MF Global: JPMorgan Produces Smoking Gun

When New York-based MF Global collapsed on October 31, 2011, its $41 billion in assets made it the eighth largest bankruptcy in U.S. history and the biggest financial firm to implode since Lehman in September 2008. Then Chairman and CEO Jon Corzine is connected to the head of one of his key regulators, the Commodity Futures Trading Commission (CFTC), through his former protégé at Goldman Sachs, Gary Gensler. He also knows the Fed's William Dudley, a key member of the Fed's Open Market Committee, from their days at Goldman Sachs. The Fed approved MF Global's status as a primary dealer, a participant in the Fed's Open Market Operations, less than one year after Jon Corzine took its helm. Corzine is also a former New Jersey governor, a former New Jersey U.S. senator and was a major campaign contribution bundler for President Obama.

MF Global failed because of a disastrous leveraged bet on weaker European sovereign debt made by Jon Corzine. The problem wasn't that the debt defaulted, rather that he didn't have the money to throw in the pot when it was his turn to ante up. The firm filed for bankruptcy protection Oct. 31 after dipping into customer accounts. Around $1.6 billion of customers' money is still missing.

Probable Shortfalls of Customer Money Throughout 2011

MF Global reportedly employed 30:1 leverage -- some reports are higher -- against a portfolio of European sovereign risks including Belgium, Italy, Spain, Portugal, and Ireland. According to Bloomberg News, Corzine's position on these sovereign trades was a gross position of around $11.5 billion, and the risk was only partially offset by short positions in stronger European credits. MF Global's March 2011 report showed a net position, including offsets, was around $6.3 billion. According to Bloomberg's information from an unidentified source: "At multiple meetings, Corzine reassured directors that the trades would work out... Corzine said the European countries he selected wouldn't default before the bonds matured, and that the market was mis-pricing the debt." ("Corzine Pushed Bet on Europe Debt to $11.5B," by Miles Weiss, Cristina Alesci and Matt Leising, Bloomberg News, Nov 28, 2011.)

The accounting board, FASB, allowed Jon Corzine to characterize his trade as a "repo-to-maturity." The problem with that is repo transactions are on balance sheets, and Jon Corzine's trade was an off balance sheet transaction. In substance Corzine's trade was a "total return swap-to-maturity," a funding that includes a type of credit derivative, and Corzines trade received the off balance sheet accounting treatment of the total-return-swap-to-maturity. It allowed Jon Corzine to make a highly leveraged bet on fixed income securities that were going down in value and it allowed him to make that bet off balance sheet.

In 2011, this trade was moving against Corzine. His reassurances to the board were empty, because his chief problem wasn't default, it was not being able to come up with the cash to meet margin calls with his trading partners on this large leveraged bet.

MF Global would have had several trading days in 2011 with moves of 5 percent to 10 percent on this sovereign risk. MF Global was so thinly capitalized that this trade alone could eat up half of its capital. Any of MF Global's other asset positions moving the same way in 2011's highly correlated markets would have put MF Global in a position of negative equity.

From a risk management point of view, examiners have to consider the very strong possibility that MF Global had several negative equity days throughout 2011. An investigation into money flows throughout 2011 is in order.

August 2011: MF Global Agrees to a $90 million Settlement

In early 2008, a rogue trader racked up $141.5 million in losses in unauthorized trades that exceeded his trading limits. It seems he accomplished this in under seven hours. In August 2011, MF Global and the underwriters of its 2007 initial public stock offering (IPO) agreed to pay around $90 million to settle claims by investors that they were misled about MF Global's risk management prior to the rogue trader's actions. Since 2008, MF Global's financial condition has been nothing to brag about. Now the settlement is in jeopardy due to the bankruptcy.

In August, customers started pulling billions of dollars out of their segregated accounts with MF Global. It was the biggest outflow of funds since January 2009. The bankruptcy trustee may claw back transfers of funds from MF Global as it was teetering, because it is likely that employees within MF Global were well aware of the problems and tipped off key customers.

Also in August of 2011, FINRA seemed to catch on that MF Global's transactions were riskier than it previously thought and asked for more capital against these trades.

