MF Global

Man Financial, the trade-processing subsidiary of the UK hedge fund manager, Man Group, was spun off from the parent in 2007 and renamed MF Global.

My take, without having studied the transaction carefully, is that Man Group was trimming away a low-growth, low PE multiple peripheral operation.  Sans MF Global, Man Group would look growthier and presumably achieve a higher PE rating from investors.  MF Global would have a chance to write its own history.  So maybe the separate parts would also be worth more than the whole.

In 2010, the board of MFG hired Jon Corzine, former crack trader, former head of Goldman, former US Senator, former governor of New Jersey (perhaps best remembered for having been in a high-speed auto accident while not wearing a seat belt) to be its new CEO.  His first-year compensation was $14 million+.  The idea was that Corzine would turn MFG into an investment bank like Goldman.

On Halloween 2011, MF Global filed for Chapter 11 bankruptcy, as the financial markets lost confidence in the aggressive proprietary trading strategy Mr. Corzine had crafted.  That’s when–like a train wreck in slow motion–the weirdness began.

investment significance

There may be a certain perverse fascination associated with looking at cases like this (after all, Schadenfreude is a word–or two).  Nevertheless, there is an important investment point as well.

It’s that when a company begins to struggle, the first signs of distress, however awful, are rarely the last.  The trail of bad news is, in my experience, almost always longer than initially expected.  It can also reach destinations never dreamed of on day one.  Therefore, betting that all the bad news is out can be very risky.

what’s come out so far

In this case, what’s happened has been highly publicized (the best account I’ve read of the run-up to Chapter 11 is in Vanity Fair):

–in August 2011, MFG issues bonds that promise to pay a higher interest rate if Corzine were to leave the firm for Washington (rumors suggested he would become the next Secretary of the Treasury)

–in October 2011, MFG declares bankruptcy–undone by Corzine’s aggressive proprietary trading strategy

–a last-minute deal to save the firm falls through because of possible accounting irregularities

–the bankruptcy trustee indicates that up to $1.6 billion in customer money is missing

–the first of many claims of “sloppy bookkeeping” are made by the authorities–the assertion that in an age of ubiquitous, cheap management control software, MFG had no procedures for recording the trades it made.  I’ve got no experience with commodities, but I find this particularly hard to believe.

–the former chief risk control officer, fired after repeatedly warning the Corzine trading strategy was too risky, says he thinks the warnings were a reason for his dismissal.

–Mr. Corzine testifies he has no idea where the missing money is.  Although he’s the CEO, he says he had no knowledge of, or involvement in, the day-to-day operation of MFG.  He names the employee who he says assured him that no client money was delivered to lenders to meet margin calls.

–the named official refuses to answer questions without being granted immunity from prosecution.  Other company executives, including the CFO, say they, too, have no idea what happened to the missing money.

the latest wrinkle

After five months, you’d think that everything about the last days of MFG would already be out on the table.  But that’s not right.

Customers who tried to close their accounts with MFG shortly before the Chapter 11 filing did not receive the wire transfers which they requested and which are the customary way of liquidating accounts.  It’s not yet clear, but it sounds like at some point MFG decided to stop wiring money to customers who closed their accounts but to send checks in the mail instead.

The use of checks has two consequences.

For customers, instead of getting their money through a wire transfer on the same day the accounts were closed, checks dated, say, October 28th arrived only in November–after MFG declared bankruptcy.  Those checks, of course, bounced.  The holders are now unsecured creditors of MFG.

For MFG, check issuance would create in effect a “float” of customer money that it could use for several days–without the same regulatory restrictions on customer accounts–until customers received and cashed their checks.

Lawyers for the clients in question are now approaching the Justice Department with collections of “float” data, which they hope will convince the government that the check issuance was not as innocent as simply shoddy bookkeeping.

is the story over yet?

My guess is that we still don’t know everything.

In my early days as an oil analyst, a veteran geologist told me that wells come in two types–good and bad.  The former continually exceed expectations.  The latter, no matter how far down you ratchet your expectations, somehow manage to still disappoint.

To me, MFG feels like a really bad well.