Are MF Global Customer Funds Being Looted to This Day Through the Same Risky Trading That Sunk the Firm?

As MF Global customers approach the one month anniversary of the cluster-circus that has become the liquidation proceedings, replete with unnecessary delays, half-measures, and outright deceptive statements by Trustee James W. Giddens (that will only ensure the proliferation of hours billable at $890 each), we wish to highlight an order entered just days after the bankruptcy that gave MF Global Holdings and its affiliates carte blanche to continue the very risky and suspicious trading that led to its demise. A hearing is set for Wednesday, November 30, 2011 at 3:00 pm on this and other germane matters, including the super priority status of JP Morgan Chase (the conflicted first-lien holder) afforded to it ahead of the customers whose segregated accounts were putatively to have been held sacrosanct.

_

On November 2, 2011, the bankruptcy judge entered a seemingly innocuous order that granted an extension of time to the Debtors (MF Global Holdings Ltd. and MF Global Finance USA Inc.) to comply with the requirements of Section 345(b) of the Bankruptcy Code and an authorization of the continuation of intercompany transactions among the Debtors and non-Debtor affiliates. Detailed arguments were provided in the 19 page Motion of the Debtors filed the day of their October 31, 2011 bankruptcy.

_

Of particular interest are the arguments for allowance of the continuation of extant investment practices. When reading the pleading, note that "Company" refers specifically to MF Global Inc., the broker dealer/futures commission merchant unit that did NOT file for bankruptcy, while "Debtors" refers to MF Global Holdings and MF Global Finance, which did file for bankruptcy. "Debtors" and "Company" are frequently mixed within paragraphs, which either causes confusion as to intent or allows for an expansive interpretation that justifies the continued looting of customer accounts. All emphasis herein is ours, except for headings:

D. The Debtors Should Be Authorized to Continue Their Investment Practices

_

23...The Deposit and Investment Practices are governed by an investment policy, which provides that such investment activities must comply with federal and state regulations, as well as any regulations imposed by its regulators. In addition, the investment policy describes the Company’s permissible investments, which include: (a) government securities and government guaranteed securities; (b) money funds; (c) United States Treasury and government money funds; (d) federal agency obligations; (e) corporate obligations; (f) money market instruments; and (g) other permissible investments approved by the Company’s investment committee from time to time.

The blanket generalization in (g) opens the door to any of the investments that the Company, MF Global Inc., had engaged in previously, including the famed $6.3 billion in European debt [off balance sheet] repo-to-maturity trades. Ordinarily, any such investments not guaranteed directly or indirectly by the US government would be subject to a performance bond:

_

24. Bankruptcy Code section 345(a) authorizes a debtor-in-possession to make deposits or investments of estate money in a manner “as will yield the maximum reasonable net return on such money, taking into account the safety of such deposit or investment.” 11 U.S.C. § 345(a). If a deposit or investment is not “insured or guaranteed by the United States or by a department, agency, or instrumentality of the United States or backed by the full faith and credit of the United States,” Bankruptcy Code section 345(b) provides that the debtor must require that the entity with which the deposit or investment is made obtain a bond in favor of the United States that is secured by the undertaking of an adequate corporate surety. Id. § 345(b).

_

However, arguments would be made for an exemption:

_

25. The Court has discretion to modify the section 345(b) requirements “for cause.” 11 U.S.C. § 345(b). Indeed, while these requirements may be “‘wise in the case of a smaller debtor with limited funds that cannot afford a risky investment to be lost, [they] can work to needlessly handcuff larger, more sophisticated debtors...

_

Sophisticated, indeed. The pleading continues with a rather confusing paragraph that implies the exemption from a performance bond is required for investments that would be in bank accounts, the balances of which exceed FDIC insurance limits. Yet, the final sentence implies there is more going on than simple bank account sweeps when it mentions "[investments and deposits] made by non-Debtor affiliates engaging in the Company's core investments businesses." (Again, "Company" refers to the broker dealer/futures commission merchant unit, while "Debtors" refers to MF Global Holdings and MF Global Finance.)

_

26. The Debtors submit that the circumstances of this case warrant such relief. The Company is a large, sophisticated entity with a complex Cash Management System that relies on multiple Banks and Bank Accounts on a daily basis. The Bank Accounts used by the Debtors are maintained in the United States and are with stable financial institutions that are insured by the FDIC. Furthermore, in light of the regular deposits and sweeps of the Bank Accounts, requiring the Debtors, or any entity with which money is deposited or invested by the Debtors in accordance with the Deposit and Investment Practices, to incur the expense of posting a bond to the extent that the balances of these accounts exceed FDIC insurance limits at a given time would be especially burdensome and wasteful. Finally, in addition to the Company’s own investment policies that serve as a safeguard of the Debtors’ funds, there is a significant distinction between the Debtors’ own investments and deposits—which support the Debtors’ cash-management function—and those made by non-Debtor affiliates engaging in the Company’s core investments businesses.

_

27. Accordingly, the Court should authorize the Debtors to continue to deposit funds and invest in accordance with the Deposit and Investment Practices and grant the Debtors a 60-day extension, without prejudice to seek further extensions, to either comply with Bankruptcy Code section 345(b) or to make other arrangements that would be acceptable to the U.S. Trustee.

_

The Debtors then argue, through a series of complex legal arguments, to be explicitly allowed to continue with intercompany transactions, the relevance of which will be explained following the excerpts.

_

E. The Debtors Should Be Authorized to Continue Intercompany Transactions

28. The Debtors’ books and records also reflect numerous other intercompany

account balances among various Debtors as of the Petition Date. All prepetition intercompany

account balances have been frozen, as of the Petition Date, and the treatment of such claims will

be determined as part of an overall reorganization plan for the Debtors.

_

29. To ensure that each individual Debtor will not, at the expense of its creditors, fund the operations of another Debtor entity, the Debtors respectfully request that, pursuant to section 364(c)(1) of the Bankruptcy Code, all intercompany claims against a Debtor by another Debtor arising after the Petition Date as a result of intercompany transactions and allocations (“Postpetition Intercompany Claims”) be accorded superpriority status, with priority over any and all administrative expenses of the kind specified in sections 503(b) and 507(b) of the Bankruptcy Code, subject and subordinate only to (a) any order granting adequate protection to the prepetition secured lenders and (b) other valid liens...

_

30. In addition, in connection with their role under the Cash Management System facilitating the operations of the non-Debtor affiliates, the Debtors may, in the ordinary course of business, periodically infuse capital into certain of their subsidiaries and affiliates, including non-Debtor non-U.S. affiliates. These infusions of capital generally are accomplished through the making of intercompany loans. The Debtors use repayments of such loans as a tax efficient method of managing cash throughout their worldwide business enterprise. Because the non-Debtor affiliates are part of the same group of affiliated entities as the Debtors, the entirety of intercompany transactions among Debtors and non-Debtor affiliates alike remain within the spectrum of the Debtors’ control.

_

31. The relief requested herein is necessary because certain non-Debtor affiliates may require intercompany advances in order to maintain their liquidity and going concern value. Courts frequently have granted such superpriority status to postpetition intercompany claims in cases such as this. ...

_

33. The Cash Management System allows the Debtors to track all obligations owing between related entities and thereby ensures that all setoffs of intercompany transactions will meet both the mutuality and timing requirements of section 553 of the Bankruptcy Code. Therefore, the Debtors respectfully request that the Debtors and their non-Debtor affiliates be expressly authorized to set off prepetition obligations arising on account of intercompany transactions between a Debtor and another Debtor or between a Debtor and a non-Debtor affiliate. Further, the Intercompany Transactions provide numerous benefits to the Debtors. The Debtors therefore seek to continue the Intercompany Transactions postpetition in the ordinary course of their businesses.

_

While it might be desirable under a "normal" financial company bankruptcy to seek maximization of benefits to the Debtors such that creditors be paid as much as possible during recovery, MF Global Inc customers (who are NOT creditors) can currently expect at best a 60% recovery going into mid-December and should be placed first in line until 100% recovery is obtained. Further, from the numerous conflations and generalizations in the paragraphs above that allow, for among other things, payments to non-US affiliates, it is possible that the looting of MF Global customer funds continues to this day. We wonder if this is why the MF Global trustee continually revises upwards the estimated maximum loss of customer funds.

_

As to exactly how this might be possible, we pointed out as early as November 9 that the Euro debt repo-to-maturity trades were performed by MF Global Inc. with an affiliate (not Goldman or JP Morgan, as was hypothesized in the media), with the affiliate to receive 80% of profits from the transactions. Inasmuch as J. Christopher Flowers and friends were among MF Global Holdings' larges shareholders, it is conceivable that outflows continue to this day to an affiliate of Jon Corzine's good friend.

_

Given the extension granted by the judge allows these potential shenanigans to continue throughout the end of 2012, it is imperative that immediate disclosure of all trading and intercompany transfers be obtained, especially if they are being conducted to the derogation of the customers.

* * *

MF Global Customer Resources:

_

Commodity Customer Coalition (7,000 members and growing)

MFGFacts.com

MyInvestorsPlace.com

EBatEPJ (website, twitter feed, email: english (at) economicpolicyjournal (dot) com)

_

* * *

Inteview with James Koutoulas of Typhon Capital Management and the Commodity Customer Coalition

Interview with Elaine of MFGFacts.com

Futures Regulators Sanctioned, Then Delayed Rule Changes Regarding Ability of Firms, Such as MF Global, to Bet With Customer Funds

EconomicPolicyJournal.com has learned that in 2003, the National Futures Association (NFA), a futures industry self-regulatory organization, wrote a letter to the Commodity Futures Trading Commission (CFTC), the industry's governmental regulator, successfully arguing for rule changes that would lift restrictions on trading with customer segregated funds by clearing firms, such as MF Global Inc.

