexcusable during this process – they could have stopped all this from happening by simply guaranteeing whatever the shortfall. They may not have wanted to lose $600 million – but that will look like a small loss when this is all said and done.
“So, we began the Commodity Customer Coalition. It’s just a group of industry professionals along with their customers and clients. We started banging on the drum, trying to make some noise.”
On court hearings and court requests…
Judge Martin Glenn, who is overseeing the bankruptcy case from a Manhattan courtroom, “is clearly on the side of customers through this.
"However, we believe the trustee (James Giddens) has substantial conflicts of interest through his relationships with various people in the creditor’s committee. And he has a natural conflict of interest since he’s earning $891 per hour. That provides very little incentive to close this up quickly.
“So, we started a legal arm that has put forth a couple of motions.
“The trustee began gathering assets and made a disbursement to some clients – it was a complete disaster in the second week (of the saga). He basically said ‘anyone who has positions, we’re going to transfer those positions to a new (Futures Commission Merchant) and 60 percent of the margin required to keep those positions viable.’
“That created 17,000 margin calls because not enough assets were transferred to hold the position. That caused people to send in new collateral or liquidate positions, regardless of whether they were hedges of cash positions or whatever.
“The trustee has two processes by which he can get money back to us: the bulk transfer process (where he sends out assets) or go through a formal claims process. The bankruptcy code requires a formal process, so we know eventually that will happen.
“The trustee proposed a really slow, arduous claims process where everything was done by U.S. mail. It didn’t take into account any of the efficiencies available in the futures industry.
“So, we filed a motion with the judge. He (told the trustee) ‘you’ve got to listen to these guys. They have experience in the industry.’ Well, the trustee adopted a few of our ideas and set up the claims process, which begins on Dec. 2.
“We’re still pushing for two things. First, we want to the trustee to agree – and get the bankruptcy court to agree – that commodity customers have a super priority lien  over all the assets of MF Global. If our money wasn’t in our accounts, if it was moved somewhere else, that’s a crime. They’ve comingled funds and stolen the money. They have to pay it back.
“We’re not a creditor of MF Global. We didn’t invest in MF Global and lose money. They stole our property.
“So, we’re in the process of drafting several motions that would get the court to agree that, ‘yes, these people do have a super-priority lien. They can’t share in the loss with all the other creditors like JP Morgan.’ JP Morgan loaned them money. Well, that carries a different risk than someone who provided collateral they’re supposed to post on an exchange to back a trade.
“There’s a hearing on Dec. 5 where a group we’ve worked with will ask that 85 percent of the funds will be released. That was the shortfall before the trustee moved the goalposts. The shortfall was pegged at $600 million and that didn’t change until (the week of November 21) when the trustee said ‘well, it could be as high as $1.2 billion.’”
Is that legitimate or do you think the number is even higher?
“We know what the maximum is. … We know it can’t be any higher than $1.7 billion.
“To us, that’s irrelevant. What if all the money is gone? It doesn’t matter – there was $41 billion in MF Global’s estate when they filed for bankruptcy. That’s more than enough to pay us back several times over.
“In any event, do I think the shortfall is higher than $1.2 billion? No.
“I believe the CME thinks that it’s actually either nonexistent or much smaller. Otherwise, they wouldn’t have recently raised their guarantee. The CME released a guarantee way, way, way too late. If they’d done that on Oct. 31, we might not be talking. Initially, they did a $250 million guarantee to facilitate the return of assets. They’ve upped it to $550 million.
“I think the trustee is using the shortfall to delay the process. And there’s a variety of reasons he could do that. I’m not saying he has nefarious motives. But his interest is to protect everyone: the commodities customers, the securities customers, the creditors, the unsecured and unsecured creditors, everyone who has a claim. He wants to make sure he has assets to pay them.
“To his mind, (customers) are just like everyone else in the line. To us, that’s absolutely ridiculous given the primacy of segregated funds. We are at the front of the line and no one should be paid until we’re made whole.”
Recently, the trustee “received a $1.3 billion transfer from Harris Bank that he said contained some customer funds.
“The trustee has said he wants to release 60 percent of customer assets. That would be about $3.24 billion. Right now, he has $3.7 billion cash on hand plus whatever Harris gave him. He’s got the money. Why is he holding on to customer money? It isn’t his money and he can’t send it out in the bankruptcy. He needs to get rid of it.
“We think with the CME’s guarantee and everything else going on, there will be an interim distribution during the claims window. It should be ‘trued up’ across the board at 75 percent and then we’ll be left to fight it out for the remaining 25 percent. Hopefully, that will happen very quickly.”
