Did the New York Fed Lie to the GAO During the Mini-Fed Audit?

Open ended question of the day...

What's wrong with these two documents? (click for larger images)

Exhibit A:

Exhibit B:

Scrubbed MF Global Filing Resurfaces at the SEC, But More Questions About Suspicious Filing Practices Surface

On December 24, 2011, we reported that the most recent financial audit filing of the MF Global Inc. broker unit had disappeared ten days earlier from the Securities and Exchange Commission's public EDGAR database. It was this key filing that provided material details about the European debt trades that helped sink the firm--more details than the 10-K and 10-Q's of its public holding company disclosed. For instance, we revealed on November 9, days after the bankruptcy filing, that the repo-to-maturity trades were conducted with an affiliate, which retained 80% of the profits from the up-front booked sale, and which left the US broker unit holding 100% of the risk.

On January 3, 2012, a copy of the missing audit reappeared under a different index number (the original, as of the time of writing, remains here). While it seems the replacement simply corrects what is an obviously wrong stamped receipt date on the face page of the original, there are a few curious annotations that we will explore. More importantly, after researching the SEC's public database for scanned paper filings, which includes private offering Form D's, exchange filings, firm advertising literature, and other filing types (including broker dealer audits themselves), we are left with more questions than answers.

It seems that sloppy scanning and filing standards combined with preferential treatment for certain large brokers has substantially reduced the value of this part of the SEC's public filing system. Since this is often the sole repository for disclosures about private companies, including broker dealers that do not have public holding companies, investors are being deprived of timely and critical information. Even for those broker dealers that do have public holding companies, such as MF Global Inc., the financial notes of the broker audits disclose different, and oftentimes, more substantial information. Since it is now apparent that Louis Freeh, the former FBI Director cum MF Global Holdings trustee, is running cover for MF's largest creditors, not the least of which is JP Morgan Chase, it is all the more critical that the integrity of the SEC's public filing system be scrutinized. [Update: according to Mr. Freeh's Statement of Disinterestedness filed with the bankruptcy Court here, MF Global Inc.'s auditor, PricewaterhouseCoopers, provides accounting services to him and his firm.]

How many MF Global customers would liked to have known that the broker unit was being left hanging out to dry on Corzine's risky trades? Yet the SEC did not post the broker's audit until mid-September, though the amended receipt date is now acknowledged to be May 31, 2011. It was just a few weeks later in early October 2011, that certain well-informed customers, such as Koch Industries, commenced the run on the broker, after which ordinary customers got the run around with botched wire transfers and bounced checks.

While this article primarily explores broker dealer filings, which are only a small subset of all the paper filings that are scanned into the SEC's public EDGAR database, a look into all of 2011's scanned paper filings reveals that only 45% of the sequentially indexed PDF files that were scanned from hard copies by the SEC remain public (7,949 out of 17,718). [The SEC has kindly left the source code to its PDF scrubbing program here, also archived here on Scribd.]

While there might be an innocuous explanation for the bulk of these deleted filings (notwithstanding the reinstated MF Global Inc. audit), there remains no explanation for several high profile broker audits that were simply erased, never to be seen again, as we previously reported here. These would be audited financial filings or amendments to such filings of JP Morgan Securities, Goldman Sachs & Co., Banc of America Securities (now owned by BNP Paribas), and a more recent find since our previous article, Newedge USA LLC (circa 2005 when it was Fimat USA Inc.). In addition, we reported that these deleted filings occurred during suspicious, potentially game-changing periods, such as when Goldman Sachs changed its fiscal year end, or, for instance, just after JP Morgan Securities became what was once the infamous Bear Stearns & Co. broker.

Though by no means an exhaustive study, in a random sampling of 30 smaller broker filings with the SEC, we found no instances of missing PDF filings of their audits (or amendments thereto). Further, and very curiously, the auditor of three of the aforementioned companies (JPM, Goldman and BoA) is PricewaterhouseCoopers, the very auditor of MF Global. Thus, an obvious question is: are there special procedures large brokers and their auditors are using to withhold from the public potentially damaging information?