Six years later, after substantial restrictions on trading with customer funds were proposed in 2010 pursuant to Dodd-Frank, MF Global lobbied the CFTC through public comment letters and private meetings. Ultimately, the CFTC would choose to delay implementation of the reforms only months before MF Global's demise and bankruptcy.

Sweeping regulatory changes in the futures industry were made in the year 2000, including to CFTC Rule 1.25, which governs the ability of firms to invest customer segregated funds. But, an obscure CFTC letter from 1984 limited the ability of clearing firms to loan customer funds and securities outright, through what are called repurchase (or repo) contracts, unless the clearing firm had explicit permission from the customer. In 2003, the CFTC proposed a revision to the rule to eliminate these and other restrictions.

In the NFA's 2003 comment letter to the CFTC, archived on its website, it said, "NFA supports the proposed amendment to CFTC Rule 1.25 allowing [futures clearing firms] to engage in repurchase agreements with collateral deposited by customers. The safeguards included in the proposal...provide ample protection for customer deposited securities. The amendment provides greater flexibility, requires less paperwork, and reduces the burden on [futures clearing firms] and their customers." The NFA also argued, "it is not necessary to provide an opt-out mechanism...[which would be] costly and burdensome...without a corresponding regulatory benefit."

MF Global filed for bankruptcy on October 31, 2011 after $6.3 billion in risky bets on European debt (so-called repo-to-maturity trades) were required by regulators to be made public, leading to ratings downgrades of the firm. Other investment firms and banks then requested more collateral as insurance for trades they had made with MF Global, which were unable to be met.

While it is alleged that the $6.3 billion in European debt repurchase trades were conducted with MF Global's own firm money, it is unknown how an estimated $600 million in customer segregated funds went missing. If MF Global had lent customer cash or securities through repurchase contracts, it is possible a counterparty to the trade kept the cash or securities as collateral for other trades with MF Global.

Pursuant to the the Dodd-Frank bill signed into law on July 21, 2010, the CFTC proposed reforms to Rule 1.25 that would have limited investment in customer funds. In a letter to the CFTC, MF Global's general counsel, Laurie Ferber, formerly managing director Goldman Sachs, objected to many of the proposed changes, including what were to be severe restrictions on repurchase transactions, including those with customer funds and with affiliates of the firm.

Ms. Ferber's influence in futures regulation is substantial and spans over two decades. As general counsel to a commodity firm owned by Goldman Sachs, in 1991, she was able to secure a secret letter from the CFTC (made public only in 2008) that granted exceptions to limitations designed to curb speculation in commodity futures.

On July 20, 2010, Ms. Ferber, along with MF Global president and former Goldman Sachs CEO, Jon Corzine, appeared in two private meetings with high level CFTC officials, including another former Goldman Sachs CEO, Gary Gensler, to discuss the proposed rule changes. The same day, the CFTC announced in the Federal Register (footnote 4) that the proposed changes to Rule 1.25 governing customer funds would not be addressed and "may be subject to future [CFTC] rulemaking."

It was only three months later that MF Global would admit to regulators that over $600 million in customer funds could not be accounted for. Over $800 million in cash remains frozen in customer accounts, including those of bona fide hedgers, such as farmers and bread producers.

Dither, MF Global Trustee Giddens

Yesterday, MF Global Inc. liquidation trustee James W. Giddens, filed an application to the bankruptcy court to establish claims procedures for MF Global brokerage customers who have had their cash frozen for over two weeks now, as well as the broker's general creditors. While this would seem a step in the right direction, the proposal falls far short of what could be done to provide relief for MF Global customers, while imposing further unnecessary delays. The proposal was filed with a motion for an expedited hearing on the matter to be conducted the very next day (today, in fact, at 3:30 pm), which was granted minutes later by the bankruptcy judge, according to the docket.

_

Per the proposal, claim forms would be mailed to MF Global customer on November 28 and be posted on the trustee's website, whereafter customers would have two months, extended up to six months in some cases, to file claims. Other documents filed suggest there would be a 60% payout, but the trustee's proposal does not outline any specific timeline or payout percentage. [Update: In a separate motion, the Trustee has requested expedited payment of 60% of customer funds.] Indeed, his proposal says interim distributions would be made "if possible". This is wholely unacceptable. Based on current estimated missing funds of $600 million, or approximately 12% of segregated account assets, the assumed 60% payout is well below any reasonable threshold, especially considering the CME Group has pledged $250 million to backstop any overpayment by the trustee.

_

Trustee Giddens cited the "relatively poor state of the Debtor’s books and records", as we noted yesterday. However, as the below press release of the Commodity Customer Coalition points out, this is irrelevant to the delay of an immediate payout. Per futures industry regulations, each futures customer receives a daily statement of cash and open positions, marked to market. Such statements were produced even on October 31, 2011, the day of the MF Global bankruptcy filing. Many customers continued to receive electronic statements for days afterwards. Thus, what should be in the futures customers' accounts is known to the penny. What assets actually back those statements up is another matter. But, again, estimated losses support a much higher initial payout than 60%, especially with the CME's backstop.

_

In the meantime, trustee Giddens will continue to charge $891 per hour against MF Global assets (in addition to research fees of 1% for misdirected wires), and SIPC, inexperienced with futures broker liquidations (and still managing the Lehman liquidation three years and counting), is all the customers have to represent their interests. It is critical that MF Global customers obtain proper representation on what might currently be a compromised creditor committee.

_

Full press release of the Commodity Customer Coalition follows.

Commodity Customer Coalition

190 South La Salle Street, Suite 3000

Chicago, IL 60603

www.commoditycustomercoalition.org

info@commoditycustomercoalition.org

FOR IMMEDIATE RELEASE

312-933-6564

November 16, 2011

CONTACT: John L. Roe (jroe@btrtrading.com)

Commodity Customer Coalition to Object to SIPC Trustee’s Claims Process for MF Global Bankruptcy, Propose Faster Alternative Claims Process

In response to the SIPC Trustee’s expedited application for an order from the court to put both securities and commodities customers of MF Global through the same claims process, the Commodity Customer Coalition (“CCC”) is filing an emergency objection to that application and proposing a faster, more efficient claims process to immediately release a majority of customer funds. The CCC issued the following statement:

The Commodity Customer Coalition applauds the Trustee’s recent motion to release 60% of assets held in cash on October 31, 2011. However, that simply isn’t good enough. This only represents a very small portion of the total assets frozen in the bankruptcy. Additionally, the Trustee has proposed a snail mail approach to collecting claims. He says they cannot use the books of MF Global to verify customer claims, but his process will only result in customers mailing him statements based on those books and it will do so over a period of months. Our proposal will streamline this process with a more commonsense approach, affirm the primacy of customer property over the claims of creditors and return funds to their rightful owners in a matter of days, not months.

The basis for the Trustee’s proposal is that he cannot give us an accurate accounting of the shortfall in customer funds. But MF Global’s estate has $1.2 billion in excess equity and the CME has thrown him a life line of $250 million if he sends home too much money. MF Global claimed under oath that only $600 million in funds is missing. So the shortfall in funds is irrelevant; the Trustee has 250% over the shortfall. That money is supposedly accounted for on a daily basis to the NFA, CFTC and MF’s DSRO, which was the CME. The Trustee has had over two weeks to sort through this and get clients their money. It’s time to truly expedite this process and make customers whole.

Mr. James Koutoulas, Esq. will appear in person tomorrow to argue the CCC motion before the court. He will make himself available to the press immediately following the hearing on the steps of the courthouse.

###

The Commodity Customer Coalition now represents over 7,000 former MF Global customers whose funds have been frozen by the SIPC Trustee. For more information, or to schedule interviews, please contact John L. Roe

(jroe@btrtrading.com, 312-933-6564).

The Commodity Customer Coalition Objects to JP Morgan's Super-Priority Protection Over MF Global Customers

Last week, we noted many peculiarities with respect to the MF Global bankruptcy, not the least of which is the first-lien protection granted to JP Morgan Chase only two days after the bankruptcy, which gives the bank (MF Global's largest creditor) priority claim over MF Global's own customers--an unprecedented act within the futures industry. To date, an estimated $600 million of what were supposed to be segregated customer funds remains missing, and the remaining cash in thousands of customer accounts, including that of farmers, producers and speculators alike, remains frozen.

Only yesterday, after collaboration with other customer attorneys, James Koutoulas filed an objection to JP Morgan's super-priority protection. Inquiries, including those of other MF Global customers and the media may made through the Commodity Customer Coalition website.

The text of the Objection follows. The full filing here:

Pg 1 of 12

James L. Koutoulas, Esq. 190

S. LaSalle St., #3000

Chicago, IL 60603

(312) 836-1180

James L. Koutoulas

Counsel for the Commodity Customer Coalition

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK

In re:

MF GLOBAL HOLDINGS LTD, et al.

Debtors

Chapter 11

Case No. 11-15059 (MG)

COMMODITY CUSTOMER COALITION’S OBJECTION TO THE

MOTION OF THE DEBTORS FOR INTERIM AND FINAL ORDERS UNDER

11 U.S.C. §§ 105, 361, 362, 363(c), AND 363(e) AND BANKRUPTCY RULES 2002, 4001,

6003, 6004 AND 9014 (I) AUTHORIZING THE DEBTORS TO USE CASH

COLLATERAL, (II) GRANTING ADEQUATE PROTECTION TO THE

LIQUIDITY FACILITY LENDERS, AND (III) SCHEDULING A FINAL

HEARING PURSUANT TO BANKRUPTCY RULES 4001(b) AND (c)

The Commodity Customer Coalition, which is made up of numerous MF Global, Inc. customers such as Phil Edgerley, a hog farmer from central Illinois, as well as those other customers listed on Exhibit A (and, on an informal basis, represents the interests of over 2,500 MF Global, Inc. customers who have indicated interest via email or through their brokers) (together, the “Customers”), objects to the Motion of the Debtors for Interim and Final Orders (“Motion”) on the following grounds:[1] (i) the Debtors have not provided adequate notice of the

1 Capitalized terms that are otherwise not defined in this Objection shall have the same meaning ascribed to them in Debtors’ Motion.

