Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Intra-day laxity: MF Global edition

I blogged two years back about the tendency in finance to be prudent at night but reckless during the day in the context of Lehman bankruptcy. A related phenomenon (compliant at night but trangressing during the day) is seen in the MF Global bankruptcy according to the preliminary trustee report released earlier this week:

The investigation to date has found that transactions regularly moved between accounts and that funds believed to be in excess of segregation requirements in the commodities segregated accounts were used to fund other daily activities of MF Global … apparently with the assumption that funds would be restored by the end of the day. By Wednesday, October 26th, as the result of increasing demands for funds or collateral throughout MF Global, funds did not return as anticipated. As these withdrawals occurred, a lack of intraday accounting visibility existed, caused in part by the volume of transactions being executed … (Paragraph 7, emphasis added)

Of course, I am not a lawyer, but it appears to me that such intra-day laxity is not consistent with the Commodity Exchange Act or the CFTC Regulations:

… all money, securities, and property received by such … [futures commission merchant] to margin, guarantee, or secure the trades or contracts of any customer … shall be separately accounted for and shall not be commingled with the funds of such commission merchant … (Section 4d of the Commodity Exchange Act)

Each futures commission merchant shall treat and deal with the customer funds of a commodity customer or of an option customer as belonging to such commodity or option customer. All customer funds shall be separately accounted for, and shall not be commingled with the money, securities or property of a futures commission merchant or of any other person … (CFTC Regulation 1.20)

… futures commission merchant … [may add] to such segregated customer funds such amount or amounts of money, from its own funds or unencumbered securities from its own inventory, of the type set forth in §1.25, as it may deem necessary to ensure any and all commodity or option customers’ accounts from becoming undersegregated at any time. The books and records of a futures commission merchant shall at all times accurately reflect its interest in the segregated funds. (CFTC Regulation 1.23, emphasis added)

It would appear to me that the words “at any time” and “at all times” prohibit intra-day withdrawal “with the assumption that funds would be restored by the end of the day” as well as “lack of intraday accounting visibility”.

As an aside, it is interesting to note that after looking at 800 computer drives and 100 terabytes of data, the trustees still do not know where the money has gone

For three months the Trustee’s investigative team has worked to understand what happened during the final days of MF Global when cash and related securities movements were not always accurately and promptly recorded due to the chaotic situation and the complexity of the transactions. With these preliminary investigative conclusions in hand, the Trustee’s investigative team will analyze where the property wired out of bank accounts established to hold segregated and secured property ultimately ended up. (Paragraph 6)

The Trustee’s investigators, including the legal and forensic accounting teams, have conducted over 50 witness interviews, preserved secure access to thousands of boxes of hard copy documents, imaged over 800 computer drives, and are maintaining over 100 terabytes of data. (Paragraph 12)


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