Louis Freeh filed a report of his investigation in his role as the Chapter 11 Trustee of MF Global Holdings, Ltd. and its affiliates. Under section 1106 of the Bankruptcy Code, a trustee is required to, among other things, “investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor’s business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan.”
The complete report is embedded below and can be read or downloaded for free. The executive summary of the report provides the following synopsis of Mr. Freeh’s findings:
Prior to the Debtors’ bankruptcy filings, MF Global, through its regulated and unregulated broker/dealers (“B/D”) and futures commission merchant (“FCM”), was a leading brokerage firm offering customized solutions in the global cash and derivatives markets. MF Global provided execution and clearing services for products in the exchange-traded and over-the-counter derivatives markets, as well as for certain products in the cash market. MF Global was headquartered in the United States and conducted operations in, among other locations, the United Kingdom, France, Singapore, Australia, Hong Kong, Canada, India and Japan.
Jon Corzine (“Corzine”) was named the Chief Executive Officer (“CEO”) and Chairman of the Board of Directors (“Chairman”) in March 2010, at a time when the Company’s future was in doubt. The Company’s traditional commodities and securities broker business earned revenues primarily (1) through commissions earned from executing customer orders, and (2) from interest earned on customer funds and from its matched repo book. In an environment of historically low interest rates, that model failed to be profitable. At the time Corzine joined MF Global, credit rating agencies were threatening to further downgrade the Company unless it increased its revenues and earnings.
Corzine embarked on a mission to transform the Company into a full-service B/D and investment bank. In order to increase revenues, and to support the Company during a period of expanding the business, the Company began, for the first time in its history, to engage in significant proprietary trading (i.e., using the Company’s own funds to trade for the Company’s benefit in order to profit from anticipated changes in market prices), directly under Corzine’s supervision. Although the Company had previously taken positions in sovereign debt and had engaged in repurchase to maturity trades, Corzine initiated a new and aggressive trading strategy, investing heavily in European sovereign debt, which was financed through repurchase to maturity transactions (the “Euro RTMs”).
MFGI and MF Global U.K. Limited (“MFG UK”) were the MF Global entities that directly engaged in the Euro RTMs. MFGI would purchase securities, and MFG UK acted as agent for the purchase because it was the only MF Global entity that was a member of the clearinghouses in Europe. One of the principal advantages of the Euro RTMs was their accounting treatment. Because of the way these trades were structured, the Company immediately recognized the income while simultaneously removing the transactions from the Company’s balance sheet.
These transactions were meant to serve as a profit “bridge” until the Company began to produce earnings from other, new lines of business, at a time when, as Corzine stressed during an earnings call in August 2010, “[e]arnings, earnings, earnings continue[d] to be the mantra and the task at hand.” The Euro RTMs involved financing the Company’s purchase of European sovereign debt, issued by countries such as Italy, Portugal, Spain, and Ireland (collectively referred to as “IPSI”). The transactions were intended to capitalize on volatility and unrest in the European markets. Although the transactions were fully financed, the clearinghouses required a payment of margin in the form of cash or other acceptable collateral at the time the transaction was executed (“Initial Margin”). MFGI, through its agent, MFG UK, also was subject to additional margin based upon a variety of factors (“Variation Margin”). Initial Margin could vary based on the credit quality of the counterparty, the credit quality of the issuer, and the maturity and duration of the bond. Variation Margin was based on market factors, such as price movements in the underlying sovereign bonds. Under stressed financial conditions, the Initial and Variation Margin demands could increase dramatically, with additional new Variation Margin required as a result of, among other things, adverse price movements in the value of the underlying European sovereign bonds.
When combined with other factors, strategic decisions and management lapses surrounding the Company’s business, the Euro RTMs ultimately sowed the seeds of the Company’s destruction. Although the trades generated the expected up-front “income,” these trades also jeopardized the Company’s available liquidity and left the Company highly leveraged as a result of these off-balance sheet transactions. When the European economy deteriorated during the summer of 2011, clearinghouses and other counterparties began making escalating margin demands, draining the Company’s liquidity and drawing the attention of regulators and credit rating agencies.
Between September 2010 and June 2011, the Board approved a series of requests initiated by Corzine to increase the risk limits for investing in European sovereign debt. The Board gave these approvals only after the Holdings Ltd. Chief Financial Officer (“CFO”) and other managers provided assurances that MF Global had sufficient liquidity, even under various stress scenarios, to satisfy any current or projected margin demands.
During the summer of 2011, the Chief Risk Officer (“CRO”), Michael Stockman (“Stockman”), recommended that MF Global stop investing in Euro RTMs, and start hedging its existing exposure. Despite this advice, rather than cease or limit its investments in Euro RTMs, management searched for additional sources of liquidity to support the Company’s trading strategy. At one point, management even debated how aggressively the B/D, on an intraday basis, could borrow FCM customer funds required to be kept in secured and segregated accounts.
As these events unfolded, Corzine and his management team failed to strengthen the Company’s weak control environment, making it almost impossible to properly monitor the liquidity drains on the Company caused by Corzine’s proprietary trading strategy. Among other significant gaps, the Company lacked an integrated global treasury system, preventing management from obtaining an accurate real-time picture of the Company’s liquidity. The inadequate controls also prevented the Company from knowing, during the last week of its existence, that customer segregated funds at the FCM were being used to meet the B/D’s liquidity needs and satisfy an obligation of MFG UK.5 These glaring deficiencies were long known to Corzine and management, yet they failed to implement sufficient corrective measures promptly.
In late October 2011, the Company announced substantial quarterly losses and additional credit rating downgrades. Subsequent MFGI customer withdrawals and losses on sales of assets,
coupled with the Company’s inadequate controls and weak liquidity position and other factors significantly impaired the Company’s ability to pay its debts as they came due, until the Company’s only means of survival was for Holdings Ltd. to sell its assets to another company.
However, a deal to avert bankruptcy through such a sale collapsed at the eleventh hour when the FCM identified a substantial unexplained shortfall in customer segregated funds. When efforts to sell the business failed, Holdings Ltd. was left with no choice but to file for bankruptcy protection for itself and FinCo.
The negligent conduct identified in this Report foreseeably contributed to MF Global’s collapse and the Debtors’ subsequent bankruptcy filings. Although a difficult economic climate and other factors may have accelerated the Company’s failure, the risky business strategy engineered and executed by Corzine and other officers and their failure to improve the Company’s inadequate systems and procedures so that the Company could accommodate that business strategy contributed to the Company’s collapse during the last week of October 2011.