Pg 2 of 12

Motion to all interested parties; (ii) no one — not the Liquidity Facility Lenders or the professionals — is entitled to priority secured interests in assets that may belong to Customers; (iii) the Debtors have not proposed any protection for the priority interests of Customers; and (iv) the Liquidity Facility Lenders are not entitled to a finding of good faith at this stage in the proceedings.

INTRODUCTION

MF Global, Inc. was a registered broker-dealer, used by its Customers to trade commodities, futures and derivatives. Customers maintained accounts at MF Global, Inc., which were supposed to be held inviolate under CFTC Regulation 4.20(c), and which have a first-priority right of recovery under 11 U.S.C. § 766(h) and 17 C.F.R. § 190.08. Yet, it appears that over $600 million in Customer funds are unaccounted for at MF Global, Inc. (“Missing Funds”), due to poor internal controls, and may have been commingled with proprietary funds held by MF Global, Inc., and the Debtors.

Presently, the Securities and Exchange Commission (“SEC”), Commodity Futures Trading Commission (“CFTC”), the FBI, and the Trustee overseeing the liquidation of MF Global, Inc., are investigating the disposition of the Missing Funds. It could be that some or all of the missing funds are held by, or are tied up in assets owned by, the Debtors. According to Section 766(h) of Chapter 11 of the Bankruptcy Code, such funds would have to be returned to the Customers before any other creditor.

Pg 3 of 12

In the meantime, Debtors, the Liquidity Facility Lenders, and the professionals representing both, have sought approval to carve out funds for themselves — under a so-called super-priority protection — without regard to the Customers’ right to have their funds returned before any other money is spent from the bankruptcy estate. Yet, the Debtors have not provided notice to all MF Global, Inc. customers, nor have they apparently even notified the trustee for MF Global, Inc. of the potential impact of the Motion on potential Customer funds.

Indeed, if granted, such a super-priority right would abrogate sacrosanct protections for commodities account holders, depriving those who trade in commodities, futures, and derivatives, of their only protection and potentially chill economic activity. It is premature to enter such an order — particularly one that includes a “good faith” finding to a lender that may have benefitted from the improper transfer of the Customer Funds to pay down an outstanding loan.

BACKGROUND

MF Global customers represent a cross-section of people across America and the world, from farmers and ranchers who hedge their crops and herds, to oil producers and miners who use futures to lock-in prices and take delivery of physical commodities, to retirees who invest in futures to diversify their portfolios. For example, farmers who have crops in the field need to sell futures in commodity markets so they can lock in prices for their future yields today, instead of taking on market risk as they would otherwise be exposed to volatile price swings. Large corporations like Coca-Cola who make money in foreign markets do not want to lose

Pg 4 of 12

money when they repatriate revenue earned in foreign currency. They have to be able to forecast future expenses and profits accurately in the currency of their domicile and hedge that currency price risk in futures markets accordingly.

Investors add volume and liquidity to these markets which allow for better, more efficient pricing of commodities. This allows for stability in prices of commodities and predictability of future profit and loss, which in turn allows for stability in producer and consumer prices. These commodities include everything from grains like corn and wheat, to energy like oil and natural gas, to soft goods like cotton and sugar, to currencies like the US dollar and Euro, to financial instruments like bonds and stock indexes. Simply put, trading in commodity futures markets is a mainstay of the American economic engine.

Segregated Funds: Cornerstone of the Commodities Industry:

One of the big differences between commodities brokers and securities (stocks and bonds) brokers is that commodity brokers have an obligation to keep customer funds completely segregated from the firm’s own assets. This is to ensure that clients are completely protected from losses sustained by the firms’ trading and operations. It also is in contrast to the securities industry, as the Securities Investors Protection Act back-stops losses suffered by securities investors due to broker malfeasance, but does not similarly back-stop similar losses suffered by commodities investors.

Many industry groups and regulators have heralded segregated account protection, arguing that no client has ever lost a penny from a segregated account as the result of a broker bankruptcy, and this has been a key driver of volume and profitability for the Chicago

Pg 5 of 12

Mercantile Exchange. “However, all futures trading accounts, including managed futures, have the advantage of specific industry rules that require the segregation of customer funds from the firm's own funds. The practice of segregating customer funds protects investors in the event of default at the Futures Clearing Merchant (FCM, the industry term for futures brokerage firms licensed to trade on futures exchanges in the U.S.) holding their account. While FCM bankruptcies are rare, they do occur. In 2005, Refco Inc. and 23 of its unregulated subsidiaries filed for Chapter 11 bankruptcy protection. However, Refco's regulated subsidiaries (where customers' futures trading and managed futures accounts resided) were unaffected and customers were able to continue trading and managing their accounts.” See “Safeguarding Customers Through Segregated Funds” by CME Group, Inc. http://www.cmegroup.com/managedfutures/Feb2011/safeguarding-customers-through-segregated-funds.html.

So, whereas securities clients are afforded various insurance in the event of a broker bankruptcy, commodities clients are afforded none—which is economically rational only because their funds cannot be commingled with a broker's assets and cannot be used to pay creditors in a bankruptcy. Segregated funds are accounted for daily to the National Futures Association (“NFA”) and to the CFTC through the broker’s designated self-regulatory organization (“DSRO”), which in MF Global’s case was the Chicago Mercantile Exchange (“CME”).

MF Global Did Not Maintain Segregated Accounts

Despite the fact that MF Global was responsible for maintaining full segregation of customer funds on a daily basis, there remains $633M in unaccounted for customer segregated

Pg 6 of 12

funds two weeks after the firm filed bankruptcy. Moreover, the officers and directors of MF Global have thus far been uncooperative in aiding the court in ascertaining the whereabouts of these missing funds, despite a formal probe by the CFTC, the US futures regulator. This has driven the Trustee’s office to comment: “Our forensic investigators have been there since last week and nothing we have found so far causes us to think anything other than there is an apparent shortfall at MF.” See “MF Global Fund Frustration Grows, CFTC Confirms Probe,” by Reuters, November 10, 2011, http://www.reuters.com/article/2011/11/11/us-mfglobal-cftc-investigation-idUSTRE7A96C420111111

These failures to cooperate are consistent with the operating history of MF Global, which is fraught with examples of misconduct and disregard for regulations. “An analysis of regulatory enforcement actions shows MF Global has drawn more sanctions from the U.S. commodity futures regulator than each of its 14 closest peers in that market over the past decade. MF Global has also drawn the second highest amount in fines, for alleged lapses in risk supervision and recordkeeping.” See “Insight: Risk, Lax Oversight Riddle MF Global’s Past,” by Reuters, November 11, 2011, http://www.reuters.com/article/2011/11/11/us-mfglobal-legal-fidUSTRE7AA2KO20111111

As of today, it is not clear where the Missing Funds might be—although they may have been taken as part of one or more margin calls related to sovereign debt held by MF Global on its own account. See “MF Global May Have Used Customer Funds In The Losing $6.3 Billion Trade Without Informing Clients,” November 8, 2011, Forbes, at http://www.forbes.com/sites/robertlenzner/2011/11/08/mf-global-used-customer-funds-in-the-

Pg 7 of 12

losing-6-3-billion-trade-without-informing-clients/. The CME has gone so far as to say that it appears MF Global moved funds immediately prior to bankruptcy from “segregated funds in a manner that may have been designed to avoid detection,” according to a CME statement on November 2, 2011. http://www.prnewswire.com/news-releases/cme-group-statement-regardingmf-global-133102203.html. It is equally possible that these funds were seized and used to pay down the line of credit held by MF Global Holdings, Ltd. or have otherwise been used to bolster cash held by the Debtors.

ARGUMENT

Due to the apparent shortfall of customer segregated funds and the lack of cooperation by MF Global officers and directors in determining its whereabouts, it is imperative that the Court does not grant any liens, encumbrances, priorities, or super-priorities of any assets in the Debtors without protection for customer funds at this time.2 To do so could allow Debtors and JPMorgan Chase Bank, N.A. (“JPMorgan”) to obtain a priority over Customers on Customer Funds, in derogation of the Bankruptcy Code and CFTC regulations. This would deprive commodity investors of the one protection they have — a right to priority payout — and possibly further chill economic activity in these troubled economic times. Accordingly, absent some protection for Customers, Debtors’ Motion must be denied.

2 Objectors realize that MF Global Holdings, Ltd. and the other Debtors wish to reorganize and that many thousands of jobs are at stake. Given the $1.2 billion in equity claimed by the Debtors in their Voluntary Petition, there should be a way to provide adequate protection without impacting the rights of segregated customer account holders. Also, if in fact $1.2 billion in equity exists, one would think that existing equity holders would provide protection to the proposed lender to protect their interests.

Pg 8 of 12

I. Customers Have Absolute Priority Over Funds Implicated By The Motion.

According to 11 U.S.C. § 766(h), a bankruptcy trustee “shall distribute customer property ratably to customers on the basis and to the extent of such customers’ allowed net equity claims, and in priority to all other claims, except [limited costs] attributable to the administration of customer property.” (emphasis added.) Under 17 C.F.R. 190.8, “customer property” includes (among other things) cash, securities or other property “received, acquired or held to margin, guarantee, secure, purchase or sell a commodity contract,” any “open commodity contracts,” and even cash, securities or property that “[w]as unlawfully converted but is part of the debtor’s estate.” The Motion implicates customer property in at least two ways.

First, it is unquestionable that there are well over $600 million in Customer funds that simply have not been accounted for. If speculation is true, the Missing Funds could have been seized in a margin call or otherwise improperly applied by the Debtors to their outstanding obligations. Commingling between MF Global, Inc. and Debtors could necessitate a finding of substantive consolidation. Such a finding would, in turn, merit treating Debtors like futures clearing merchants. Such a finding would obviate the protection of Chapter 11, necessitate Debtors’ immediate liquidation, and would unquestionably require priority return of assets to Customers. Until such time as the SEC, CFTC, FBI, and the trustee overseeing the MF Global, Inc. liquidation have completed their forensic analysis, the Court ought to treat the funds that the Debtors seek to use as if they include the Missing Funds.