Investigators Examining Possibility of Illicit Transfers in August

According to the New York Times, "investigators are now examining whether MF Global was getting away with illicit transfers as early as August." The illicit transfers refer to the use of customer funds to make up for MF Global's own shortfall of funds needed to meet its margin calls and other expenses. As noted previously, it would be reasonable for investigators to look at MF Global's accounts even earlier in the year. ("A Romance With Risk That Brought On a Panic," by Azam Ahmed, Ben Protess, and Susanne Craig,NYTimes' Dealbook, December 11, 2011.)

Wednesday, Oct 26, and Thursday, Oct 27, 2011: "Substantial Deficit" in Customer Accounts

Christine Serwinski, MF Global's chief financial officer for North America, testified in last Wednesday's congressional hearing that she was told on October 27 of a "substantial deficit" in customers' accounts for October 26, the previous day. She was on vacation when she was informed of the shortfall and claims she was told the shortfall was only in the "cushion" that MF Global had in customer accounts. She claimed the deficit didn't violate rules -- which is implausible given other events of that week (see MF Global's check kiting below). Obviously there was a huge problem at MF Global and this would have gone to the top of the house, to CEO Jon Corzine, in a firm that had any sort of reasonable corporate governance. Serwinski further testified that on October 30, she was told of a nearly $1 billion deficit in customer funds. Regulators weren't told of deficits until October 30. The firm collapsed into bankruptcy on October 31. ("MF Global exec cites early worry on risk to funds," AP, March 27, 2012.)

Thursday October 27: MF Global Breaks Custom of Wire Transfers and Writes Rubber Checks Instead

Jon Corzine claims he didn't know about improper transfers of customer funds and of shortfalls in customer accounts until October 30, yet on Thursday, October 27, four days before the bankruptcy and again on Friday, October 28, three days before its bankruptcy, dozens of MF Global customers asked forwire transfers when they closed accounts, and they didn't get them. Instead, MF Global wrote paper checks, sent the checks via snail mail. The checks bounced, since customers received them after MF Global declared bankruptcy on Monday, October 31. ("Clients Raise Questions About MF Global Checks," NY Times Dealbook, April 1, 2012, by Azam Ahmed and Ben Protess, and "MF Global and the Rubber Check," by Matthew Goldstein, Reuters, November 5, 2011.)

October 28: Edith O'Brien writes of Corzine's "Direct Instructions" to transfer $200 million

By now every officer of MF Global should have been on red alert that MF Global was short of cash and was at risk of using customer funds to meet its daily needs, and this is prohibited.

On the morning of Oct. 28, three days before MF Global's bankruptcy, JPMorgan contacted MF Global about an overdraft in London. A Congressional memo circulated March 23, 2012, quoted an email from Vinay Mahajan, MF Global's global treasurer. Vinay wrote JPMorgan was "holding up vital business in the U.S." and called for funding "A.S.A.P." Bloomberg News reported that on October 28, Edith O'Brien, an assistant treasurer for New York-based MF Global, wrote an email saying that a $200 million transfer of funds was "Per JC's direct instructions." It turns out that part of that money was customer money, and the transfer was impermissible. ("MF Global's Corzine Ordered Funds Moved to JPMorgan, Memo Says," by Phil Mattingly and Silla Brush, Bloomberg News, March 23, 2012.)

October 28's Smoking Gun: JPMorgan Doesn't Buy Corzine's Story

Jon Corzine testified before the Senate Agriculture Committee in December: "I never gave any instructions to misuse customer money, never intended to give any instructions or authority to misuse customer funds, and I find it very hard to understand how anyone could misconstrue what I've said as a way to misuse customer money." But that isn't the standard to which Corzine is held. If investigators can show he knew of the risk that customer money might be included in the $200 million transfer he ordered, Corzine faces potential legal liability. ("MF Global's Corzine May be Liable if Customer Risk Known," By Linda Sandler and Phil Mattingly, Bloomberg News, Mar 25, 2012.)

Money went from a U.S. customer account to a U.S. MF Global account, and then it was transferred to a UK account. Even those who wish to claim Corzine slipped through a dubious loophole in the UK are out of luck. The original impermissible transfer of money occurred from a U.S. customer account to a U.S. based MF Global account. In my opinion, Corzine knew or should have known there was a strong probability that customer funds would be transferred. As it happens, they were.

