Is Corzine Guilty of Raiding MF Global’s Client Accounts?

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Jonathan Ernst / Reuters

Former MF Global CEO Jon Corzine testifies about the firm's bankruptcy during a hearing on Capitol Hill in Washington December 8, 2011.

When it comes to the law, intentions are often relevant. But that might not be enough to save Jon Corzine, the former politician and more recently former head of failed commodities and futures brokerage firm MF Global.

On Thursday, Corzine, 64, was back in Washington, this time on the other end of the grilling that as a Senator he used to expertly dole out to executives and regulators. At issue was the $1.2 billion in client funds that have been missing at least since late October, shortly before MF Global crashed into bankruptcy. Perhaps the most telling moment of his testimony was when Corzine was asked whether he authorized the use of client funds to finance the firm’s own bets on European bonds. Corzine’s reply: “I never intended to break any rules.” He probably didn’t intend to sound guilty either, but he did.

There is still the possibility that the missing money of MF Global’s client will be found and that it was never used inappropriately. So Corzine could be saying in a guarded way that he didn’t do anything wrong. But assuming the money is gone for good, as it is increasingly looking, and the funds were diverted improperly into the company’s own losing bet on European bonds, then there are at least two different ways to read Corzine’s telling non-admission. One is that Corzine never planned to break any rules. He went into his ill-fated multi-billion-dollar bet on European bonds, which would eventually sink MF Global, expecting only to use his firm’s cash. But as the bet went south, potentially taking Corzine’s reputation with it, he eventually found himself quite liberally dipping into client accounts rather than admitting he had messed up. Another way to read Corzine’s statement is that his firm was funding its bet on European bonds with client money all along, and Corzine didn’t know it — or at least didn’t know that doing that was against the rules.

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What makes determining Corzine’s innocence, and parsing his statement, so tricky are two strange facts about modern brokerages. One is that they are indeed allowed to take their clients’ money and make their own trades with it. And they don’t even have to tell clients they are doing it. Brokers — and that includes the ones you know, like E-Trade and Morgan Stanley Smith Barney — can take the idle funds in their clients’ accounts and invest it into “safe” investments;  profits go to the firm, not the clients. And the bonds of European governments, like the ones MF was buying, were long considered to be in that “safe” category. Second, brokerage firms are allowed to borrow against the money their clients give them as collateral. This can be a big deal at a commodity and futures brokerage, where clients often trade on margin, putting down a small portion of the value of their trade and borrowing the rest. The brokerage is in essence taking out a loan on the downpayment a client put down on their margin loan – that’s piling leverage on leverage.

Regulators do have rules in place so that firms don’t abuse these practices. Those “safe” investments made with client money are supposed to stay in separate accounts, and not be co-mingled or used to fund previously made firm trades. And there are strict limits on how much firms can borrow against their clients’ collateral. MF Global does appear to have mixed its client trades with the firm’s trades. And some are guessing that the firm may have used its London subsidiary to get around the rules that limit how much it could leverage up its clients collateral.

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Nonetheless, this is complicated stuff. So it’s believable when Corzine says he wasn’t involved in the clearing of trades or his firm’s other back office operations, and therefore wasn’t aware of any improper use of client funds even if that was going on. (Which is basically what Corzine said at the hearing.) Corzine said he first learned of the client shortfall on October 30, just days before MF Global went under, and that he was “stunned.” He said he had no knowledge of the firm using client money to fund his bets on European bonds. Corzine defended his firm’s books, saying they deteriorated in the final days amid a run on the bank. He also said that the bets he placed on behalf of the firm on European bonds didn’t ruin the firm, and that it still appears they would have paid off if MF Global hadn’t been forced into bankruptcy. He said he had many of the same questions about what happened at MF Global that everyone else does.

The bottom line is that if Corzine is guilty, he’s not the only one. Clearly, complicated rules on what brokerage firms can and can’t do with their clients’ money definitely opened the door and contributed to what went wrong at MF Global. The rules that are in place should be simple enough and common-sense enough for someone like Corzine, who after all spent most of his career in finance and was once the head of Goldman Sachs, to understand — and to know when a firm he is the head of is breaking them.

Still, that doesn’t mean Corzine is off the hook. Keeping a financial firm afloat is more than just allocating your capital. You also have to make sure you have the liquidity — cash on hand — to operate. And Corzine should have known that as the value of his $6.3 billion bet on many of Europe’s troubled nations dropped in value the cash to maintain those bets was going to have to come from somewhere. He should have known Wall Street and the people who work there well enough to guess that corners would be cut even if he didn’t give the direct order to do it. For that reason, if in fact MF Global’s clients’ funds were pilfered, he’s as guilty as anyone at the firm — even if that wasn’t his intention.

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