More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- RIAs and Customer Identification Just as RIAs owe a duty to diligently protect their clients privacy and guard against theft, firms also play a vital role in customer identification. Although RIAs are not subject to an anti-money laundering rule, securities regulators expect advisors to address these issues in their policies and procedures.
Decisions by Jon Corzine to chart a “radically different course for MF Global and try to turn the 230-year-old commodities broker into a full-service investment bank,” were the main reason the firm went bankrupt, according to a preview of a House subcommittee report released Wednesday.
Specifically, the report says, Corzine's missteps included his insistence that “no one could challenge his decisions,” and the fact that he acted as a “de facto chief trader” and insulated his trading activities from the company’s normal risk management review process.
House Republicans' full report, “The Collapse of MF Global,” is to be released Thursday by the House Financial Services Subcommittee on Oversight and Investigations, chaired by Randy Neugebauer, R-Texas.
“Our investigation is essentially an autopsy of how MF Global came to its ultimate demise and what can be done to prevent similar customer losses in the future,” Neugebauer said in the release announcing some of the report’s key findings.
As the release notes, Corzine, a former co-chairman of Goldman Sachs who later became a U.S. senator and governor of New Jersey, resigned from MF Global on Nov. 4, 2011, almost 20 months after becoming the firm’s chairman and CEO. The brokerage had declared bankruptcy four days earlier and its collapse revealed a $1.6 billion shortfall in customer funds.
“Choices made by Jon Corzine during his tenure as chairman and CEO sealed MF Global’s fate,” Neugebauer stated. “Farmers, ranchers and other customers may never get back over $1 billion of their money as a result of his decisions. Corzine dramatically changed MF Global’s business model without fully understanding the risks associated with such a radical transformation.”
The subcommittee’s staff investigation of MF Global involved three hearings, more than 50 witness interviews, and the review of more than 243,000 documents obtained from MF Global, its former employees, federal regulators and other sources.
“By expanding MF Global into new business lines without first returning its core commodities business to profitability, Corzine ensured that the company would face enormous resource demands and exposed it to new risks that it was ill-equipped to handle,” the subcommittee report states.
In order to generate the revenue needed to fund MF Global’s transformation, Corzine invested heavily in the sovereign debt of struggling European countries, the report states. These investments, which carried enormous default and liquidity risks, were a “prime focus” of Corzine’s attention and he failed to develop a corporate strategy for managing the risks, the subcommittee majority staff found.
Corzine also created an “authoritarian atmosphere” at the firm. He made “significant changes to MF Global’s senior management, including the hiring of Bradley Abelow, his former gubernatorial chief of staff, as the firm’s chief operating officer,” the report notes.
When MF Global’s chief risk officer disagreed with Corzine about the size of the company’s European bond portfolio, Corzine directed him to report to Abelow rather than to MF Global’s board of directors, the report says. “This change effectively sidelined the most senior individual charged with monitoring the company’s risks and deprived the board of an independent assessment of the risks that Corzine’s trades posed to MF Global, its shareholders and its customers.”
Corzine Insulated Trading Activity From Review Process
By acting as MF Global’s “de facto chief trader,” Corzine insulated his trading activities from the company’s normal risk management review process, which enabled him to quickly build the company’s European bond portfolio “well in excess of prudent limits without effective resistance.”
The report states that rather than hold the European bonds on MF Global’s books, which could expose the company to earnings volatility, Corzine chose to use these bonds as collateral in repurchase-to-maturity transactions. “This permitted the company to book quick profits while keeping the transactions off its balance sheet.”
Failure to Initially Disclose Extent of Risks
The report also notes that the “belated disclosure in October 2011 of its extensive European RTM portfolio–which amounted to 14% of MF Global’s total assets–combined with poor earnings news prompted credit rating agencies to downgrade the company’s credit rating to junk status.”
The downgrade set off a “run on the bank” by MF Global’s investors, customers and counterparties that created a liquidity crisis during what would turn out to be the company’s final days.
“Because Corzine had failed to integrate systems and controls for managing the company’s liquidity and protecting customer funds, the company could not fully assess and anticipate its liquidity needs during the crisis, nor could it coordinate its cash management, liquidity monitoring and regulatory compliance functions,” the report says.
Liquidity Crisis Prompts Withdrawal of Customer Funds
“As the company struggled to find additional liquidity,” the subcommittee reports, “company employees identified excess company funds held in customer accounts. However, because they did not have an accurate accounting of the amount of customer funds the company held, they withdrew customer funds as well as company funds.”
The subcommittee notes that it will be up to prosecutors and regulators to determine whether MF Global or its employees violated laws or regulations when these withdrawals of customer funds were made.
‘Dereliction of Duty’
“However, the responsibility for failing to maintain the systems and controls necessary to protect customer funds rests with Corzine,” the report maintains. “This failure represents a dereliction of his duty as MF Global’s chairman and CEO.”
In its report, the subcommittee recommends that Congress consider legislation to impose civil liability on the officers and directors of futures commission merchants like MF Global who sign financial statements or authorize transfers from customer segregated accounts. Such legislation could “restore investor confidence in the derivatives markets and ensure that an FCM does not misuse customer funds in the future,” the subcommittee report said.
Other Findings of Investigation to Be Released
The subcommittee report is also expected to address regulatory agencies’ failure to share critical information with each other about MF Global, failures by credit rating agencies to sufficiently review MF Global’s public filings, and concerns about the New York Federal Reserve’s decision to designate MF Global as a “primary dealer” despite the company’s troubled financial situation.