Second, the Motion and Amended Interim Order each provide that JPMorgan can obtain a super-priority or first priority lien (JP Morgan currently is an unsecured creditor) on all

Pg 9 of 12

property in which Debtors have an interest, including “intercompany indebtedness ... owed by MF Global, Inc. to each Debtor.” In other words, it is possible, under the Motion, for JPMorgan to obtain a seemingly preferred interest in payments that MF Global, Inc. owes to Debtors—and could use that priority to force MF Global, Inc. to pay JPMorgan rather than pay Customers. The Proposed Order, in Paragraph 5, also gives JPMorgan priority over any claims.

Put simply, given the unknowns at this stage in the proceeding, it is undeniable that the Motion may impact funds and/or assets that should first be paid out to Customers—not to lenders and professionals.

II. Customers Should Have Received Notice.

In this matter, notice has been given in haphazard fashion. Debtors sought and received interim rights over cash collateral and JPMorgan received its super-priority rights on an interim basis without any real notice being given. Then, a hearing was noticed for November 14, 2011. An amended notice, found at Dkt. No. 63, re-set the hearing for Thursday, November 16, 2011, at 3:30 p.m. It also set the objection date for November 11, 2011. Of course, the 16th is a Wednesday and November 11, 2011, was a federal holiday.

Even assuming Debtors have calendar-challenges rather than devious intent, Customers still should have received notice of the Motion. As first-priority claimants for whom over $600 million in collateral has vanished, it seems unquestionable that Customers of MF Global, Inc. potentially have rights that ought to be protected in the closely related bankruptcy of MF Global Holdings, Ltd. Yet, no effort was made even to post notice of the Motion on the SIPC trustee’s website in the related bankruptcy.

Pg 10 of 12

http://dm.epiq11.com/MFG/Project/default.aspx. For this reason alone, the Motion ought to be denied at this time, until adequate (and accurate) notice can be provided to Customers.

III. The Court Ought To Protect Customer Funds.

As noted above, a finding of commingling between MF Global, Inc. and Debtors could necessitate a finding that MF Global, Inc. and the Debtors were substantively consolidated. Such a finding would, in turn, merit treating Debtors like futures clearing merchants. And, such a finding would require that the Court give first priority not to JPMorgan or the professionals in this matter, but to Customers.

It is not beyond the pale to expect that the massive investigation being undertaken by the SEC, CFTC, FBI, and SIPC trustee, will unearth facts that support such a finding. Accordingly, assuming the Court finds that Debtors provided adequate notice, the Court should protect the Customers’ funds. One such protection would be to release $633 million immediately from the estate of MF Global Holdings, Ltd., which reports excess equity of more than $1.3 Billion. (See Mot. at 5.) This would leave Debtors and their lenders with sufficient additional equity to wind-down Debtors’ business.

Absent such relief, Customers have no other recourse. Indeed, the SIPC cannot provide relief to the Customers, as its protections only inure to those trading in securities. The CME’s offer of $250,000,000 in liquidity does not staunch the bleeding, either. It is an insufficient band-aid, at best. As a result, hundreds, if not thousands, of commodity traders are being forced to liquidate trading positions, are losing opportunities to trade and to hedge market risk, and are losing trading positions because the cash they need in order to make margin calls is

Pg 11 of 12

tied up with MF Global. These parties’ inability to trade, combined with the commodity market’s loss of confidence resulting from this collapse, will certainly have a chilling effect on the economy.

Accordingly, the Customers ask that the Court protect Customer funds by immediately releasing $633 million to them or, in the alternative, clearly providing — in any final order relating to the Motion—that: (i) Customers shall have a right to an ad hoc committee to monitor events in these bankruptcy proceedings; and (ii) any priority lien given to any party in this bankruptcy shall not be superior to the rights, if any, of the Customers to recover from this bankruptcy estate; and (iii) professionals have no right to recover for fees and expenses until such time as any funds deemed — by the SEC, CFTC, FBI, the SIPC trustee, or this Court — to be Customer funds have been released to the Customers.

IV. It Is Too Soon To Make A Good Faith Finding.

In the Interim Order, it specifically provides that JPMorgan is deemed to have acted in “good faith” and, accordingly, is entitled to the protection of Bankruptcy Code Sections 363(m) and 264(e). Simply put, until the SEC, CFTC and SIPC trustee have completed their investigations, it is simply too soon to determine whether JPMorgan bargained in good faith, at arms-length, for the right to super-priority liens in this matter. Accordingly, Customers respectfully request that the Court note, in any final order relating to the Motion, that it is withholding judgment as to whether JPMorgan has acted in good faith in these proceedings.

Pg 12 of 12

V. Conclusion.

Were this Court to allow any party to have an interest superior to customer segregated funds, it would provide a loophole in the protections which are the bedrock of commodity trading. This Court should only provide for the use of Cash Collateral which protects customer funds as Congress, the CFTC, CME, and hundreds of thousands of commodity traders have, for over 100 years, believed to have been the case. The system of regulation in the commodities industry is based on this bedrock principle, and this proceeding should in no way affect it. Wherefore, Phil Edgerley, et al request this honorable Court to deny the request in its current form to utilize Cash Collateral, and only allow such use in a manner which protects segregated customer account holders.

Dated: November 14, 2011

By: /s/ James L. Koutoulas

James L. Koutoulas, Esq.

Pro Hac Vice Pending

On Behalf of Commodity Customer Coalition

and Plaintiffs Listed in Exhibit A

190 S. LaSalle St., #3000

Chicago, IL 60603

(312) 836-1180

Disclosure: Neither the author of this post nor his affiliates is represented by Mr. Koutoulas, nor are they members of the Commodity Customer Coalition.

Who is Laurie Ruth Ferber of MF Global?

Laurie Ferber is MF Global's general counsel, and was previously a managing director of Goldman Sachs and general counsel of Drexel Burnham Lambert. More recently, she co-authored the December 2, 2011 letter to the CFTC arguing against many of the contemplated changes to CFTC Rule 1.25, which governs the investment of customer segregated funds. Yes, the same funds that have gone missing to the tune of over $500 million, which has given the excuse for Trustee Giddens,
working
billing at $891 per hour, to freeze ALL customer cash..billions of dollars spread over 50,000 active accounts. We highlighted this letter in our previous expose of MF Global's shady dealings here.

She also attended this meeting:

And this one:

"Alternatives to Credit Ratings" is the Rulemaking subsection that regarded reforms to Rule 1.25, investments of customer funds.

[Update] She also wrote this email to regulators on October 31, 2011, the day MF Global filed for bankruptcy, to advise of "a significant shortfall in segregated funds account".

Her full work bio is here:

Ms. Laurie R. Ferber serves as the General Counsel of MF Global Holdings Ltd. Ms. Ferber is responsible for legal and compliance functions, has operational and administrative responsibility for internal audit function, and is also responsible for regulatory relationships. She joined MF Global in 2009 and plays a key role in developing and implementing MF Global's corporate strategy. She is also responsible for managing litigation, compliance and regulatory matters of MF Global. Ms. Ferber served as Chief Regulatory Officer and General Counsel of International Derivatives Clearing Group, LLC since February 2009 and was responsible for all its legal and regulatory affairs, including compliance and a variety of corporate governance issues. She served as a Managing Director at Goldman, Sachs & Co. Prior to International Derivatives Clearing Group, from 1987 to 2008, she served in a number of capacities at Goldman Sachs & Co., including as General Counsel of J. Aron & Company and Co-General Counsel of the Fixed Income, Currency and Commodities Division. Ms. Ferber also headed Goldman Sachs Derivatives Legal Group, and spent much of the last 9 years developing new businesses, including Economic Derivatives. She served as Chief of Staff of the Global Business Selection and Conflicts Group at Goldman and worked on its transition to a Bank Holding Company. Earlier in her career, she was an Attorney with the law firm Skadden, Arps, Slate, Meagher & Flom and thereafter with Schulte, Roth & Zabel. Prior to joining Goldman Sachs, Ms. Ferber was general counsel of Drexel Burnham Lambert Trading Corp. and also traded energy products. She began her legal career in 1980 as an associate at Skadden, Arps, Slate, Meagher & Flom, and then at Schulte, Roth & Zabel. She is a Trustee of the Institute of Financial Markets and of New York University School of Law. She serves as a Director of the Futures Industry Association and on the Board of Trustees of the Institute for Financial Markets, and is a Member of the Lincoln Center Business Council. Ms. Ferber holds B.S. from State University of New York at Buffalo and earned her J.D. from New York University School of Law.

Ferber was likely placed at MF Global in 2009 by J. Christopher Flowers, one of Global's largest shareholders and also a Goldman alum. This would have paved the way for ex-Goldman Sachs CEO Jon Corzine to take the helm in February 2010.

Update: It seems Ms. Ferber almost single-handedly made commodities an asset class when she obtained this secret exemption letter from the CFTC, which did not surface until 2008. The letter was written to her by Jean Webb, CFTC Secretary, when Ms. Ferber was General Counsel of J. Aaron & Company, owned by Goldman Sachs. It granted an exemption to speculative position limits in commodities based on the hedging activities related to the Goldman Sachs Commodities Index. Matt Taibbi wrote about this here, but got his facts wrong, confusing the recipient (Ferber) with the sender (Webb).

Below is an excerpt from a post we wrote last year about how the GSCI was unexpectedly rebalanced in the summer of 2006 right as Paulson came into the Bush administration. It was the energy component that was substantially revised downward, which led to immediate forced selling and lower gas prices into the election. From this filing, we know Ferber sat on the GSCI Policy Committee at the time. She would have been the energy expert.