“Quickly” meaning in the next few weeks, a few months?
“I hope we’re talking about weeks.
“Our goal is to have this trued up – 75 percent, or more – by the end of the year. We hope that’ll be 100 percent by the close of the claims window, which is Jan. 31.
“It all comes down to how this is adjudicated. If the court agrees that we have a super priority lien then there’s no reason we shouldn’t be able to get all our money – 100 percent -- by the end of January.
“If they disagree and say ‘no, you must share in a pro-rata loss’ it will be years.”
Farmers and ranchers
What about the farmer/rancher side of this specifically? Do you have any elevators that are customers?
“We’re working with an (investment bank) and all their clients are through elevators.
“We’ve spoken to ranchers in Tennessee and farmers in Iowa, Indiana, Minnesota, and throughout the Midwest.
“I’m sure your readers know all too well how illiquid the average farmer is. Usually their money is tied up in real estate and equipment with the rest in working capital.
“To ask a farmer to post more funds to cover margins is very difficult to do. It may require the sale, or mortgage, of real estate assets or liquidation of equipment.
“The people we’ve spoken to say this will be devastating. Some could face bankruptcy very quickly if they’re not liquidated.
“And (farmers) are really in the worst position of all the customers. The trustee created all these new protective classes, by accident, in the bankruptcy process.
“My investment bank, almost all our accounts, we got to cash on Oct. 31. So, they’re getting 60 percent of their funds sent to them.
“But if you’re a farmer with a hedge on and open positions, they just transferred 60 percent of your margin. … That means you’ll probably have less than 25 percent of your total assets sent to you. In some cases, it’ll be less than 10 percent or 5 percent.
“So, farmers have all this money tied up with no idea when you can get out. And you have to be able to access it. It’s a terrible position to be in.
“The only advice we have for farmers, right now: make as much noise as you can.”
On congressional hearings and the coalition’s public relations…
“Aside from our legal campaign, we have a public relations campaign. We’re trying to influence anyone with the ability to sway this process. Right now, that’s focused primarily on the judge and trustee because they have the most immediate effect. But it’s branching out to Congress.
“In mid-December, the House Finance Services Committee will hold a hearing (on this). I’m speaking with (legislators) this week to try and get several of our customers before that committee to help put a human face on this disaster.
“Right now, the witness list contains a who’s who of who is at fault. That will help ascertain who to blame and, perhaps, how to prevent this from happening (again). But it won’t help explain what’s happened to customers. We want farmers, ranchers and others to provide statements – get them before the committee, talking – so the congressional record reflects ‘hey, this isn’t just Wall Street people being burned. This is Main Street being burned big.’
“Eventually, this will affect consumer prices. If farmers don’t think futures trading is a viable mechanism to offset their price risk, they’ll begin using other means. Down the line, that will yield price inflation. You add that into a fragile economic recovery and it’s a recipe for disaster.”
Hearings and questions
What about the Senate Agriculture Committee hearing on Thursday?
“Gensler should be asked why he thought commodity customers would be best protected as a (Security Investors Protection Act)liquidation. To my mind, that makes very little sense.
“The cornerstone of the futures industry is segregated funds. (The Security Investors Protection Act)doesn’t have the same respect for those because they view customer accounts as insured vehicles. In the case of commodities, ‘well, this is high risk and you’re on your own without insurance.
“They must also ask (Gensler): how is this possible when these funds are accounted for on a daily basis to you, the (National Futures Association), and, in this case, the (Chicago Mercantile Exchange)?
Second, ‘at what point were you going to get around to preventing extraordinarily high risk trades from being placed with customer funds?’
“If that’s what happened here – they made perfectly legal trades and took loans from customer funds to back them – how is it acceptable to take a 40-to-one leveraged position with customer funds? How can the CFTC regulate the industry well if it allows such?”
Any push-back against your group?
“We’re on everyone’s radar. That much is clear. There hasn’t been any blowback that we’re aware of. But we anticipate some.
“Inevitably, when you rattle cages someone is bound to rattle yours.”
Any farmer or commodity advocacy groups in your corner on this?
“What’s interesting … is there’s often an advocacy group that’s ill-equipped and underfunded to deal with something like this. We’re trying to get those groups to join with us.
“A group with a $10,000 annual budget can’t do $100,000 worth of litigation. We wouldn’t have been able to do that either without attorneys willing to work pro bono or at incredibly reduced rates.
“So, we’re trying to rouse those groups and get them to join in.”