Last week’s headline-grabbing lawsuit by an obscure federal regulator against onetime business and political titan Jon Corzine offers up colorful new evidence—much of it from taped phone calls—that his recklessness as CEO of MF Global allowed the illegal use of about $1 billion in customer funds, as the firm spiraled into bankruptcy in late October 2011. (Read “The last days of MF Global,” Fortune.com, June 4, 2012)
The 47-page civil enforcement action by the Commodities Futures Trading Commission (CFTC) doesn’t assert that Corzine, a former U.S. Senator and New Jersey governor who previously ran Goldman Sachs, either directed or was overtly told of this diversion. But it charges that he failed to act to keep it from happening, despite repeated red flags. As CEO, the CFTC flatly declares, Corzine “is legally responsible for MF Global’s misuse of customer money.”
In its complaint, filed Thursday in federal court in New York, the CFTC also sued former MF Global assistant treasurer Edith O’Brien, alleging that she knowingly tapped the customer funds—which are supposed to be sacrosanct—during a frantic effort to save the firm. A bankruptcy trustee for the firm’s brokerage business, which was placed in liquidation, has since recovered the vast bulk of the missing customer money.
The suit against Corzine is a landmark action for the CFTC, which has never before taken on such a high-profile target. It comes after a complex twenty-month investigation to sort out what happened at MF Global, which one agency official described as “CSI CFTC.”
If they lose, Corzine and O’Brien could face hefty fines, restitution, and a lifetime ban from the securities industry.
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Corzine’s lawyer, Andy Levander, declared that he vehemently disputes the CFTC’s charges and is prepared to fight. “This is an unprecedented lawsuit based on meritless allegations,” Levander said in a written statement. “Mr. Corzine did nothing wrong, and we look forward to vindicating him in court.”
O’Brien’s lawyer did not offer any comment.
In a more detailed statement, Corzine spokesman Steven Goldberg insists that the former CEO was “never informed, nor was he ever given reason to believe, that customer funds were at risk or were being used improperly. He did not receive a single indication, either written or oral, that segregation rules had been or were in jeopardy of being violated.”
The CFTC suit, however, paints a vastly different picture. It charges that Corzine failed to adequately upgrade MF Global’s weak cash-management controls, which relied heavily on manual accounting to track customer money; was warned repeatedly that the company was violating internal policies aimed at safeguarding customer funds; and directed the payment of large obligations even when he knew that the firm had little of its own cash remaining.
When Corzine took over as CEO in March 2010, MF Global was an unprofitable futures broker, trading pork bellies and currencies for farmers and hedge funds. His turnaround strategy was to transform it into an investment bank that took much greater risk with its own money. A former bond trader himself, Corzine supervised that effort, personally placing billion-dollar bets on European sovereign debt. By mid-2011, the firm’s net exposure had grown to $6.4 billion.
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But as the European debt crisis worsened, those trades generated growing margin demands, sucking up MF Global’s limited “house” funds.
By October 2011, the firm was struggling to survive. O’Brien, who handled cash management from MF Global’s office in Chicago (Corzine and the headquarters staff were in Manhattan), began frantically juggling hundreds of millions between accounts.
According to the CFTC suit, the firm’s global treasurer on October 6 told another MF Global employee on a recorded phone line (many Wall Street calls are routinely taped) that he had advised Corzine the firm’s liquidity situation was “not sustainable” and “grave.” “We have to tell Jon that enough is enough,” the treasurer added. “We need to take the keys away from him.” Corzine, according to the CFTC, nicknamed the treasurer “the Gravedigger.”
Corzine was clearly aware of the firm’s dire position. “We have no buffer, no room for mistake,” he said on an October 18 call, reluctantly agreeing to tap a $1.2 billion unsecured line of credit. A rating-agency downgrade soon drained more liquidity, as customers began closing accounts and counterparties and trading clearinghouses demanded even more cash.
On October 26, O’Brien openly expressed fear that money improperly borrowed intraday from “segregated” customer accounts to meet these needs would not be returned quickly from one of MF Global’s banks. On a recorded line, O’Brien described the situation as “a total clusterfuck” and said if the money didn’t arrive by morning, “I am going to have a seg problem…I can’t afford a seg problem.”
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After advising the bank in an email that certain transfers from customer accounts were proper, according to the CFTC, she later told a colleague on a recorded line that she hadn’t copied others on the email because “I don’t want to take anyone down with me.” In another call, she later voiced fear that if at least $355 million she’d transferred from customer accounts wasn’t returned soon, it could be “game over” from a regulatory perspective.
Although these comments weren’t made to Corzine, the CFTC suit quotes several conversations showing that the CEO knew his firm was operating on a razor’s edge. On October 27, one subordinate advised Corzine that O’Brien had concluded “we are not in a significant cash position.” Replied Corzine, on a recorded line: “It would be very dangerous if we are not.” Later, he asked if the firm had received back “enough to be in compliance.” He was told, “no, she[‘s] indicating she’s net short $106 million.”
As a “control person” at MF Global, Corzine, asserts the CFTC, “either did not act in good faith or knowingly induced these violations.”