Ms. Ferber is also currently on the board of the Futures Industry Association, which wrote this letter in 2003 to support new rules that would allow repos with customer funds without notification or opt-out. We have not been able to establish if Ms. Ferber was on the board in 2003.

Excerpt from "Ex-Goldmanite Gary Gensler "Tickled Pink" as CFTC Ramps Up for Price Fixing"

A prime example is the rebalancing of the Goldman Sachs Commodity Index (GSCI) that took place in the summer of 2006. At the time, about $60 billion tracked the index, including some large pension funds, which would allocate a portion of their assets to purchasing commodity futures contracts in the exact weightings prescribed by the index. A change in the index composition would trigger buying or selling in the days and weeks that followed. There are several such commodity indexes, and they are periodically rebalanced pursuant to announced schedules, usually annually. However, according to the New York Times, on August 9, 2006, Goldman announced it would not roll over certain gasoline futures contracts into newly reformulated contracts. The result:

Unleaded gasoline made up 8.72 percent of Goldman’s commodity index as of June 30, but it is just 2.3 percent now, representing a sell-off of more than $6 billion in futures contract weighting.

...

Wholesale prices for New York Harbor unleaded gasoline, the major gasoline contract traded on the New York Mercantile Exchange, dropped 18 cents a gallon on Aug. 10, to $1.9889 a gallon, a decline of more than 8 percent, and they have dropped further since then.

Rob Kirby quoted Bill King, who had taken notice at the time:

Goldman's changes probably induced arbs, commercial hedgers, and other traders to sell September and October unleaded gasoline future contracts to avoid possible (settlement, delivery, etc.) problems.

September futures expired in August; October contracts expire September 29. So unleaded gasoline prices collapsed in August and September.

For the conspiracy minded, note that ex-Goldman Sachs CEO Hank Paulson was sworn in as Treasury Secretary just a month prior in July, 2006, and that rising gas prices were becoming an issue for the approaching mid-term elections. The fall in the energy complex not only led to relief at the pump, but a pretty drastic (but short-lived) selloff in commodities overall.

Bernanke Confirms Fed Might Raise Inflation Target [to Justify More Printing]

File under: expect the money printing to continue. Bernanke is giving the Fed an excuse to continue with its monetary expansionist profligacy against the backdrop of rising prices, which is smacking the Fed in the face. During the Bernanke press conference after the November 3, 2011 FOMC meeting, we Tweeted:

@zerohedge Did Ben just suggest the Fed is considering raising its inflation target?

This was in response to a curious phrasing by the Chairman. From the transcript:

ROBIN HARDING. Robin Harding from the Financial Times. Mr. Chairman, could you explain the menu of options that the Committee has for improving its communication about when it might raise interest rates and what the conditions are in which it might do that? For example, might it makes sense for the Fed to publish a forecast of its own future interest rates, and what’s the advantages and disadvantages of that? Thank you.

CHAIRMAN BERNANKE. Well, again, as I noted in my opening remarks, no decisions have been made, so I want to be very clear that no final—you know, there is no final outcome here in this discussion. But clearly, there’s a range of things that we can do. We can provide more information about our objectives, for example. We could provide information about where we want inflation to be in the long term, for example. We can also provide information about the future path of interest rates, which we’ve done to some extent via our “mid-2013” language in the statement. An alternative approach, which Charlie Evans and others have suggested, is to tie that to economic conditions and to provide more information about under what circumstances we would raise rates. That is certainly something that we have discussed and I think is an interesting alternative. There’s a lot of interest in using the survey of economic projections in constructive ways as we have up until now to provide information to the public about our plans. And in particular, using the SEP as a way of giving information about our future policy decisions is something that’s on the table. There’s no decision made about that, but that’s one direction that we might find productive.

Today, at a town hall meeting with soldiers and their families, Bernanke again said:

We pursue those two important goals by influencing the level of interest rates and other financial conditions. My colleagues and I on the Federal Reserve's monetary policymaking committee equate price stability with inflation being at 2 percent or a little less. That rate is low enough that people and businesses can make financial decisions without having to worry too much about rising costs, but high enough to keep the economy away from deflation--falling wages and prices--which is both a cause and a symptom of an extremely weak economy. Although spikes in oil and food prices, and other transitory factors, pushed inflation up earlier this year, inflation appears to be moderating, and we expect, based on the best information that we have today, that it will remain reasonably close to our objective of 2 percent or a bit less for the foreseeable future.

In the longer term, monetary policy is the main determinant of inflation, and so Federal Reserve policymakers have considerable latitude to choose our longer-term inflation goal. In contrast, "maximum employment" depends on many factors outside of the Federal Reserve's control, such as the skills of the workforce and the pace of technological innovation. Right now, my colleagues on the Fed's policymaking committee estimate that the U.S. economy could sustain an unemployment rate of somewhere between 5 and 6 percent without generating a buildup of inflation pressures. But, regardless of whether the sustainable rate is 5 or 6 percent, with unemployment currently at 9 percent, our economy is certainly falling far short of maximum employment. That high unemployment rate is why the Federal Reserve is focusing its monetary policy at strengthening the recovery and job creation, including keeping short-term interest rates near zero and longer-term rates, such as mortgage rates, at the lowest levels in decades. Keeping borrowing costs very low supports consumer purchases of houses, cars, and other goods and services, as well as business investment in new equipment, software, and facilities. Over time, greater demand on the part of households and businesses leads to increased economic activity and employment.

Yes, in the topsy turvy world of Keynesian economics, 9% unemployment must be remedied by more money printing to make consumer products more expensive. Unfortunately, wages of the poorest are always the last to rise, since inflation is actually a subsidy to those who get the money first.

Full Text of National Futures Association Letter Approving of FCM Repos with Customer Funds Without Their Consent or Opt-out

Presented without comment (emphasis ours):

September 05, 2003

Via E-Mail (secretary@cftc.gov)

Ms. Jean A. Webb
Secretary
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street., N.W.
Washington, D.C. 20581

Re: Investment of Customer Funds, 68 Fed. Reg. 125 (June 30, 2003)

Dear Ms. Webb:

NFA appreciates the opportunity to comment on the Commission's proposed amendment on the investment of customer funds. The proposal will give FCMs and DCOs greater flexibility in handling customer funds while ensuring that those funds are handled in a safe and efficient manner. Therefore, we support the proposal.

NFA supports the proposed amendment to CFTC Rule 1.25 allowing FCMs to engage in repurchase agreements with collateral deposited by customers. The safeguards included in the proposal, such as the marketability requirements, exclusion for specifically identifiable property, and required compliance with Rule 1.25(d), provide ample protection for customer deposited securities. The amendment provides greater flexibility, requires less paperwork, and reduces the burden on FCMs and their customers.

Since the amendment excludes specifically identifiable property, it is not necessary to provide an opt-out mechanism where a customer could instruct an FCM not to subject collateral/securities to a repurchase agreement. Furthermore, NFA believes that an opt-out provision would be costly and burdensome by requiring revisions to existing customer account agreements without a corresponding regulatory benefit.

The exclusion of specifically identifiable property also eliminates the need to require the FCM to replace the securities in the event of a default. Although replacing the securities may be the preferable course of action, NFA believes that it is acceptable, in the rare event of a default by a counterparty to a repurchase agreement [what about bankruptcy of FCM itself?], for the FCM to make the customer whole by giving the customer the cash equivalent of the securities plus any transaction costs that might be incurred in replacing them.

Additionally, NFA would support an amendment eliminating the dollar weighted average of the time-to-maturity limitation imposed on FCMs that invest solely in U.S. Treasury instruments. As mentioned by the Commission, Treasury instruments do not pose the same level of risk as other permitted investments. These instruments should, however, be subject to appropriate haircuts.

If you have any questions concerning this letter, please contact me at 312-781-1413 or tsexton@nfa.futures.org.

Respectfully submitted,

Thomas W. Sexton
Vice President and General Counsel

Thomas W. Sexton, III remains Vice President and General Counsel to the NFA to this day.

Did the New York Federal Reserve Tank MF Global?

From FRBNY's website (emphasis ours):

*This week's purchase table includes $950 million of purchases that were made to replace transactions cancelled with MF Global Inc. (MF Global). MF Global, which had been a primary dealer, recently came under stress and ultimately a trustee was appointed pursuant to the Securities Investor Protection Act to liquidate the business. During this time, the Federal Reserve Bank of New York (the Bank) took progressive and proportionate steps to manage its exposure to the firm and ensure the ongoing effective implementation of monetary policy through open market operations.

The Bank ceased doing new business with MF Global and required the firm to post margin in respect of its $950 million outstanding agency MBS forward transactions with the Bank. The margin protected the Bank against potential exposure to MF Global due to fluctuations in the market value of the positions. When the firm was unable to meet a subsequent margin call on these transactions, the Bank declared an event of default, cancelled the transactions with MF Global and entered replacement transactions with other firms.

Replacement transactions were conducted in 30-year agency MBS and included purchases of: $300 million FNMA 3.5% coupons for December settlement, $100 million FNMA 4% coupons for November settlement, $200 million FNMA 4% coupons for December settlement, $250 million FHLMC 3.5% coupons for December settlement and $100 million FHLMC 3.5% coupons for January settlement.

The cost of replacing the cancelled transactions with MF Global was $3,089,843.75, which is based on the net difference between the price of the original trades and the price of the replacement transactions. The margin posted by MF Global was sufficient to cover the replacement cost.

When the trustee was appointed to liquidate the business, the Bank terminated MF Global's status as a primary dealer.

These measures were taken to protect the public interest and minimize risk to taxpayers, and under the framework of the primary dealer policy. The Federal Reserve did not suffer any loss as a result of the firm's failure.

So did the Fed return the difference between the $950 million margin posted and the replacement transactions costs, which would be about $946,910,156.25?

(ht Hilsenrath)

The MF Global Bankruptcy Cheat Sheet; Where are the missing customer funds and how can customers and creditors preserve their rights?

