March 26, 2023

DealBook: A Year After MF Global’s Collapse, Brokerage Firms Feel Less Pressure

Jon S. Corzine, the former chief of MF Global, at a House panel in 2011.Alex Wong/Getty ImagesJon S. Corzine, the former chief of MF Global, at a House panel in 2011.

When MF Global toppled a year ago, chaos engulfed a Chicago trading floor. Customers were locked out of their accounts, later discovering that about $1 billion of their money had disappeared.

The debacle, which played out on the evening of Halloween, prompted federal authorities to immediately bear down on the brokerage firm and the broader futures trading industry.

But a year after a federal grand jury issued subpoenas and regulators vowed reforms, the largest bankruptcy since the financial crisis has begun to fade from Wall Street’s memory.

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Federal authorities have all but cleared MF Global’s top executives of criminal wrongdoing, people briefed on the matter say. The government has yet to usher in a wider overhaul of futures trading rules, save for certain piecemeal policy changes. And the profit-making exchanges that rely on brokerage firms for business still police the futures industry, presenting potential conflicts of interest.

The slowing momentum for change has provided relief for the brokerage firms that dominate the futures trading industry. The Chicago companies, which largely dodged the humbling losses that scarred Wall Street in 2008, continue to cast MF Global as a fleeting distraction rather than a permanent black eye for their business.

“We haven’t seen a dramatic change,” said Terrence A. Duffy, executive chairman of the CME Group, the giant exchange that oversaw MF Global.

But the aftermath, Mr. Duffy noted, has left some customers wary.

Farmers and ranchers traded futures contracts through MF Global to protect themselves from the price swings of their crops. While the clients have received 82 percent of their missing money, they are still owed millions of dollars.

With the prospect of a full recovery unlikely, some traders are sitting on the sidelines. Others who continue to trade are seeking added assurances that the brokerages will follow the law.

“Every conversation with clients is about safety and sanctity of customer funds,” said Mike O’Callaghan, a managing director of business development at Knight Capital’s futures business.

Futures customers — and the integrity of the industry — were dealt a further blow this summer when another firm collapsed after misusing customer money. The chief executive of the firm, the Peregrine Financial Group, attempted suicide before eventually pleading guilty to carrying out a nearly 20-year scheme to raid customers’ accounts.

The problems have taken their toll on customer confidence.

“The general tenor is fear,” said James L. Koutoulas, chief executive of Typhon Capital Management, a hedge fund client of MF Global and the head of the Commodities Customer Coalition, a group of customers fighting for the return of their missing money.

Mr. Koutoulas and other customers are eager for a reckoning. They have questioned why authorities have not taken a harder line with Jon S. Corzine, the former chief executive of MF Global. Criminal investigators have largely concluded that chaos and porous risk controls at the firm, rather than fraud, led to the disappearance of the money.

“You can’t raid customer accounts and get a slap on the wrists,” Mr. Duffy said. “There needs to be stiffer penalties.”

MF Global executives might still face legal repercussions. The Commodity Futures Trading Commission, the industry’s federal regulator, could level an enforcement action against Mr. Corzine, even though such an action would be weeks or months away.

“It must be frustrating to people not to have a final outcome for what may appear to be malfeasance,” said Bart Chilton, a commissioner at the agency. “But investigations take time and we need to ensure that we’ve done a thorough review.”

As authorities continue to build a regulatory case, a Congressional investigation into MF Global’s collapse is drawing to a close. The chairman of the House Financial Services Committee’s oversight panel announced Wednesday that he would release an investigative report about MF Global in the next “few weeks.” Randy Neugebauer, Republican of Texas, said the report would serve as an “autopsy of how MF Global came to its ultimate demise and what policy changes need to be made to prevent similar customer losses in the future.”

MF Global was also a topic of conversation Wednesday at an annual industry conference in Chicago. Futures firms there planned to discuss new ways to protect customer cash and restore confidence in their industry.