Aside from the more isolated cases of deleted filings, there are many inconsistencies from year to year, as to the actual content of the public record of broker dealer filings. [All of MF Global Inc.'s broker filings may be found here (click on the "X-17A-5" links, then "scanned.pdf" in the page that follows).] For instance, in MF Global Inc's 2011 report (as of the year ended March 31, 2011), there is a cover page, an oath by Ms. Christine Serwinski, an auditor's report by PwC, and a statement of financial condition (balance sheet), followed by financial notes.

In the 2010 filing one year earlier, there appears the cover page, the oath, the auditor's report, balance sheet, but no financial notes (wouldn't it be interesting to see those detailed notes, inasmuch as Corzine had just taken the helm?). Instead, what follows the 2010 balance sheet is a report by PwC on MF Global Inc.'s internal controls. In addition, toward the bottom of page 2 of the PDF, a box is checked, indicating that a "Report describing any material inadequacies found to exist or found to have existed since the date of the previous audit" should be included, yet it is not.

This report, along with the internal controls statement, and others, are actually among an extended set of documents required by SEC and CFTC rules to be filed contemporaneously. These documents are not required to be made public by the SEC if the broker follows certain procedures.

From the SEC's website:

Confidentiality

Rule 17a-5(e)(3) provides that the audited financial statements “shall be public, except that, if the Statement of Financial Condition . . . is bound separately from the balance of the annual audited financial statements . . . the balance of the annual audited financial statements shall be deemed confidential, except that they shall be available for official use . . .”

In order to receive confidential treatment for the financial statements other than the Statement of Financial Condition in accordance with Rule 17a-5(e)(3), the broker-dealer should do the following:

Bind the Statement of Financial Condition separately from the balance of the annual audited financial statements or place it in a separate package. Complete and attach an “Annual Audited Report, Form X-17A-5, Part III, Facing Page” to the Statement of Financial Condition. Mark the Facing Page “Public.”

Bind the balance of the annual audited financial statements separately or place them in a separate package. Complete and attach an “Annual Audited Report, Form X-17A-5, Part III, Facing Page” to these statements. Mark the Facing Page “Confidential Treatment Requested.”

The public and non-public portions of the financial statements must be clearly segregated and the Facing Page must be appropriately marked. For example, the Facing Page attached to the Statement of Financial Condition should not be marked “Confidential.” Further, if the Statement of Financial Condition is not bound separately or placed in a separate package, then, in accordance with Rule 17a-5(e)(3), none of the statements will be accorded confidential treatment.

Rule 17a-5(e)(3) does not require the submission of a letter requesting confidential treatment. It is not necessary to mark the mailing envelope “Confidential.”

Thus, it appears the SEC has provided a little-known, yet easy way for broker dealers to keep a substantial portion of their annual filings non-public, without having to file a confidentiality request. Several smaller brokers we contacted were not aware of this.

If the internal controls report of MF Global Inc. made it into its 2010 public filing, yet the financial notes did not, was it simply a case of improper separation of the public and private bound filings on the part of the filer? If so, why is the SEC not enforcing substantive error checking, inasmuch as we have found this phenomenon to be quite common for broker filings?

Or, is the SEC selectively determining itself which portions will be public and private, and committing errors (intentional or not) in the process? Recalling the deleted filings of JPM, Goldman, BoA and others, is it possible that what was supposed to be confidential was inadvertently made public, and upon petition from the filer (or its auditor), the entire public filing was simply deleted?

As we noted prior, it is likely a combination of factors that has led to the poor state of the SEC's public broker dealer filings: sloppy and delayed scanning, with special consideration given from time to time to large firms. Procedures regarding record handling at the SEC can also change with the SEC's Commissioner, as was recently discovered as part of the SEC's National Archives scandal, in which NARA learned the SEC was potentially illegally destroying its own records.

In light of these records problems at the SEC, our questions are all the more relevant--as is the previous point of timeliness of record posting. This gets back to the MF Global Inc. filing that began this entire line of inquiry. Here is the original cover page for the 2011 filing:

The stamped filing date is September 2, 2010, which should be September 2, 2011. The handwritten "9/2" at the bottom also confirms the month and day.

Here is the replacement filing:

Rather than change the filing date to September 2, 2011, it is now reflected as May 31, 2011, a full three months prior. Our research indicates it takes on average 10 business days, or two weeks, for the "scanned.pdf" file to appear after initial processing, so this critical report first indexed on September 2, was likely not available on EDGAR until September 16, or thereabouts--well after FINRA had already required a regulatory capital increase of the firm.