On October 28, JPMorgan didn't buy Corzine's story, either. Having been a risk manager myself, I believe Barry Zubrow, JPMorgan's chief risk officer, did exactly the right thing. He called Jon Corzine to get him to verify that the funds belonged to MF Global and that none of the money was customer money. Zubrow, an outsider, was well aware of the possibility that customer funds had been transferred. It's implausible that Corzine wasn't aware of the potential impermissible transfer of customer funds when he gave the authority to make the transfer. By doing its job, JPMorgan removed Corzine's ability to credibly deny knowledge of the potential problem.

October 28: JPMorgan Asked for Written Assurances and Didn't Get Them

According to the NY Times,

Jon S. Corzine, the former chief executive of MF Global, was told during the brokerage firm's final day of business that a crucial transfer of $175 million came from the firm's own money, not from a customer account, according to an internal email. The email, sent by an executive in MF Global's Chicago office, showed that the company had transferred $175 million to replenish an overdrawn account at JPMorgan Chase in London. The transfer, the email said, was a 'House Wire,' meaning that it came from the firm's own money. The email, sent at 2:20 p.m. on Oct. 28 to Mr. Corzine and two of his assistants in New York, says the transfer came from a 'nonseg' account, industry speak for a noncustomer account.

("E-Mail to Corzine Said Transfer Was Not Customer Money," by Ben Protess and Asam Ahmed, NY TimesDealbook, March 25, 2012)

The problem with the NY Times report is that the email never said that the original source of funds wasn't from a customer account, and a 'house wire' just means an internal transfer of funds. The email only verifies that the money was eventually transferred from a 'nonseg' account. It doesn't rule out that money was transferred from a customer account to an MF Global account, which as it happens -- and the NY Times later reports within the same story -- it was.

The New York Times bolloxed up the title of this story, and even within the story it acknowledges: "But it is unclear whether someone at the commodities brokerage firm told Mr. Corzine the origins of the money during a phone call or in person."

To be clear, the email in no way exonerates Jon Corzine and it in no way proves that he was unaware that the original source of funds was from a customer account and that the transfer included customer money. The email only suggests that the eventual transfer to the UK was from a U.S.-based MF Global account. But MF Global was short of funds, and the money that seemingly magically appeared in its 'nonseg' account was first transferred from a customer account.

According to his December Congressional testimony, Jon Corzine said he spoke with Ms. O'Brien, who confirmed that the transfer was proper. "I had explicit statements that we were using proper funds, both orally and in writing, to the best of my knowledge." But "proper funds," could just mean funds from a 'nonseg' account that gave the appearance of being proper. Corzine knew or should have known that MF Global's U.S. account only had funds because customer money from a U.S. account had been transferred into it. Ms. O'Brien has asked for, but not yet been granted, immunity. Last week she invoked her Fifth Amendment rights at a Congressional hearing.

As for JPMorgan, it asked Jon Corzine for a signed letter stating that the transfer was legitimate. He reportedly responded: "Send me the letter and we'll have our people look at it." It was disingenuous of Jon Corzine to pass JPMorgan's letter to Edith O'Brien to sign given that it asked for a sign-off that all "past, present and future" transfers complied with the law. Ms. O'Brien would have been asked to take responsibility for all transfers without having the authority over them. Jon Corzine had the broad authority to sign the letter, but by passing it on, he effectively stalled.

JPMorgan sent additional versions of this letter in response to MF Global's requests for revisions, but JPMorgan never received a signed letter back.

On October 31, 2011, MF Global Admitted to Impermissible Transfers

MF Global's officers admitted to federal regulators that before the collapse the firm diverted cash from customers' accounts that were supposed to be segregated: 

MF Global Holdings LTD... violated requirements that it keep clients' collateral separate from its own accounts... Craig Donohue, CME Group's chief executive officer, said on a conference call with analysts today that MF Global isn't in compliance with the rules of the exchange and the Commodity Futures Trading Commission.

("MF Global Probe May Involve Hundreds of Millions in Funds," Bloomberg News, November 1, 2011, by Silia Brush and Matthew Leising.)