Currently, over $500,000,000 in customer segregated funds is missing from MF Global Inc., the US broker/dealer and futures commission merchant (FCM) that filed for Chapter 11 bankruptcy protection last Monday, October 31, 2011. This is simply unprecedented in the futures industry, which passed relatively unscathed through the 2008 turmoil. When an FCM is about to declare bankruptcy, the brokerage accounts have historically been separated or sold from the failing entity to protect the integrity of the customer accounts. This did not occur with MF Global, and now the cash in 50,000 active accounts is frozen and subject to the actions of the trustee, James W. Giddens (the same trustee who was appointed to Lehman Bros.).

How could this have happened? Where are the missing funds? What can be done about it? This article will attempt to offer some theories and possible courses of action. Time is of the essence. Critical deadlines for that affect customer and creditor rights are rapidly approaching.

Please be advised: WE ARE NOT ATTORNEYS and nothing here should be construed as legal advice. The hope is that professionals with more time and resources will be able to use this information to protect their clients. All emphasis in quotations should be construed as ours, except as otherwise noted.

Part I - Background

The chain of events that led to MF Global's demise began with proprietary trades made in European debt. Izabella Kaminska of FT Alphaville outlines (emphasis original):

What caused MF Global’s downfall?

According to Bradley Abelow, MF Global’s Chief Operating Officer, much of the blame may lie with Finra’s unreasonable request for MF Global to add capital to support its off-balance sheet exposure to European sovereign debt and reveal them publicly. These were, as we have discussed, structured as repo-to-maturity trades. They were also maintained off-balance sheet.

In a personal declaration filed in Chapter 11 proceedings (H/T Zerohedge), Abelowwrites:

As a global financial services firm, MF Global is materially affected by conditions in the global financial markets and worldwide economic conditions. On September 1, 2011, MF Holdings announced that FINRA informed it that its regulated U.S. operating subsidiary, MFGI, was required to modify its capital treatment of certain repurchase transactions to maturity collateralized with European sovereign debt and thus increase its required net capital pursuant to SEC Rule 15c3-1. MFGI increased its required net capital to comply with FINRA’s requirement.

Upon this notice, Moody’s got a little skittish. As Abelow notes:

On October 24, 2011, Moody’s Investor Service downgraded its ratings on the Company to one notch above junk status based on its belief that MF Holdings would announce lower than expected earnings.

But that wasn’t good enough for Finra. They wanted the exact details of the trades revealed publicly in MF Global’s October results:

On October 25, 2011, MF Holdings announced its results for its second fiscal quarter ended September 30, 2011. The Company revealed that it posted a $191.6 million net loss in the second quarter, compared with a loss of $94.3 million for the same period last year. The net loss reflected a decrease in revenue primarily due to the contraction of proprietary principal activities.

Dissatisfied with the September announcement by MF Holdings of MFGI’s position in European sovereign debt, FINRA demanded that MF Holdings announce that MFGI held a long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity, including Belgium, Italy, Spain, Portugal and Ireland. MF Holdings made such announcement on October 25, 2011. These countries have some of the most troubled economies that use the euro. Concerns over euro-zone sovereign debt have caused global market fluctuations in the past months and, in particular, in the past week. These concerns ultimately led last week to downgrades by various ratings agencies of MF Global’s ratings to “junk” status. This sparked an increase in margin calls against MFGI, threatening overall liquidity.

This brought attention to MF Global’s precarious liquidity exposure to the likes of the CFTC and SEC, pushing MF Global into seeking out alternative arrangements before its liquidity position became too precarious:

Concerned about the events of the past week, some of MFGI’s principal regulators – the CFTC and the SEC – expressed their grave concerns about MFGI’s viability and whether it should continue operations in the ordinary course. While the Company explored a number of strategic alternatives with respect to MFGI, no viable alternative was available in the limited time leading up to the regulators’ deadline. As a result, the Debtors filed these chapter 11 cases so that they could preserve their assets and maximize value for the benefit of all stakeholders.

Specific to everyone’s concerns were, of course, were MF Global’s ‘repo-to-maturity’ sovereign debt trades.

Anyone following MF Global’s regulatory notices would though have been able to spot their disquiet early on.

On September 1, for example, MF Global filed the following:

As previously disclosed, the Company is required to maintain specific minimum levels of regulatory capital in its operating subsidiaries that conduct its futures and securities business, which levels its regulators monitor closely. The Company was recently informed by the Financial Industry Regulatory Authority, or FINRA, that its regulated U.S. operating subsidiary, MF Global Inc., is required to modify its capital treatment of certain repurchase transactions to maturity collateralized with European sovereign debt and thus increase its required net capital pursuant to SEC Rule 15c3-1. MF Global Inc. has increased its net capital and currently has net capital sufficient to exceed both the required minimum level and FINRA’s early-warning notification level.

The Company does not believe that the increase in net capital will have a material adverse impact on its business, liquidity or strategic plans. In addition, the Company expects that its regulatory capital requirements will continue to decrease as the portfolio of these investments matures, which currently has a weighted average maturity of April 2012 and a final maturity of December 2012.

Regulators’ concern no doubt centred around the fact that such off-balance sovereign positions could pose very real and sudden liquidity issue in terms of margin calls. They were probably also conscious of such things as Lehman’s notorious Repo 105 arrangement.

Most articles have posited or assumed that the counterparty to the $6.3 billion European debt repo-to-maturity trades was a large Wall Street entity, such as Goldman, JP Morgan or even Nomura. This is likely not the case because regulatory filings of the broker/dealer unit indicate that, as of March 31, 2011, the counterparty was an affiliate of MF Global Inc. See the audited financial statements of MF Globla Inc. (not those of the holding company, MF Global Holdings) filed with the SEC:

From Note 4:

Securities sold under agreements to repurchase $14,380,145,100 (1)

(1) includes $7,497,154,700 collateralized with European Sovereign debt and transacted with an affiliate

And from Note 11:

The Company entered into repurchase agreements with an affiliate that are collateralized with European Sovereign debt. The affiliate identified the market opportunity and manages the collateral associated with these transactions, although the Company retains the issuer default and liquidity risk. For these services the Company paid a management fee to the affiliate. The management fee represents approximately 80% of the trade date gain recognized by the Company from entering into these repurchase agreements.

The first question is, who is the affiliate? Given the interconnectedness of the large shareholders, directors and officers at MF Global within financial circles, the list could stretch into the hundreds, including any number of affiliates of J.C. Flowers Group and its funds. It was J. Christopher Flowers himself who helped launch Corzine's political career and who helped usher him into MF Global as CEO. And, throughout his tenure at MF Global, Jon Corzine remained an Operating Partner of J.C. Flowers & Co. LLC. His engagement letter was filed with the SEC here.

The second question is, wouldn't the likely fact that the repo-to-maturity trades were carried out with an affiliate lower the likelihood of crippling collateral/margin calls (setting aside for the moment, the conspiratorial view that the affiliate intended to sink MF Global)? Did FINRA take this into account when it forced MF Global to increase its regulatory capital and make subsequent disclosures that rattled investors and counterparties?

Based on the above disclosures and existing regulations, it's unlikely that substantial European debt trades were carried out with customer account funds. Even if MF Global had invested customer funds in sovereign bonds (subject to the limits of the applicable rules), it's unclear why it would not be able to account for them. Although distressed, all of the sovereigns that were invested in by the firm with its own money continue to be paid out at par. It's unlikely that MF Global invested $1 billion in customer funds (about twice the missing amount) in the high yielding Greek debt that was subsequently negotiated to be paid out at 50%.

Of much more interest are the provisions regarding repurchase agreements (repos) and resale agreements (reverse repos).

Part II - Key regulatory provisions regarding Investment of Customer Funds

This section is a bit legalistic, so casual readers may wish to skip forward to Part III.

CFTC Rule 1.25 governs Investments of Customer Funds, and it's position on sovereign debt is as follows:

(D) Sovereign debt is subject to the following limits: a futures commission merchant may invest in the sovereign debt of a country to the extent it has balances in segregated accounts owed to its customers denominated in that country's currency; a derivatives clearing organization may invest in the sovereign debt of a country to the extent it has balances in segregated accounts owed to its clearing member futures commission merchants denominated in that country's currency.

Provisions for repurchases and resales:

(2)(i) In addition, a futures commission merchant or derivatives clearing organization may buy and sell the permitted investments listed in paragraphs (a)(1)(i) through (viii) of this section pursuant to agreements for resale or repurchase of the instruments, in accordance with the provisions of paragraph (d) of this section.

(ii) A futures commission merchant or a derivatives clearing organization may sell securities deposited by customers as margin pursuant to agreements to repurchase subject to the following:

(A) Securities subject to such repurchase agreements must be “readily marketable” as defined in §240.15c3–1 of this title.

(B) Securities subject to such repurchase agreements must not be “specifically identifiable property” as defined in §190.01(kk) of this chapter.

(C) The terms and conditions of such an agreement to repurchase must be in accordance with the provisions of paragraph (d) of this section.

(D) Upon the default by a counterparty to a repurchase agreement, the futures commission merchant or derivatives clearing organization shall act promptly to ensure that the default does not result in any direct or indirect cost or expense to the customer.

And, regarding concentration limits:

(ii) Repurchase agreements . For purposes of determining compliance with the concentration limits set forth in this section, securities sold by a futures commission merchant or derivatives clearing organization subject to agreements to repurchase shall be combined with securities held by the futures commission merchant or derivatives clearing organization as direct investments.

(iii) Reverse repurchase agreements . For purposes of determining compliance with the concentration limits set forth in this section, securities purchased by a futures commission merchant or derivatives clearing organization subject to agreements to resell shall be combined with securities held by the futures commission merchant or derivatives clearing organization as direct investments.