The fact that the stamp says "REGISTRATIONS BRANCH" is also a deviation from the filing stamp that broker filings usually receive. Here is MF Global Inc.'s 2010 report, which contains the typical diamond shaped filing stamp (truncated at the top):

Finally, we hinted at the top that there are a few curious annotations in the replacement MF Global Inc. filing. Though the typeset content of both reports appears identical, compared to the original filing, the replacement filing has text that is slightly smaller and more blurred. Also, the right margin is wider, which all suggests it is a photocopy. Thus, we are left to wonder whose hands this copy passed through before being scanned, and just who was interested in the first paragraph of the financial notes, which specifically addresses the definitions of the various MF Global entities:

And further, why would this person have scribbled below the sentence that specifically addresses the European repo-to-maturity trades that were transacted with an affiliate of the broker unit?

Here is the original:

Interestingly, we included only two excerpts from the MF Global Inc. financial notes in our November 9 article, and the sentence above the handwritten scribble constitutes one, the other being this:

These annotations, combined with the three month delay in scanning, along with the atypical filing stamp all suggest that the 2011 MF Global Inc. report has been receiving special attention at the SEC. Yet, the public record reveals very little of this file tampering, and would likely have gone unnoticed had MF Global not been so high profile. Indeed, the deleted filings of JP Morgan Securities, Goldman Sachs & Co., Banc of America and Newedge USA [the old Fimat USA] have gone unnoticed for years.

While the fully electronic filings constitute the bulk of the SEC's public EDGAR database and are the primary focus of investor disclosures, evidence suggests that the SEC maintains its scanned hard copy filings at a much lower standard. The current system is ripe for not only inaccuracies and inconsistencies, but outright abuse by the large brokers and their auditors.

On the First Day of Christmas, MF Global Documents Disappeared from the SEC's Public EDGAR Database

Say what you will about the Securities and Exchange Commission's approach to regulating the capital markets, but at least we can sleep soundly under the warm blanket of integrity that is its Electronic Data Gathering And Retrieval (EDGAR) system--that internet portal available to all, which maintains the financial reporting and related documents of tens of thousands of entities that transact business in the US capital markets. Or can we?

While the more commonly referenced files on EDGAR, such as public company annual 10-K's and quarterly 10-Q's, are fully digital and searchable, some filings are simply scanned from hard copies. While often overlooked, these documents, such as the annual audited financials of broker-dealers, can yield precious insights relevant to their parent holding companies.

For instance, we wrote shortly after MF Global's bankruptcy that the last audited financials of the broker unit, MF Global Inc., revealed many more details about the famed European debt repo-to-maturity trades than were disclosed in its parent's filings. Not the least of which was that the trades were with an affiliate on terms to the derogation of the broker customers. Eighty percent of the profits were shipped to the affiliate, while ALL risk remained at the broker unit (see Note 11 to the financial statements embedded at the end).

It was while searching for this very filing recently that were were confronted with a giant Orwellian sucking sound--for the downloadable PDF link from the EDGAR reference page had simply been removed.

First, see the filing for the year ended March 31, 2010, which is still intact [click any image in this post to enlarge].:

While it's common to see the "File Date Changed" not match the actual "Filing Date", it is usually quite close. The middle download link labelled "scanned.pdf", will produce the actual report. The other two links merely contain electronic header information.

Now see the March 31, 2011 filing:

Note the obvious omission of the "scanned.pdf" line, as well as the recent "Filing Date Change"--to December 14, 2011. Only the header links remain. Interestingly, the URL of the PDF that we had posted in early November (prior to the redaction) is still valid, but likely not for long. For the historical record of EDGAR database changes at the SEC has been one of permanent deletion.

Up next, Banc of America Financial Services, Inc. (now owned by BNP Paribas), vintage year-end 2007, which you might remember from such themes as, the sub-prime and equities peaks, as well as the great August quant blowout:

Remember when Goldman Sachs transformed itself nearly overnight from a mere broker to a bank holding company vis a vis an emergency order from the Federal Reserve in late 2008? The broker unit changed its reporting month to calendar year end (from November 30) along with its holding company, such that its financials ended 2009 would contain thirteen months. The audit of the broker until would be filed March 1, 2010, but an amendment was filed only two days later. It is this very amendment that has also been forwarded to dev/null.

