Jon Corzine bet $11.5 billion on European sovereign debt in his bid to rebuild profits at MF Global Holdings Ltd., almost twice the net amount disclosed to investors, and relied on short-term hedges that left the firm exposed to larger losses if they couldn’t be rolled over.
Corzine, who was chairman and chief executive officer of the futures broker before it went bankrupt last month, overcame resistance from directors, senior traders and risk managers to accumulate the bonds, according to two people with knowledge of the situation. He used the hedges, or offsetting trades, to cut the net risk reported to shareholders to $6.4 billion, according to an Aug. 3 regulatory filing by the company.
A former New Jersey senator and governor, Corzine joined MF Global in March 2010 with a plan to remake the company into an investment bank in the image of Goldman Sachs Group Inc., where he had been co-chairman before entering politics. He repeatedly ratcheted up his wager on the debt of countries including Italy and Spain, booking gains along the way, according to filings. The short-term hedges matured before the bonds, meaning the net amount at risk could increase if investors lost confidence in either European sovereigns or MF Global and new hedges couldn’t be bought.
“If that assumption does not come to pass, their risk mushrooms,” said Matthew Pieniazek, president of Darling Consulting Group, a Newburyport, Massachusetts, firm that advises banks on managing their balance sheets. Hedges that matured along with the bonds would have been prohibitively expensive, he said.
Steven Goldberg, a spokesman for Corzine, and Diana DeSocio, an MF Global spokeswoman, declined to comment for this story.
‘My Personal Responsibility’
There was never any doubt about who engineered the sovereign-debt trade.
“Our positions and the judgment about risk-mediation steps are my personal responsibility,” Corzine, 64, said on an Oct. 25 conference call to answer questions about a record quarterly loss and debt-rating downgrade that sliced the firm’s market value that week by 67 percent, or $410 million, as MF Global slid toward collapse.
The firm’s Oct. 31 bankruptcy filing, the eighth-biggest by a public company in the U.S., led to at least 1,066 workers losing their jobs, disrupted commodities markets and undermined investor confidence in futures brokers. The trustee liquidating MF Global’s broker-dealer said more than $1.2 billion in customer money may be missing, and the company is being investigated by regulators and the U.S. Justice Department.
About $200 million of the missing funds have been found at JPMorgan Chase & Co., the New York Times reported, citing people briefed on the matter that it didn’t identify. MF Global had an overdrawn account at New York-based JPMorgan in its final days, the newspaper said. The funds were transferred before its bankruptcy filing, it said.
Marie Cheung, a spokeswoman for JPMorgan in Hong Kong, declined to comment today.
U.S. investigators are unaware of any missing funds in the U.K., according to a person familiar with the Federal Bureau of Investigation probe of MF Global’s collapse who declined to be identified because the matter isn’t public. Peter Donald, a spokesman for the FBI in New York, didn’t immediately return an e-mail after business hours seeking comment. Kent Jarrell, a spokesman for MF Global trustee James Giddens, declined to comment.
Corzine resigned on Nov. 4, and has hired attorney Andrew Levander, a partner in the law firm Dechert LLP whose clients have included money manager Ezra Merkin in litigation tied to Bernard Madoff’s fraud scheme. Neither Corzine nor anyone else at MF Global has been accused of any wrongdoing.
MF Global reported a loss in the four quarters prior to Corzine’s hiring. Central to his strategy for turning the futures broker around, Corzine promised to bulk up principal trading, or the use of the firm’s own capital to make deals for itself and clients. In the latter half of 2010, within months of taking the helm, he started buying the Italian and Spanish bonds, as well as those of Portugal, Ireland and Belgium.
On earnings conference calls with investors, Corzine described the debt, which matured at various points in 2012, as a low-risk way to profit from “dislocations” in Europe’s sovereign-debt market. To limit its risk, MF Global entered into a minimum of $4.9 billion in offsetting wagers that would pay off if the bonds fell in value, filings with the U.S. Securities and Exchange Commission show.
