MF Global Shakes Confidence in the System

Like some kind of bad financial soap opera, the implosion of MF Global remains shrouded in mystery and subject to speculation nearly two weeks after the futures and commodities brokerage filed for bankruptcy, with a reported $600 million of customer funds yet to be located. (See: MF Global Accounts Moved, Minus Much of the Cash.)

One thing is for sure -- enormous damage is being done to client confidence in the financial system and regulatory bodies, such as the Chicago Mercantile Exchange (CME), the Commodities Futures Trading Commission (CFTC), and the Securities Investor Protection Corporation (SIPC). Investors say those bodies are losing credibility in the crisis.

"This isn't about a bunch of futures traders or farmers," says Andrew Abraham, a Commodity Trading Advisor who used MF Global to manage client money. "This is about the backbone of the financial system."

Confidence in that system erodes as the crisis drags on with fewer answers and more ambiguous communication from the powers that be. The Wall Street Journal said officials are still hunting for the lost client funds. Bloomberg reported today that CFTC Commissioner Bart Chilton says the missing client money may be a "massive hide-and-seek ploy" by the broker.

"It's a distinct possibility, some would say probability, that somebody has done something with the money, and that it's not going to be 'all of a sudden discovered' with an innocent explanation," Chilton said in an email quoted by Bloomberg.

Statements such as these have rattled investors and money managers and reinforced the idea that MF Global reflects regulatory fairlure. The CFTC is under fire both for letting MF Global collapse and for being subject to a conflict of interest. (CFTC Chairman Gary Gensler and Jon Corzine, the former MF Global CEO, were colleagues at Goldman Sachs.)

Today the CME took some steps to shore up confidence by pledging a $300 million guarantee to help release customer funds.

This is an important step. Investors had been told previously that claims could be filed with the SIPC for any lost funds, even though that agency says it does not cover losses for futures brokerages.

Bill Fleckenstein, manager of Fleckenstein Capital and an MF Global client, has been covering the topic in his daily market commentary. He expressed frustration with all the parties involved, including the CFTC, CME, and SPIC, saying they have acted slowly to protect client interests. He was disturbed when he learned the SIPC does not cover losses from fraud at futures brokerages, even though MF Global advertised on its Website that it was protected by SIPC insurance and was instructing investors to make claims there. Other clients have confirmed that the firm was doing this. (See: MF Global Update: Kafkaesque Reader Tales.)

"That was a lie," Fleckenstein said in an interview this morning, though he is not yet convinced that the missing funds were a result of fraud. "The questions now are has there been a crime committed and have the authorities done a good job? The answers is that nobody has done the right thing here."

He points out that regulatory agencies such as the CFTC and the futures exchanges, including the CME, have sustained a lot of damage in the process. "There should be some real questions about the CME now."

Fleckenstein makes a great point: If a crime was committed, why are there still no arrests? He says that if there's nobody in handcuffs yet, that makes it less likely the client money was stolen outright. "Misappropriating client funds is a crime and a fraud. If the money were misappropriated from [customer] segregated funds, it should be obvious. The longer this goes without an indictment, the less likely it is that they took segregated funds."

At this point, it's more likely that MF Global is simply an accounting mess that has yet to be unraveled, he says. "Let's say there was a run on the bank and people were wiring money everywhere... I know it was a mess getting money out of there. There could have been sloppy record keeping, and they can't figure it out."

Whichever scenario turns out to be true, MF Global clients (disclosure: I am one of them) have been badly shaken by the episode.

The longer the situation takes to sort out, the more the financial system's credibility will be damaged. If it turns out that there was a fraud, it's disturbing that it is taking so long to figure it out. If there was no fraud but pure incompetence on the part of MF Global, it's clear that the actions by the CME, the CFTC, and other authorities have been slow and inadequate.