A regulatory effort, while incomplete, has generated new measures that aim to protect customer funds.

The CME Group, which has started a $100 million protection fund for farmer and ranchers, has stepped up its surprise audits of brokerage firms. The CME and the National Futures Association, another self-regulatory group, also championed the so-called Corzine rule, which forces top executives to approve any transfer of more than 25 percent of the funds sitting in a customer account. And last week, the trading commission voted unanimously to propose new customer protections aimed at closing loopholes.

For their part, many MF Global employees remain chastened by their firm’s collapse. Lawmakers hauled Mr. Corzine, a former senator from New Jersey, to Washington three times to testify before Congressional committees. Some MF Global employees remain unemployed while others took major pay cuts to work for the trustee unwinding the firm’s assets.

Several MF Global employees planned to gather on Thursday for drinks at a Midtown Manhattan bar, just blocks from their old firm, to commiserate on their trying year. They canceled the event after another disaster, Hurricane Sandy, left some people stranded without power.

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DealBook: Confusion Follows Claim That Corzine Knew of Funds Transfer

From left, Jon S. Corzine, MF Global's former chief executive; Bradley Abelow, the chief operating officer, and Henri Steenkamp, the chief financial officer, testifying before the Senate Agriculture Committee on Tuesday.Chip Somodevilla/Getty ImagesFrom left, Jon S. Corzine, MF Global’s former chief executive; Bradley Abelow, the chief operating officer, and Henri Steenkamp, the chief financial officer, testifying before the Senate Agriculture Committee on Tuesday.Terrence Duffy, executive chairman of the CME Group, appeared to contradict Jon S. Corzine, MF Global's former chief, on money transfers before the firm's collapse.Andrew Harrer/Bloomberg NewsTerrence Duffy, executive chairman of the CME Group, appeared to contradict Jon S. Corzine, MF Global’s former chief, on money transfers before the firm’s collapse.

WASHINGTON — A Senate hearing into the collapse of MF Global was thrown into confusion on Tuesday after a main witness implied that Jon S. Corzine, its former chief executive, knew the firm had been misusing customer funds, an accusation that could not be substantiated.

Terrence A. Duffy, executive chairman of the CME Group, told lawmakers that MF Global had used $175 million in customer funds to lend from one arm of the firm to another — an assertion that, on its face, may not be illegal — and that Mr. Corzine had known about it.

Later, however, Mr. Duffy accused the firm of improperly transferring customer money, without specifying whether MF Global’s chief executive had known of those transactions.

“Mr. Corzine was aware of the loans being made,” Mr. Duffy told the Senate Agriculture Committee, adding that MF Global had submitted documents to CME, the major exchange where MF Global did business, that kept “regulators in the dark.”

Mr. Duffy’s words, at first, appeared to contradict Mr. Corzine’s earlier testimony before Congress. On Tuesday, Mr. Corzine told the Senate panel that he had not been aware of missing customer money until the late evening of Oct. 30, shortly before the firm filed for bankruptcy. Mr. Duffy suggested that Mr. Corzine had been briefed on the transfers hours or days before.

At the time, futures brokerage firms like MF Global could legitimately use customer money to lend between divisions — if they put a placeholder security in place of the customer cash.

And on Tuesday, Mr. Corzine did say that he had been aware that MF Global occasionally borrowed from customers while putting Treasury securities in the place of client cash. Such borrowing was permitted.

A spokesman for Mr. Corzine declined to comment.

“You raised a serious allegation about what Mr. Corzine may have known,” Senator Debbie Stabenow, a Michigan Democrat who is chairwoman of the committee, said to Mr. Duffy. He did not dispute her statement.

A spokeswoman for the CME Group, one of MF Global’s many regulators, declined to elaborate later on Mr. Duffy’s statement.

The confusion stemming from Mr. Duffy’s testimony comes as the exchange faces questions about its oversight of MF Global. CME was charged with policing the firm, a job that some wronged MF Global customers say it failed to do.