MF Global’s regulatory filings don’t give dollar amounts for the gross purchases of European sovereign debt or for the hedges. Instead, the investments are shown as percentages of a bigger base of assets, leaving investors to calculate the numbers themselves. Those assets are reported on a market-value basis.
The firm in filings and an October investor presentation disclosed the net amount at risk from its European bonds after hedges. Neither the presentation nor regulatory filings explained that the hedges matured before the bonds and thus would have to periodically be renewed.
MF Global didn’t have any trouble replenishing the hedges through the end of October, when its operations were handed over to trustees, said a person briefed on the matter who asked not to be identified because the information isn’t public. KPMG LLP, whose London office is serving as the special administrator for MF Global’s U.K. unit, said in a Nov. 17 statement that “the overwhelming majority” of the firm’s European sovereign-debt portfolio, along with the related hedges, had been liquidated.
Although the trades didn’t require pre-approval by the board, directors later questioned Corzine’s investment, according to a person familiar with the discussions. After challenging the size of the bets and the concentration on a small number of countries, the board set dollar limits on the amount of sovereign debt its chairman could buy. Corzine came back to the board at least once to get the ceiling raised.
At multiple meetings, Corzine reassured directors that the trades would work out, said the person, who asked not to be identified because the discussions were private. Corzine said the European countries he selected wouldn’t default before the bonds matured, and that the market was mis-pricing the debt, according to the person. Underpinning Corzine’s view was the euro zone’s European Financial Stability Facility, which could backstop government short-term debt through June 30, 2013.
Some risk managers and traders at MF Global shared the directors’ concerns, according to a former employee with knowledge of the matter. The risk-management department began asking for daily prices of credit-default swaps on sovereign debt to keep track of how the market viewed the underlying bonds, a second person said.
The demise of MF Global, which was spun off from fund manager Man Group Plc in 2007, shows how Corzine’s stature made it hard for the board or underlings to oppose him, even as the crisis in Europe deepened. Directors believed that rejecting the trades would have been an affront to the veteran trader and would have been tantamount to firing him, said the person familiar with the board’s deliberations.
“This was a board that could not possibly have been more expert in exposure to risk, a board with at least as much, if not more, expertise than the CEO,” said Jeffrey Sonnenfeld, senior associate dean at the Yale University School of Management in New Haven, Connecticut, and founder of a nonprofit educational and research institute focused on CEO leadership and corporate governance. “This was an example of people not having the courage to stand up to the CEO.”
Trader at Heart
Even after nine years in politics, Corzine never shook the trading bug. He was a prominent presence on MF Global’s trading floor, frequently leaving corporate meetings to check on the markets, according to one person familiar with the firm. He had a reputation for knowing where prices were minute-by-minute, an unusual level of detail for the CEO of a global financial institution.
“He loved to prowl the trading room,” said Mike Fitzpatrick, a former MF Global oil trader who was recruited by Corzine to work in its principal strategies group, the unit that placed proprietary trades. “I find it hard to believe a trader of Corzine’s experience and longevity didn’t calculate, ‘What’s the worst that could happen?’” said Fitzpatrick, who left MF Global in October 2010.
“It got so far out of hand so fast,” he said.
Poor Risk Management
A lack of internal controls eventually doomed the company after a last-minute purchase of the futures-brokerage unit by Interactive Brokers Group Inc. was scuttled when it couldn’t account for hundreds of millions of dollars in customer funds, Hans Stoll, an Interactive Brokers board member, said in an interview earlier this month.
Poor risk management had hurt MF Global before Corzine’s arrival. The company’s shares fell 40 percent in two days in February 2008 after it lost about $141 million on unauthorized wheat trades by an employee in Memphis, Tennessee.
The company sought to tighten its order-entry systems and created a chief risk officer position to calm shareholders. In September 2010, Corzine brought in Bradley Abelow, his chief of staff as governor, to be MF Global’s chief operating officer. Abelow’s duties included overseeing risk management.