Yet on November 1, Kenneth Ziman, a lawyer for MF Global, relayed information from MF Global to U.S. Bankruptcy judge Martin Glenn in Manhattan: "To the best knowledge of management, there is no shortfall." If that sounded like a cover-up, it was:

According to a U.S. official, MF Global admitted to federal regulators early Monday [October 31, 2011] that money was missing from customer accounts. MF Global acknowledged a shortfall in a phone call amid mounting questions from regulators as they went through the firm's books.

("MF Global's Collapse Draws FBI Interest," by Devlin Barrett, Scott Patterson, and Mike Spector, Wall Street Journal, November 2, 2011.)

The initial bankruptcy estimate was a shortfall of around $600 million. As of Monday November 21, MF Global's liquidating trustee believed the shortfall may be as much as $1.2 billion and later estimates put the shortfall of customer money at $1.6 billion. 

MF Global Debacle Damages a Key Global Market

Even if all of the money is eventually clawed back and recovered, this remains an impermissible act. Moreover, full recovery -- even if it is possible -- is not the same as restitution. People have been denied access to their money, and businesses and reputations have been tarnished.

The futures market is a globally connected market and it is a key mechanism for farmers, metals miners, and metals fabricators (among others) to hedge their risk. Confidence in the futures market has been shaken. No one knows if their money is safe, but what is more disturbing is the appearance of crony capitalism once again giving favored treatment, lax regulation, and absent oversight to a crony capitalist that abused all of these perks to blow up a large financial firm and damage a key global market.

So far, no one has been held accountable.

On March 26, 2012, I discussed these issues with Lauren Lyster on RTTV's Capital Account:

http://www.huffingtonpost.com/janet-tavakoli/mf-global-jpmorgan-produc_b_1401059.html

Ashenden on Contador

Blood expert decries UCI policies on confidentiality

The following extract comes from an interview carried out by Andy Shen from nyvelocity.com with anti-doping expert Mike Ashenden. The full interview can be found over at nyvelocity.com.

Andy Shen: I understand that you'll no longer be on the panel for the Biological Passport Program. Can you explain your reasons for resigning your position?

Michael Ashenden: That's correct insofar as I will not be an expert on Lausanne's Athlete Passport Management Unit (APMU). I do intend however to remain a member of WADA's Expert Panel. As well, Dan Eichner at the Salt Lake City lab has also convened their own APMU with a truly formidable panel of experts, and I've accepted their offer to participate on that panel. I'm enthusiastic about the prospects for that to grow and establish itself in the future.

From the beginning of 2012, Lausanne have been managing cycling's Passport program, so it means I will not be interpreting rider's blood profiles any longer. The reason I have resigned comes down to an issue of freedom of speech.

In their terms of agreement, Lausanne inserted an additional confidentiality clause that precluded an expert from making any public comment or giving any personal opinion on any aspect of their role as an expert on the panel. Not just now, but for eight years after the expert leaves the panel.

In my opinion such a clause is ludicrous. Perhaps an employer can insist that their employee signs such a contract, but us experts are not employed by the APMU, and in fact their contract states that we must at all times exercise the greatest care to ensure that we do not become dependent to the APMU. In other words, they see independence as being of paramount importance. So it comes down to the APMU squashing the freedom of speech of a person who by their own charge is completely independent of them, and I refuse to be a part of that.

Of course, I am willing to sign confidentiality clauses which preclude me from sharing any information I encounter in my role as an expert, and that is precisely the clause and contract I signed to be on WADA's Expert Panel. However I am not willing to go further and allow the APMU to censor the expression of my personal opinions about non-confidential matters.

In my opinion, that clause can only serve one purpose, which is to muzzle us experts from giving interviews to the media. I think it's important to have transparency and accountability in all facets of sport and antidoping. As meagre as our role might be, we experts are an independent entity within the Passport program which means we can serve as a canary in the mineshaft, a crosscheck.

As I said earlier, I consider the media's role to be pivotal to maintain antidoping vigilance, and unless the media has access to expert interviews that vein of information will be strangled and eventually expire. We understand the Passport, how it works, and what it can and cannot do. Our opinion and contribution to media is vital. I cannot condone that role being snuffed out, thus I have refused Lausanne's offer to be a part of their expert panel.