As to the specific requirements of the repurchase and resale agreements, with some interesting bankruptcy provisions (emphasis ours):

(d) Repurchase and reverse repurchase agreements . A futures commission merchant or derivatives clearing organization may buy and sell the permitted investments listed in paragraphs (a)(1)(i) through (viii) of this section pursuant to agreements for resale or repurchase of the securities (agreements to repurchase or resell), provided the agreements to repurchase or resell conform to the following requirements:

...

(12) The agreement makes clear that, in the event of the bankruptcy of the futures commission merchant or derivatives clearing organization, any securities purchased with customer funds that are subject to an agreement may be immediately transferred. The agreement also makes clear that, in the event of a futures commission merchant or derivatives clearing organization bankruptcy, the counterparty has no right to compel liquidation of securities subject to an agreement or to make a priority claim for the difference between current market value of the securities and the price agreed upon for resale of the securities to the counterparty, if the former exceeds the latter.

To be thorough, another excerpt from Rule 1.25 that contains a bankruptcy clause:

(9) For purposes of §§1.25, 1.26, 1.27, 1.28 and 1.29, securities transferred to the customer segregated account are considered to be customer funds until the customer money or securities for which they were exchanged are transferred back to the customer segregated account. In the event of the bankruptcy of the futures commission merchant, any securities exchanged for customer funds and held in the customer segregated account may be immediately transferred.

And, a final excerpt from Rule 1.25 that allows the FCM's own funds and securities to be deposited into segregation, which we will return to in a bit:

(f) Deposit of firm-owned securities into segregation. A futures commission merchant shall not be prohibited from directly depositing unencumbered securities of the type specified in this section, which it owns for its own account, into a segregated safekeeping account or from transferring any such securities from a segregated account to its own account, up to the extent of its residual financial interest in customers' segregated funds; provided, however, that such investments, transfers of securities, and disposition of proceeds from the sale or maturity of such securities are recorded in the record of investments required to be maintained by §1.27. All such securities may be segregated in safekeeping only with a bank, trust company, derivatives clearing organization, or other registered futures commission merchant. Furthermore, for purposes of §§1.25, 1.26, 1.27, 1.28 and 1.29, investments permitted by §1.25 that are owned by the futures commission merchant and deposited into such a segregated account shall be considered customer funds until such investments are withdrawn from segregation.

A variant of the repurchase/resale structure is that of the tri-party repo, in which a third party custodian intervenes between the seller and the buyer. A New York Federal Reserve white paper explains:

Description of Tri‐Party Repo Market

The tri‐party repo market is large and important, but not very well understood. It represents a significant part of the overall U.S. repo market, in which market participants obtain financing against collateral and their counterparties invest cash secured by that collateral. Large U.S. securities firms and bank securities affiliates finance a large portion of their fixed income securities inventories, as well as some equity securities, via the tri‐ party repo market. This market also provides a variety of types of investors with the ability to manage cash balances by investing in a secured product. The “tri‐party” label refers to repo transactions that settle entirely on the books of one of two “Clearing Banks” in the U.S. market: Bank of New York Mellon (BNYM) and JP Morgan Chase (JPMC). The Clearing Bank is thus a third party involved in the repo transaction between a “Dealer” (party, not necessarily a Broker‐Dealer, borrowing cash against securities collateral) and a “Cash Investor” (party lending cash against securities collateral). 1

The attractiveness of the tri‐party repo market is driven by the treatment of repurchase transactions in bankruptcy, the use of securities as collateral (including daily margining and haircuts), and the custodian services of the Clearing Banks which provide protections that do not exist for bilateral repo investors or unsecured creditors. As a result, the U.S. repo market contributes significantly to the liquidity and efficiency of the U.S. Treasury and Agency (including Agency MBS) securities markets, which collectively make up approximately 75% of the total collateral in the U.S. repo market. The importance of the U.S. repo market is underscored by the fact that it is the market in which the Federal Reserve operationally implements U.S. monetary policy.

Whether or not tri-party repurchases and resales are permitted for investments of customer funds under Rule 1.25 is unknown, but they would certainly be available to MF Global using its own money. A timely article also published by the New York Fed highlights a current quirk of the US tri-party repo market (repo being generalized for both repurchases and resales), the resolution of which has been delayed, and also points out a key bankruptcy provision (emphasis ours):

The Unwind Defined

The centerpiece of the current reform effort is the elimination of the wholesale daily unwind of tri-party repos, on both maturing and continuing term trades. The unwind consists of an extension of credit to a dealer by its clearing bank to facilitate the settlement of the dealer’s repos (for more details, see this New York Fed staff report.) The clearing banks return cash to cash investors and collateral to dealers each day and, in the interim, extend credit to dealers against their entire tri-party repo book. This unwind temporarily transfers the risk of a dealer’s default from cash investors to the clearing bank. When new repos are settled and continuing term trades are re-collateralized, the exposure to the dealer is transferred back from the clearing bank to cash investors (including new investors).

Why Eliminate the Unwind?

In a recent blog post, I argued that eliminating the wholesale unwind of tri-party repos could reduce fragility in that market. The delays in the reforms, however, leave the market just as vulnerable to the risk that a clearing bank might refuse to unwind a dealer’s trades as it was during the recent financial crisis. If a clearing bank refused to unwind a dealer’s repos, the dealer would almost certainly be forced into bankruptcy, because the dealer would probably not be able to attract new funding that day. That event could create instability in the tri-party repo market that could in turn spill over into other markets. While this risk is not new, its continued existence remains a serious concern.

Part III - An ominous letter written by MF Global

So why are repurchase and resale contracts relevant to the instant case of the MF Global bankruptcy proceedings of both the holding company and the broker unit? We'll let MF Global speak for itself, as it wrote a lengthy letter to the CFTC dated December 2, 2010 after the CFTC, under the direction of Dodd-Frank, had issued proposed reforms to its Rule 1.25, which governs how customer funds may be invested by a broker. We highlighted the original comment letter and posted it here.

The ironic, if not prophetic, introduction:

As a general matter, we applaud the CFTC for seeking new ways to ensure the safety and liquidity of investments made by futures commission merchants under CFTC Rules 1.25 and 30.7. However, as we set forth below, we believe the specific amendments being proposed: (a) are unnecessary, considering that the current permissible investments under Rule 1.25 have not, to our knowledge, resulted in any FCM's inability to provide customers their segregated funds upon request or to continue as a solvent entity, (b) will, in many cases, create new investment risks and logistical difficulties for FCMs, and (c) may well change the pricing dynamics for customers and the industry at large. Recognizing the CFTC's concerns, however, we have set forth our own proposed amendments which we believe satisfy the CFTC's desire for the enhanced security of customer segregated funds without the risk of significantly increasing costs to customers.

On fixing something that is not broken (until it is):

B. The Investments Currently Permitted Under Rule 1.25 Have Not Put Customer

Funds at Risk.

We believe strongly that the CFTC's proposed amendments endeavor to "fix something that is not broken." Indeed, the evidence is clear that the investments permitted and safeguards required under Rule 1.25 have met the CFTC's stated "objectives of preserving principal and maintaining liquidity" of customer segregated funds. Sec Rule 1.25(b). Among other things, since the CFTC's 2004 expansion of permissible investments under RuIe 1.25, we are not aware of any FCM that has been unable to liquidate and provide to their customers upon request any segregated funds invested under Rule 1.25 (or under Regulation 30.7 either, for that matter).4

Further, since this expansion, no FCM to our knowledge has failed or otherwise been unable to meet any other of its financial obligations as a result of investments made under Rule 1.25.5 In short, we believe the current investment criteria set forth under Rule 1.25 have worked, including over the past two years of market instability and uncertainty - the ultimate stress test. Nevertheless, the Commission has proposed changes so sweeping that they may in fact increase systemic risk by imposing new burdens on otherwise effective, efficient and liquid settlement processes. Such a radical overhaul, in our view, is unnecessary considering the Rule's stellar track record. At most, the CFTC should be adjusting only slightly the products, counterparties and concentration percentages currently permitted. 6

Per the Federal Register, we know the expansion of permissible investments in 2004, noted by MF Global, was in fact that of repurchases and resales. Prior to that, CFTC Staff Letter 84-24 permitted investments of customer funds in repurchases and resales, but only with explicit permission by the customer. The National Futures Association (NFA) and others were unfortunately successful when they argued against notification and opt-out provisions, having considering the possibility of counterparty default, but apparently not that of the FCM itself.

The MF Global letter continues on this issue:

d. Repurchase and Reverse Repurchase Transactions

The CFTC proposes to reduce counterparty concentration limits on reverse repurchase agreements to 5% of an FCM's portfolio (currently there are no limits), citing the potential credit risk posed to FCMs by investing a substantial portion of their funds with one counterparty. In our view, this proposal will unnecessarily restrict a very liquid and secure investment that has provided important flexibility as well as reasonable returns for FCMs and their customers. We believe the CFTC should focus on the critical fact that the customer segregated account and the secured amount will be fully collateralized with qualified Rule 1.25 products at all times, even in the event of a counterparty default on a reverse repurchase agreement.

Commission and clearinghouse rules require that FCMs routinely transact and fund margin requirements involving large transactions executed against considerable time constraints, often on an intra-day basis. However, the CFTC's proposed concentration limits could severely undermine an FCM's ability to meet these obligations efficiently, thereby creating particular risk for intra-day funding requirements. The CFTC should recognize that imposing a 5% counterparty concentration limit would (a) require FCMs to have relationships with a minimum of 20 (and as many as 25 or more) different counterparties, which would at best be difficult to manage, and would significantly increase systemic risk, and (b) decrease liquidity and increase operational risk, due to a significant increase in the number of required transactions and the resulting potential fails. We believe that introducing these new risks is unwarranted, especially as there is no evidence that any FCM has been unable to timely return customer funds or meet margin requirements as a consequence of investing customer funds with a limited number of reverse repurchase counterparties.