Eye on Costs
The tension between beefing up internal controls and trying to improve earnings surfaced during a conference call in November 2010. Then-Chief Financial Officer J. Randy MacDonald was asked by an analyst about the company’s non-compensation expenses. MacDonald stressed the importance of building the “middleware” and distribution platforms across the brokerage’s businesses, saying the company had “some investments to make.”
As the analyst moved on to his second question, Corzine interrupted: “Make no mistake, we’re looking to produce earnings now, and we are keeping a sharp eye on costs.” He said he was mindful of ensuring the company didn’t “bite too quickly on running up costs in front of revenue growth.”
Abelow couldn’t be reached for comment.
To execute his European debt trade, Corzine used repurchase agreements, a type of transaction that allows investors to finance most or all of the purchase, depending on the securities involved, the length of the deal and the credit quality of the borrower. In earnings calls, the CEO said the firm was seeking to profit from the difference between the yield it received on the European bonds, purchased at a discount to face value, and the interest rates it paid under the repurchase agreements.
After setting up the trade so the bonds and the financing agreements matured on the same dates in 2012, accounting rules dictated that MF Global treat the transaction as a sale rather than a collateralized loan. Those rules meant MF Global had to book all of the profit upfront, rather than recognizing it over the life of the contracts, and kept the assets and liabilities from the trades off of its balance sheet, according to Peter Testaverde, a partner in New York at accounting firm EisnerAmper LLP who does audits of hedge funds and brokerages.
The multiple transactions were conceived as a revenue- generation strategy that would improve the financial results for MF Global’s nascent trading unit, according to the person familiar with the board, who wasn’t authorized to speak publicly.
MF Global disclosed in a May 20 filing that its net holdings among the five European countries consisted of $6.3 billion in debt at the end of March that had an average maturity of April 2012. The company said in the Aug. 3 filing that its European sovereign portfolio had risen to $6.4 billion of debt with an average maturity of October 2012. In both instances, MF Global said the figures were “net of hedging transactions the company has undertaken to mitigate issuer risk.”
While reporting its net holdings had increased 2 percent, MF Global had expanded its bets to $11.5 billion as of June 30 from $7.64 billion as of March 31, according to data contained in the SEC filings. The firm didn’t quantify its holdings at the end of 2010. The firm’s hedges, known as reverse repurchase agreements, jumped to $4.93 billion at June 30 from $1.08 billion as of March 31, the data show.
Revenue from the European sovereign trades was about $47 million during the fiscal fourth quarter ended March 31, or 16 percent of net revenue, and $38 million, or 12 percent, in the following quarter, according to an October investor presentation.
Beginning of End
“This perspective reinforces our strategic view that diversifying into client dealing and principal trading works to reduce dependence on a single line of business and allowed us to grow revenues even in a difficult environment,” Corzine told analysts during a July 28 conference call.
The deal began to unravel in August when the Financial Industry Regulatory Authority told MF Global to add capital to its U.S. brokerage to back the trades. Then on Oct. 24, Moody’s Investors Service downgraded MF Global to one level above junk status, citing its ongoing inability to meet earnings targets and concern that it wasn’t sufficiently managing risk. The next day, MF Global reported its worst-ever quarterly loss.
By the end of that week, the broker’s credit ratings were cut to junk, its bonds were trading at distressed levels and it had drawn down its entire $1.3 billion revolving credit facility.
Corzine’s strategy may ultimately have proven “very profitable” had the firm been able to hold the trades to maturity, said Josh Galper, the managing principal at Finadium, a Concord, Massachusetts, investment research and consulting firm. The firm’s collapse stemmed from a cash shortage, with trading partners and lenders seeking more collateral after the credit downgrade, rather than actual losses on the bonds, Galper said.
“If MF Global had bought the same trade without leverage, there would have been no issue,” Galper said in an interview.
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