I sought to find a compromise with Lausanne but with no success. That was certainly disappointing, but I find it unconscionable that an antidoping entity would seek to impose an omerta on us experts. Particularly where cycling is concerned, because we have struggled for years to break the rider's omerta, and asked riders to speak out about their peers who are cheating the system. Yet Lausanne takes that omerta one step further and prevents its experts from speaking out not just via an unspoken code but also reinforced with a legal contract.

I am distressed that this has led to me no longer being involved in cycling. I have been involved in their program since day one when Anne Gripper first sought out my participation. The UCI have certainly broken new territory, and at the same time there is still a long way to go. However at the end of the day, I seek to live by my principles, and I intend to do so not just now but in the future as well.

AS: Even though the Contador case was specifically about Clenbuterol, you were brought in as WADA's expert witness because they had a theory that the Clenbuterol entered his system as a result of blood doping?

MA: Depending on how you choose to look at the Contador case, it was either drop dead simple to resolve, or impossible to address. Quite honestly I sometimes waver within those two extremes myself. But at the end of the day, the presence of clenbuterol had been established, and there was no proof available to establish how it entered Contador's system. From that perspective, it seems quite straightforward that it would lead to a two year sanction.

I think the enormous volume of public debate muddied the waters. As well, Contador made a persuasive case in the court of public opinion that unless WADA could establish how it entered his system, the only reasonable thing to do was to accept his proposal that it came via a steak. What concerns me about that argument is why Contador should be treated any differently to any other athlete, for whom the reverse has always been true. As succinctly summarised in paragraph 265 of the ruling, the athlete has to establish how the prohibited substance entered their system, rather than the other way around. I don't think the number of races you've won, or whether or not the Prime Minister is in your corner, should change how your case is adjudicated.

When the first hearing took place in Spain, that RFEC panel was only presented with Contador's evidence that the clenbuterol had come from a steak, and no other alternatives were put before it. The RFEC concluded that on the evidence placed before it, the clenbuterol came from steak. When the UCI and WADA appealed that decision, they argued that the clenbuterol might not have come from a steak but instead from, for example, a transfusion or a contaminated supplement. As I understand it, the CAS panel needed to decide whether the evidence put before it indicated that it was more likely that it came from steak than from any other possibility. My role at the hearing was to help the panel evaluate, based on the evidence available, whether a transfusion could have taken place. Experts from WADA attended the hearing to help the panel understand whether, if a transfusion had taken place, it could have led to the clenbuterol concentrations found in Contador's urine.

Although that might seem like the same argument made twice, in fact there is an important distinction. Both steps would be necessary to explain clenbuterol at the concentrations found. Each argument was considered separately, with me being responsible for helping the panel evaluate the first but not the second argument, and vice versa for WADA's experts. It is therefore not surprising that Contador's legal team sought to rebut each of those arguments separately, and they brought different arguments to bear in each case.

AS: So you were called to evaluate Contador's passport profile. How were you able to establish his ‘normal' values, considering that he's suspected of blood doping?

MA: First I need to clarify a misconception - when you say I was there to evaluate his passport profile, in fact this was not an Athlete Passport case. I realise the confusion has been propogated by the panel's use of the abbreviation ‘ABP', which they mistakenly apply whether talking about actual Athlete Biological Passport data (which is the correct use of ‘ABP') or blood data in general. I was there to evaluate his blood results, period. Whether those data came from his passport profile, or somewhere else, was not relevant provided that the data were reliable. As you can see in paragraph 351, which describes the blood data I based my opinion on, I incorporated data from as far back as 2005 which predates the beginning of WADA's ABP.

Because Contador had previously applied to the UCI for an exemption for high haematocrit, during 2006 he had spent several days at the Lausanne antidoping laboratory who collected some very carefully controlled blood tests. Those data were obviously considered to be reliable - Contador had been granted an exemption based on the validity of those data thus it would be very difficult for him to turn around and suggest those data could not be relied upon. I used those data to establish to my satisfaction what his natural values for haemoglobin and reticulocytes were.

