The great Bob Dylan song
Who Killed Davey Moore, tells the story of all the folks who contributed to a boxer's death. (I prefer the emotional
Pete Seeger rendition.)
Each person, in his own words, denies responsibility: the referee, the crowd, the manager, the gambler, the boxing writer, and the opponent. After each denial, the chorus wails,
Who killed Davey Moore?
How come he died, and what's the reason for?
This repeated question, of course, has no answer. It hangs, unresolved.
Its about collective responsibility and denial.
So what does this have to do with MF Global?
Something around $1 Billion of customers' money is "missing". This point is sorta personal to me, because some of that is
my money.
Every person you can find denies responsibility. And yet ... clearly someone is responsible. My money didn't "vaporize" in some mysterious act of god.
Why don't I have my money?
Sharing responsibility are various regulators (SEC, Fed, CFTC, CME, accounting standards boards, ...), various executives (CEO, CFO, CROs, ...), the board of directors, various banks (JP Morgan mostly), various liquidation trustees (Giddens, Freeh), congress, journalists.
Every one of these folk has a denial story.
You've heard the congressional hearings. I don't think they brought any sunshine to the situation at all. Congress folk get some guy in the headlights, and yell at him to create good TV for themselves.
The finance committee pummeled the two MF Global Chief Risk Officers, for example, even tho we all know that these guys didn't have the final decision authority on the taking of risks. Their job was to organize the assessment of investment risks, and make sure the board understood same at all times. Really not much to see here.
The risky investments caused people to lose faith in the company, but didn't cause customers to lose money.
As the public lost faith in MF Global, they were in the process of being bought by Interactive Brokers. If it were not for a little accounting problem, the sale would have succeeded, and no customers would have lost any money. This is a clue that it is the accounting problem, and not the so-called "risky" investments that is at the heart of the customers loss.
The Ag committee pummeled Jon Corzine mercilessly. Over and over they asked "Mr Corzine, where is the money?" Each time he said he did not know. And you know what? I believe him.
What did the congress folk think? Did they think Corzine moved the money to a secret Swiss bank account? I don't think that.
Trustee Giddens issued
a report recently that is more aligned with my thinking.
Commodity brokers (FCMs) are supposed to keep customers' money "segregated", but what does that actually mean? The answer is surprising. It is based on accounting ideas from a past century. The FCM keeps an account in which he is simply required to keep an amount of money that is greater than the amount in all customer accounts. Because many (perhaps thousands) of customer transactions are in flight at any instant, it is assumed that the FCM cannot know the exact amount he is required to keep segregated at any time. What FCMs do to solve this problem is to put some of their own money in the "segregated" account, to ensure that in spite of their inability to know exactly where they should be at any instant, the account balance will still be larger than required by law.
At MF Global, the excess was routinely on the order of $500 Million. Amazing amount of slop, isn't it?
There's a moral hazard here. What's worse, there's no reason for it. It is an anachronism.
The moral hazard: If you know that you routinely keep $500 Million extra in the seg funds account, then you know that there's some money in there you can "borrow" when you need it elsewhere.
In fact, that's what MF Global routinely did. Giddens' report tells us that MF Global
routinely borrowed up to $50 Million from the seg funds account. Some writers have called this evidence of fraud, but I think it is not. If you are borrowing from the excess money in the seg funds account, that isn't customers' money. That's ok. The law doesn't require you to have
excess funds in the seg funds account.
The problem came about in the final hectic days, when the accounting systems couldn't keep up. Giddens doesn't tell us how high the transaction volumes were, but we can safely guess they were 5X to 10X normal. He does tell us that the failed transaction count was 5X normal. When the accounting systems can't keep up with transactions, then MF Global employees have no way of knowing how much money is supposed to be in the seg funds account at any time.
You can imagine then, some of that routine "borrowing" getting out of hand. Once the music stopped, and somebody (a guy who wanted to buy the company) forced them to figure out how much money was really supposed to be in there, well shucks.
It isn't necessary for there to have been an intent to steal. The money could be misused without criminal intent, given sloppy enough accounting systems and procedures.
I'm not saying there's no criminality. There is criminal negligence.
Clearly a fundamental evil here is the accounting system. It wasn't up to the job. It is really important that transaction handling systems must be able to handle several times more volume than occurs under ordinary circumstances.
Now, lets set the blame.
Company management (board, CEO, CFO, and various accounting folks, IT folks) had a responsibility to ensure that the accounting system was adequate. This is a grave and fundamental responsibility in a company whose primary business is handling other people's money! Is there criminal liability for negligent accounting? Surely there must be. At some size this must become a criminal issue.
The auditor, PwC, had a responsibility to ensure that the accounting system was adequate. We never heard a peep out of them on this issue. What is their liability?
The regulators (CME, CFTC, SEC) had a responsibility to ensure that the accounting system was adequate. Do these guys even have any procedures in place that put requirements on accounting systems, or apply tests, or audits to same? I'll bet that they do not.
Anecdote: The CFTC, after MF Global's demise, reported that it was going to check seg funds at all the other FCMs. Customers envisioned an emergency audit of all FCMs that would check to see if appropriate seg funds were
really present.
What the CFTC actually did was so much less that it was just hilarious and hopelessly stupid. They only looked at 12% of the FCMs, and of those guys they just requested two pieces of paper, one saying how much seg funds should be present, and one saying how much seg funds were present. If the first number was smaller than the second number, CFTC assumes they're good. This is not an audit. It is a joke. Gosh guys, if you're only going to ask for two pieces of paper, surely you can ask all the FCMs instead of just a few of them. Are you short of the postage for the letters to make the requests?
The CFTC has primary regulatory authority here, and the CFTC was completely asleep at the switch. I've previously called for the resignation of all CFTC commissioners.
With today's technology, one should not base system assumptions on the idea that it is good enough to just put some slop in the account, on the assumption that it would be too difficult to know how much money should actually be there at any time.
Modern computers can do all this in real time. Accounting standard should demand real time accounting. If you
know how much money should be in an account, there is no need to keep extra money in there, and there is no opportunity to "borrow" the excess.
The regulators must be set up to audit these funds. Clearly CFTC is not set up to do this. The hilarious recent events demonstrate that well. How many investors understood that the CFTC didn't have the ability to do serious audits? Golly.
Question: Who killed MF GLobal?
Answer:
The Accountants.
I call for criminal indictments for incompetent accounting. Other brokers probably have more competent accountants. Maybe. Don't know for sure. No way to tell. God knows the CFTC, CME, SEC, PwC won't tell us.
We should thank Interactive Brokers for bringing the problem to light. They should get a medal.