We also believe the CFTC's proposed prohibition on in-house and affiliate repurchase and reverse transactions is unnecessary because such transactions (a) may only involve Rule 1.25-permissible securities, (b) are conducted within a regulated entity and, (c) are contained within properly titled Rule 1.25 segregated accounts, as are the related cash and security movements. Eliminating these transactions is inconsistent with the CFTC's stated objective of reducing FCM investment risk, since FCMs would be unable to enter into and execute such transactions with and through entities and personnel with whom they have created an effective, efficient and liquid settlement framework.

Consequently, we recommend that FCMs not be subject to a 5% counterparty concentration limit on reverse repurchase transactions, and that they continue to be able to enter into repurchase and reverse repurchase transactions with affiliates and on an in-house basis. However, to the extent the Commission continues to be concerned with the safety of such transactions with unaffiliated third parties, we recommend that it consider (a) limiting FCM repurchase and reverse repurchase transactions to those external counterparties maintaining a certain level of capital (such as $50 or $100 million), or (b) reducing the counterparty concentration limits to only 25% per counterparty.

To sum up, the CFTC was considering the ban of the very transactions with affiliates that would eventually precipitate MF Global's demise. Further, it was going to severely restrict the ability of MF Global to enter repurchase and resale contracts with customer funds. So what happened with the proposed regulation reform?

Part IV - The private meetings between the CFTC and MF Global

Shortly after MF Global had written the letter to the CFTC arguing against various regulatory reforms, Jon Corzine met personally with CFTC Commissioner Bart Chilton regarding "Segregation and Bankruptcy" rulemaking.

Make of that as you will. While MF Global representatives appeared in numerous meetings with CFTC staff, sometimes with representatives of other firms, it is the high level private meetings that are of interest. On December 21, 2010, Jon Corzine again met with CFTC staff to discuss, among other things, the same "Segregation and Bankruptcy" rulemaking.

Perhaps more interesting was one of two private conference call that took place on July 21, 2011, this one with the two ex-Goldman Sachs CEOs, Jon Corzine and CFTC Chairman Gary Gensler.

Note the memorandum at the bottom:

Conference call on topics relating to the Regulation 1.25/30.7 rulemaking including MMMFs, asset-based and issuer-based concentration limits, counterparty concentration limits, in-house transactions and repurchase agreements with affiliates.

Although one would not know it from the "Alternatives to Credit Ratings" title, the notes regarding concentration limits directly relate to allowable investment of customer funds.

Finally, there was another related conference call later that same day, this time with Jon Corzine and Commissioner Bart Chilton again:

By July 21, 2011, problems with European debt were again in the forefront and it would be only days before a tremendous slide in US equities would commence that would eventually lead to 20% plus declines in the major indexes. Had the changes to CFTC Rule 1.25 been implemented as other rulemaking areas were at the time, MF Global would have been under serious pressure to unwind some or all of its repo-to-maturity transactions and bring the European debt it had bought onto its balance sheet.

Was the CFTC unduly influenced by the private meetings with MF Global to delay implementation of Rule 1.25 reforms? Is this in part why Chairman Gensler has recused himself from the MF Global investigation?

Part V - The Bankruptcy Proceedings & A Call to Action

On October 31, 2011, bankruptcy proceedings were initiated for its holding company, MF Global Holdings Ltd (MF Holdings) with concurrent SIPC-led liquidation proceedings for its broker/dealer/FCM unit, MF Global Inc. Two days later, on November 3, the bankruptcy judge in the MF Holdings proceedings, Martin Glenn, issued an Order which, among other things, authorized the use of cash collateral by MF Holdings in an amount up to $8 million. In return, as MF Holdings largest creditor (over $1 billion), JP Morgan was given first lien status on unencumbered property:

(i) First Lien on Unencumbered Property. Pursuant to § 364(c)(2) of the Bankruptcy Code, a valid, binding, continuing, enforceable, fully perfected first priority lien on, and security interest in, all tangible and intangible prepetition and postpetition property in which the Debtors have an interest, whether existing on or as of the Petition Date or thereafter acquired, that is not subject to valid, perfected, non-avoidable and enforceable liens in existence on or as of the Petition Date (collectively, the “Unencumbered Property”), including, without limitation, any and all avoidance actions, unencumbered cash, intercompany indebtedness owed by one or more non-debtor entities to either or both Debtors (including, without limitation, any and all amounts owed by MF Global Inc. to each Debtor), accounts receivable, inventory, general intangibles, contracts, securities, chattel paper, owned real estate, real property leaseholds, fixtures, machinery, equipment, deposit accounts, patents, copyrights, trademarks, tradenames, rights under license agreements and other intellectual property, capital stock of the subsidiaries of each Debtor and the proceeds of all of the foregoing; provided that, the Debtors shall not be required to pledge in excess of 65% of the capital stock of their direct foreign subsidiaries or any of the capital stock or interests of indirect foreign subsidiaries (if adverse tax consequences would result to the Debtors) or other assets that would be unlawful to pledge as determined by a final order of a court of competent jurisdiction; and provided, further, that the Court will reconsider at the Final Hearing (defined below) both the grant of liens on avoidance actions and whether the superpriority administrative claim shall be applicable to proceeds of avoidance actions, solely with respect to any further authorization to use Cash Collateral in excess of amounts authorized to be used pursuant to this Order.

Boomberg Businessweek explains the relevance of the highlighted text above:

Senior Lien

JPMorgan Chase, based in New York, was given a senior lien on all MF Global's available assets in exchange for letting it use $8 million in cash collateral during the company's first day in bankruptcy court.

Wilmington Trust has taken over from Deutsche Bank AG, which resigned, as trustee to more than $1 billion in unsecured notes. Other unsecured creditors include Headstrong Services LLC, owed $3.9 million, New York-based law firm Sullivan & Cromwell LLP, owed $596,939, and Oracle Corp., owed $302,704.

JPMorgan Chase was also given rights to what a judge said may be the only asset for unsecured creditors: so-called avoidance actions, the lawsuits that let creditors win back assets transferred out of the estate 90 days before its bankruptcy filing. The judge said he doesn't usually permit such extraordinary rights for a lender, and left the door open to re- evaluate JPMorgan's request at a Nov. 14 hearing.

In other words, in exchange for the use of $8 million in cash, JP Morgan may get to keep any and all assets it may have withdrawn from MF Global within the last 90 days, whether they be thousands or billions, which would have otherwise been subject to investor claw-back lawsuits.

How would this affect the liquidation proceedings of the MF Global broker unit and the attendant issue of missing customer funds? With the lack of critical facts at this stage, one can only speculate, but the following is one of many potential scenarios.

We know from the annual regulatory filings of MF Global and MF Holdings that they maintained repurchase and resale derivatives books that measured tens of billions of dollars in size. As stated in Part II, JP Morgan is one of only two tri-party repo custodians in the US and would could have refused to unwind some of MF Global's tri-party repos, keeping custody of the cash or collateral. As the New York Fed article pointed out, this alone could trigger bankruptcy.

While no allegation of impropriety is being made here, the fact that JP Morgan may soon attain a permanent shield against clawback claims out to get the attention of all unsecured creditors. The final hearing on the Order and attendant issues will be held in the MF Holdings bankruptcy case on [Updated pursuant to an Order on 11/9] November 16, 2011 at 3:30 pm Eastern. Final objections to the Cash Management Motion must be received by no later than 5:00 pm Eastern on November 11, 2011. Final objections to the Cash Collateral Motion must be received by no later than 5:00 pm Eastern on November 21, 2011.

With respect to the missing customer funds at the MF Global broker unit, we also pointed out in Part II that a provision of CFTC Rule 1.25 regarding investment of customer funds allows an FCM such as MF Global to segregate its own securities in the customer accounts.

This is extremely relevant, because under no circumstances should any once-proprietary firm securities or cash be returned to either MF Global or MF Holdings, as they would likely become assets to be dispersed to the MF Holdings creditors.

This point must be made to the trustee, James W Giddens, and SIPC in the MF Global liquidation proceedings. Either (a) any proprietary firm securities and/or cash recovered should be divided pro rata among the MF Global customer, or (b) firm securities and/or cash should be excluded from the customer accounts and no distribution of recovered assets should be made as though MF Global or MF Holdings were ordinary customers.

Exactly how funds or securities would be missing is unclear, but it is conceivable that they might have been lost in an unwound repo or tri-party repo transaction (not related to the repo-to-maturity transactions, however), especially if proper procedures were not followed. Accordingly, if a material portion of the missing customer funds or securities are those of MF Global or MF Holdings, this would remove a major obstacle to the return of nearly all of the legitimate customer funds. As such, this should be immediately explored by the Trustee.

******************

We will continue to update on this blog and through Twitter (EBatEPJ) as events unfold. If anyone wishes to reach us, please use the comments below or email "english at economicpolicyjournal.com".

UPDATE: According to the Financial Times, MF Global sold $1.5 billion of its European debt portfolio at a loss just prior to filing for bankruptcy. Also, the New York Fed itself was among the parties making collateral calls on MF Global in the week leading to its failure.

UPDATE 2: Pursuant to an Order entered late day on November 9, the hearing on November 14 was pushed back to November 16 at 3:30 pm Eastern, but objections to the Cash Management Motion must be filed by November 11, 5:00 pm! The deadline for objections to the Cash Collateral Motion have been pushed back to November 23, 5:00 pm.

UPDATE 3: From various comments and emails, it's apparent the final paragraphs of this article were not clear. A minor edit has been made, and the following will provide more information. The assertion was not that the unwound repo or tri-party repo was related to the European debt repo-to-maturity trades. The assertion was that these would be separate repos. Consider: lots of customers hold their accounts in securities, such as T-Bills, not necessarily cash. Let's say the customer accounts were getting low on cash after some big withdrawals, but there were plenty of securities in the customer accounts. MF Global might have repo'd them to satisfy cash withdrawal requests. If the cash were not there upon repo maturity, or if JP Morgan (or other) as custodian (assuming tri-party repo) did not want to provide intraday credit, the repo would not have unwound, and the counterparty or custodian would be left holding the customer securities.