Choose Your Broker Wisely – A Lesson from MF Global
In what reads like an epilogue of the MF Global fiasco which is now but a blip in the faded recent memories of financial headlines, Erico Matias Tavares of Sinclair & Co., a victim of said brokerage house collapse, recounts the physical encounter he experienced with Jon Corzine, the central figure who caused him years of grief.
Mind you, amongst more attention grabbing headlines like the 2008 financial crisis and the Eurozone PIGS crisis where not billions, but trillions are being tossed around, the $40 billion bankruptcy, the 8th largest in US history at the time, amounts to mere rounding errors when it comes to news-worthiness.
Unless you happen to be one of the account holders, that is.
A Brief History
Before we get to the aftermath, a quick recap is in order.
After losing the re-election in 2010, ex-governor of New Jersey and ex-Goldmanite Jon Corzine took over the helm of MF Global, a leading commodity futures brokerage house with branches worldwide. In his bid to turn the brokerage house into an investment bank powerhouse, he made some wrong bets on risky Eurozone bonds which turned sour in 2011 and managed to drive the company into the ground in a short year and a half under his watch.
Amid the mad scrambles to come up with money to meet margin calls in its final days just prior to its demise, some $1.2 billion of client funds somehow got lost in what was later described by the people in charge as ‘vaporized’. For those who had to resort to such an uneducated and definitely unprofessional term as ‘vaporized’ to describe the criminal case of commingling and subsequent disappearance of clients’ supposedly segregated funds, the happy note to this otherwise sorry event is that the world since then has a term to describe such an event – the clients’ funds have been “corzined”. Congratulations to the man-turned-verb.
What Happened to Clients’ Accounts?
As it turned out, the clients’ money did not magically go puff. Most of it was eventually traced to banks like JPMorgan. Whether the clients managed to get their money back was a different matter and depended on which country the client accounts were opened in.
To understand why that is the case, it is first instructive to know that just because you have an account with a global brokerage firm operating in your own country does not mean that your assets in that account remain on home soil. To take advantage of the regulatory asymmetry on how a bank or prime broker can use, or hypothecate, its clients’ assets for its own proprietary trading, brokerage companies transfer their clients’ assets to another regulations-light jurisdiction, the UK in this case, where a broker-dealer can re-hypothecate said assets by an unlimited amount (check out this primer on re-hypothecation).
Unknowingly, with their supposedly segregated funds commingled with the firm’s own capital, the clients became unsecured creditors behind a long line of secured creditors when the bank or broker-dealer blows up in the derivatives casino.
As Erico Matias Tavares and his clients found out, how much a client gets to recoup depends on where his assets were at the time and the governing regulations of the jurisdiction where the account was opened. Here’s how the clients fared across different jurisdictions, starting from the luckiest.
Canada. The Canadians got 100% of their money back within a few short weeks after the company filed. Arguably the most conservative of the bunch, banking regulations in Canada do not permit re-hypothecation. RBC Dominion Securities was the trustee where MF Global Canada customers’ funds were held and, by law, segregated. It is not sure whether any of the funds ever left the trustee in Canada and ended up in the land of infinite re-hypothecation which is the UK. If said funds did end up having left the country, in all likelihood RBC would have probably gotten a tap on the shoulder from the government and told to ‘eat the loss and keep quiet about it’ in order not to cause any panic. Outside observers will never know.
Singapore. Its citizens got 90% of their money back soon after Canada did.
The United Kingdom. By default funds in a brokerage account are not segregated from the firm’s pool unless the client explicitly requests so. So when MF Global went bust, these clients found themselves at the end of the line of creditors. It took months before segregated clients recovered 26% of the total. All others would have to wait further to access financial insurance ($80,000 max per claim). Many small and medium firms who hedged their foreign exchange exposure through MF Global could not wait and were forced to sell their claims at a big discount so that they could get some money back and remain in operation.
Australia. The most SOL award went to the Aussies. For the longest time, the clients had no visibility whatsoever of what was going on and no status updates on the process or the payouts. The author never found out if they ever got their money back.
Moral of the Story
So should I be worried? Will my money be protected if something like this happens here, you might ask?
The answer is, of course, it depends. The critical circumstances are what (bank, brokerage house, etc.) blows up and whether it is just a garden variety explosion which levels only a city block or it has a mushroom cloud. If the blowup is relatively small and contained, chances are very good that your money will be protected by the applicable insurance pool. However, given the size of the derivatives casino (check out this primer on derivatives), interconnectedness of the global financial system and the amount of leverage the financial institutions are engaged in (see Bail-in At Your Local Bank – Part 2: The Derivatives Time Bomb), chances are also good that one of the blowups will be neither small or contained. When that happens, any insurance pool would get depleted in no time and the authorities will be making rules up as they navigate through uncharted territories. Under the guise of using no more taxpayers’ money to bail out failing financial institutions, numerous bail-in regimes have been put in place to bail in the account holders (see Bail-in At Your Local Bank – Part 3: Institutionalizing the Money Grab). You will be on your own.
So what can you do? Not a heck of a lot, unfortunately. The following are a few due diligence questions you should find out in order to minimize your risk if not eliminate it.
- Ask your broker explicitly whether your account is segregated.
- Whether the firm has oversea branches where your funds or securities can be sent, and if so, whether your funds and securities are being shipped overseas as a matter of practice.
The Land of the Free
So whatever happened to Corzine, the man now famously turned verb, and the executive team who managed to corzine their clients’ fund?
No one has been charged to date and chances are none will ever spend a day in court, let alone jail. For that matter, ditto for those bankers who caused the 2008 financial crisis. In fact, Corzine is right now busy doing the circuits fund raising for Hillary Clinton’s next presidential campaign, thank you very much.
That’s right. In the Land of the Free, the criminals walk free.
Curious about how the encounter went between Tavares and Corzine? Here’s the horse’s mouth.
- A close encounter with Jon Corzine
- The (sizable) Role of Rehypothecation in the Shadow Banking System
- MF Global and Rehypothecation
- MF Global’s Missing Customer Money All Accounted For: Trustee