The exact source of Mr. Duffy’s information was also unclear. He said he had been relying on reports from one of his lawyers, who learned of the details from a lower-level CME auditor, who had spoken with an MF Global employee. The unidentified MF Global employee indicated that Mr. Corzine had known MF Global used customer funds to lend to itself.

The testimony caught lawmakers off guard. Mr. Duffy said he had learned about the loans over the weekend, although he failed to include any mention of the transfers in his prepared remarks for the hearing.

Instead, he abruptly inserted the allegations about Mr. Corzine into his opening statement before the committee. Mr. Duffy spoke just minutes after Mr. Corzine left the hearing room following his testimony, leaving Mr. Corzine no opportunity to defend himself before the panel.

“You have sort of tossed a bomb here,” said Senator Pat Roberts of Kansas, the committee’s ranking Republican. “We probably should have had you on first.”

CME, Mr. Duffy told the lawmakers, had referred its information to the Justice Department, which is investigating some $1.2 billion in customer funds that vanished from MF Global during the firm’s dying days.

Aside from Mr. Duffy’s revelation, the hearing Tuesday offered few insights that Mr. Corzine himself had not already given in earlier testimony. But this time, the lack of answers also involved Mr. Corzine’s top deputies at MF Global, Bradley Abelow, the chief operating officer, and Henri Steenkamp, the firm’s chief financial officer.

Senators often appeared frustrated with the lack of answers about where the money had gone and who had been responsible for its disappearance.

Mr. Roberts wondered aloud whom the committee would have to call on to get some answers, suggesting it might even require a PowerPoint presentation and testimony from the firm’s custodian.

Mr. Corzine sought to make two things clear on Tuesday: that he had not directly or indirectly intended to authorize misuse of customer money and that he needed documents to know what happened when.

“I never gave any instructions to misuse customer money, never intended to give any instructions or authority to misuse customer funds, and I find it very hard to understand how anyone could misconstrue what I’ve said as a way to misuse customer money,” he said during questioning.

Asked about when the transfers of customer money might have started, Mr. Corzine declined to speculate, saying only, “I literally would have to go back through thousands of pages.”

While Mr. Corzine drew most of the attention, his deputies were also subjected to the questions of skeptical lawmakers, some of whom have constituents who are bearing the brunt of the MF Global collapse.

Many farmers, grain elevator operators and others in the food industry have their cash trapped at MF Global. Four of them testified before the committee earlier in the day.

None of the three executives offered any insight as to the whereabouts of the money or even how it might have gone missing. They were repeatedly pressed to offer names of MF Global employees who would have been charged with safeguarding customer money.

Senator Mike Johanns, Republican of Nebraska, pressed the firm’s chief financial officer.

“Mr. Steenkamp, I’ve been watching your body language and you seem like the odd man out,” he told the executive, who had been questioned notably less than his two co-panelists. “Do you realize how incredible your testimony sounds to this committee?”

“I wish I could …” Mr. Steenkamp, clearly uncomfortable, began before tapering off.

Mr. Johanns then asked Mr. Steenkamp who was responsible if not the chief financial officer.

“In MF Global Inc., my understanding is that there were numerous controls in place,” Mr. Steenkamp said.

“I want names,” Mr. Johanns boomed. “Who would authorize and who would have that oversight?”

Mr. Steenkamp paused for a long moment. “I don’t think anyone would have the authorization” to misuse customer funds, he replied.

“You’re dancing around with me,” the senator fired back. “I want a name.”

“I’m not trying to dance around the issue,” Mr. Steenkamp replied. “I am not 100 percent sure who the exact person is.”

Ben Protess reported from Washington and Azam Ahmed from New York.

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Court Rules Against Finra on Enforcement Actions

A federal appeals court in Manhattan ruled on Wednesday that Finra, an important regulator of Wall Street for more than 70 years, does not have the right to take its members to court to enforce its disciplinary actions.