AS: Based on that baseline data, what were you able to establish about Contador's '10 Tour test data?

MA: His 2010 Tour data definitely attracted my attention. As described in the panel's ruling, my testimony was that his reticulocytes were higher than I would have expected. Not just a single result, but every result during that race was equal or above the carefully collected results he'd provided to the Lausanne lab in 2006.

At first I thought this could have been due to the analyser used during that Tour. If the analyser had been reporting results slightly high, that would have explained why Contador's values were higher than expected. However I cross-checked the results of other riders, and it was not due to the instrument.

My second thought was that perhaps this signature was just typical of how Contador's body responded to the competition of a major stage race. Again I was able to cross-check this with his other results during previous victories at major Tours, and that did not explain the 2010 Tour values either. In fact his 2010 Tour results were higher than any other value he'd provided during any of his previous major victories.

The inescapable conclusion was that his reticulocyte results were unusual for him. In fact, neither his own blood expert nor myself could conceive of any naturally-induced circumstance that could explain his elevated reticulocyte results during the Tour. I was surprised to read paragraph 359 of the ruling, which in fairness only refers to written submissions that had preceded my opportunity to address questions to Contador's expert. However what that paragraph does not reflect, which the court transcript can establish, was that during the hearing itself I categorically asked Contador's expert whether he had any natural explanation for Contador's reticulocytes during the 2010 Tour, and he did not. Both of us also agreed that some forms of doping, for example a microdose EPO regime, could yield higher-than-expected reticulocytes.

During the hearing, I helped the panel to objectively evaluate for themselves just how unusual Contador's reticulocyte results were during the 2010 Tour. They refer to this in paragraph 368. I presented a probabilistic evaluation which replaced my subjective opinion with mathematical odds. The calculation found that the probability of Contador's four highest results occurring at a single race was less than 1 in 7000. However, the panel concluded that probability calculations, which had been scrutinised by two colleagues each with a PhD in statistics, were not a sufficiently secure method of establishing inconsistencies.

As I explained earlier, I regard haemoglobin and reticulocytes as separate entities and when I examined Contador's haemoglobin values during the 2010 Tour I found his results to be more or less what I would have expected. However since I already had his data from previous major victories in hand, I went ahead and compared his 2010 haemoglobin results with those other races and I was concerned that I was not able to see consistency between races. In very general terms, you'd expect the same rider to show the same response each race. There is a dilution of the haemoglobin as the cumulative impact of multiple days of stage racing leads to an influx of water into the circulation. Whereas I would have been reassured to find the same characteristic signature in Contador during every one of his victories, I did not.

Marc Faber Interview

Precious Metals are Poised for a Bounce

 by Ross Clark of CIBC via King World News

http://bit.ly/HF2c3r

“Our ongoing comparison of the 2003-04 and 1976-80 markets in gold related to the action of the current bull market continues to move along with few deviations. The scheduled late-February early-March high, coupled with the HUI testing its upper 50-day Bollinger Band, concluded with the dramatic $100 ‘leap day’ break in gold on February 29th. The next two time windows of significance were to be lows at the end of March and again at the end of May with the best advance following the second low.”

“The 61.8% retracement ($1625) of gold’s December to February rally continues to be an important support. Holding this level will keep it in the context of November 1979, with a close above $1770 (and 550 in the HUI) confirming the start of the next upward phase to new all-time highs in the bull market. A violation of $1625 would likely lead to new lows for the year as we move into late May.

The silver, mining indices and S&P are also moving similar to 1979 (even without the help of the Hunt brothers).  The Barron’s Gold Mining Index peaked in October 1979 in both nominal terms and relative to the S&P (see ratio).  This was followed by a period of underperformance and a 23% decline as the metals consolidated. It then increased by 122% (88% relative to the S&P) into February 1980.

The HUI is currently oversold having declined by 28% from the September highs. The ratio of HUI/S&P has oversold StochRSI(14) readings found during optimum buying opportunities throughout the last 10-year out performance versus the S&P.”

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2012/4/2_Gold_Bull_Market_Set_Up_for_a_Spectacular_Move.html

Jim Grant Interview

MFGlobal connection to the Vampire Squid