The Corzine Subpoena… Future of Segregated Funds Hangs in the Wind

There was speculation over whether or not Corzine would testify in front of a Congressional hearing next week.  He had previously only been “invited” to attend the hearing.  Now Corzine has to appear because of a subpoena.  Customers, investors and creditors are not likely to learn anything new about the demise of MF Global nor how Corzine pushed the limits off the cliff in betting the firm’s assets. It seems crazy that the trades that blew up the firm were leveraged bets on Italian sovereign debt, but the potential theft of customer funds is where this really becomes lunacy.

Corzine has already lawyered-up for civil suit protection and we’d put the odds that he will “Plead the Fifth” at 99.9%.  After all, it would be in his best interest unless he can somehow claim that this whole implosion was just a misunderstanding.  The odds of that ‘unless’ factor: zero.

Investors need to know and understand one thing about the ramifications if the “Where are the customer funds?” question is not answered and if the customers are not made whole here.  Customer funds are supposed to sacred as “Seg Funds” and are not supposed to be commingled to support a firm’s trading or operating expenses.

With the manner in which these repos were handled and with the math not adding up (is it $600 million missing, or is it $1.2 billion?), the ramifications of tomorrow are awful. They are bloody awful.  Imagine if this happened at a “too big to fail” institution and millions of customers are suddenly told “we do not know where you client funds are and you cannot close out or hedge any of your positions.”

A report from Managed Futures Today outlines the segregation process about segregated funds of futures trading accounts and Futures Clearing Merchants.  Even in the REFCO bankruptcy, customers were treated better than they have been in this MF Global implosion.  That report noted, “In 2005, Refco Inc. and 23 of its unregulated subsidiaries filed for Chapter 11 bankruptcy protection. However, Refco’s regulated subsidiaries (where customers’ futures trading and managed futures accounts resided) were unaffected and customers were able to continue trading and managing their accounts.”

Frankly, if it turns out that the customer funds are truly at risk then the regulators need to be responsible here.  Criminal filings also better come if the customer funds are missing, because it will be no different from robbery.  The fact that customers not only couldn’t access their funds but also could not hedge or close positions is a tragedy already.  If those funds and positions are allowed to be held by the trustees and bankruptcy attorneys, it could be years before this gets sorted out.  Who really wins in bankruptcy?  The lawyers, of course.

Imagine what can happen if a firm can just magically declare bankruptcy and then says that its customer segregated funds accounts do not add up.  It would be a license to steal and the millions and millions of dollars (actually billions and billions) would be large enough that many managers who are supposed to have a fiduciary duty might be willing to risk prison.

This all sounds pretty extreme, but the problem is that each new case can set a legal precedent as the new basis for future case law.  Ask your self this one simple question… What if your customer funds are not really safe and protected?

JON C. OGG