The surprise decision curbs the powers of Financial Industry Regulatory Authority, formerly the National Association of Securities Dealers, at a time when it has been under pressure to impose greater accountability on its licensed brokers and brokerage firms.

The ruling came after a 14-year fight waged by Fiero Brothers, a tiny penny-stock brokerage firm, and its owner, John J. Fiero. In December 2000, after legal disputes that lasted several years, Finra accused Mr. Fiero and his firm of violating federal fraud statutes — specifically, engaging in a manipulative activity known as naked short-selling. Besides expelling the firm, the regulator imposed a $1 million fine.

The firm was shuttered and its owner was barred from the market — but both refused to pay the fine and, ultimately, Finra wound up in federal court trying to collect the money.

But Finra had no right to do that, according to a three-judge panel of the United States Court of Appeals for the Second Circuit, which encompasses Wall Street.

In an opinion written by Judge Ralph K. Winter Jr., the panel unexpectedly overturned a lower court and ruled that neither the nation’s foundational securities laws, adopted in 1934, nor a “housekeeping” rule adopted by Finra in 1990 gave it the right to pursue its monetary sanctions in court.

“The principal issue is whether the Financial Industry Regulatory Authority Inc. has the authority to bring court actions to collect disciplinary fines,” Judge Winter wrote. “We hold that it does not and reverse.”

T. Grant Callery, Finra’s general counsel, said the organization would “continue to review the ruling and weigh our options.” But he insisted the decision would not affect the self-regulatory group’s “ability to enforce Finra rules and securities laws, to discipline firms or protect investors.”

But some securities law experts predicted that the ruling could have both practical and psychological effects.

“The decision neuters Finra,” said John C. Coffee Jr., a securities law professor at Columbia who has been a consultant both to regulatory agencies and to private defendants appearing before them. “It has been trying to show that it has teeth and could hold its members more accountable — now, those teeth have been surgically removed.”

Martin H. Kaplan, a lawyer for Mr. Fiero and his firm, agreed that the ruling “changes the regulatory landscape in a profound way.” He said the decision vindicated those who had complained for years that Finra was exceeding its statutory power and abusing the rule-making process.

“Not only did the court find that Finra/N.A.S.D. never had authority to enforce fines using the courts, but it also highlighted Finra/N.A.S.D.’s failure to follow rule-making procedures and its frustration of Congressional intent,” Mr. Kaplan said.

At a practical level, Finra still retains its most potent weapon: the power to suspend or expel misbehaving brokers from the financial industry, what the appeals court called a “draconian” power.

But Susan Merrill, a securities lawyer and a former head of enforcement at Finra, said the decision cast an adverse light on the process Finra used to adopt the 1990 rule and, potentially, other “housekeeping” rules.

The court said the 1990 rule should have been given a more formal review, with an opportunity for public comment, because it did not deal with mere housekeeping matters. Rather, the rule “affected the rights of barred and suspended members to stay out of the industry and not pay the fines imposed on them in prior disciplinary proceedings.”

Analyzing whether other Finra rules may be affected by the decision is something “people will be wrestling with in days to come,” Ms. Merrill said.

The court’s criticism will also sting a bit at the Securities and Exchange Commission. The commission oversees Finra’s rule-making, and the chairwoman and chief executive of Finra during much of the time it pursued the Fiero case in court was Mary L. Schapiro, the current head of the commission.

The Fiero case has been a colorful one since it began in the mid-1990s, and regulators blamed Mr. Fiero and other “naked shorts” for bringing down a small clearinghouse that served 41 other small brokerage firms. Clearinghouse failures are rare and potentially dangerous, since they can greatly magnify the consequences of a single firm’s failure.

Since banned brokers cannot return to the industry unless they pay any unpaid fines, it has been extremely rare for Finra to sue to recover unpaid penalties.

Until now, both Finra and its members assumed that it had the power to do so if necessary. If it does not, its misbehaving members need no longer fear that a stiff fine will follow them into Wall Street exile.

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