That was a good week in 2010 for deleting amendments, because that would also be the fate of J.P. Morgan Securities Inc., the inheritor of the Bear Stearns broker.

And what would a collection such as this be without Refco Securities LLC?

Yes, the "scanned.pdf" link is there, but if one examines the PDF, all that is present is the cover section--absolutely no financial data. Inasmuch as the "Filing Date Changed" is over six months from the "Filing Date", we are left to wonder if a redacted version was simply slipped in toward the end of 2004 (which, incidentally, is when the company was preparing for its fraud-laced IPO).

For what it's worth, the MF Global Inc. financials for the year ended March 31, 2011 can still be found here:

mf global audit - 9999999997-11-014930

Why was MF Global put through a SIPA liquidation designed for securities brokers?

The answer: to protect the creditors.

Had MF Global been resolved under Subchapter IV of Chapter 7 of the Bankruptcy Code (appropriately entitled "Commodity Broker Liquidation"), customers would have been put first, against the interests of the large bank creditors of MF Global. From the unambiguous Historical and Revision Notes in the US Code (emphasis ours):

SENATE REPORT NO. 95-989

[Section 765] Subsection (a) of this section [enacted as section 766(h)] provides that with respect to liquidation of commodity brokers which are not clearing organizations, the trustee shall distribute [commodity] customer property to customers on the basis and to the extent of such customers' allowed net equity claims, and in priority to all other claims. This section grants customers' claims first priority in the distribution of the estate. Subsection (b) [enacted as section 766(i)] grants the same priority to member property and other customer property in the liquidation of a clearing organization. A fundamental purpose of these provisions is to ensure that the property entrusted by customers to their brokers will not be subject to the risks of the broker's business and will be available for disbursement to customers if the broker becomes bankrupt.

Some tough questions need to be asked to those who approved the last minute handing over of what was primarily a commodities broker into the hands of a trustee experienced only with securities brokers, and pursuant to SIPA legislation that does not afford protections first to the commodities customers. The entire model of customer protection under SIPA is that it establishes an insurance fund for securities customers. Because no such fund exists for commodities customers, they are put at an extreme disadvantage from the outset.

Who made the decision to throw MF Global into a SIPA liquidation? More to come...

Dear Congress: Bernanke Just Lied to You

Dear Congress,

On December 6, 2011, Ben Bernanke, Chairman of the Federal Reserve System (the Fed), responded to recent media accusations regarding the Fed's emergency lending during the financial crisis. In attempting to correct "numerous errors and misrepresentations", Mr. Bernanke himself relies on a variety of misleading, if not outright deceptive, tactics and fact-twisting. It's important to set the record straight, which is that the Fed abhors transparency and indeed subsidized to the greatest extent the large banks that it faithfully serves.

Below, I excerpt and comment on the most egregious affronts on truth made by Mr. Bernanke, which he presents as evidence of his claims. All emphasis is mine.

Correction of Recent Press Reports Regarding

Federal Reserve Emergency Lending During the Financial Crisis

Recent press reports contain numerous errors and misrepresentations about Federal Reserve emergency lending during the financial crisis.

First, these articles have made repeated claims that the Federal Reserve conducted "secret" lending that was not disclosed either to the public or the Congress. No lending program was ever kept secret from the Congress or the public. All of the programs were publicly announced when they were initiated, and information about all lending under the programs was publicly released--both on a weekly basis through the Federal Reserve's public balance sheet release and through detailed monthly reports to the Congress, both of which were also posted on the Federal Reserve's website.

This is a common tactic of Mr. Bernanke, whereby he cloaks himself in the after-the-fact limited disclosures provided on the websites of the Fed and the Federal Reserve Banks, often made only after significant arm twisting. Most of the details, when they are released, such as counterparties or program agreements, are done so long after the time when public debate might have increased scrutiny on what now look like suspicious dealings.

For instance, when Bear Stearns failed and most of its operations and portfolio were taken over by JP Morgan Chase (JPM), the Federal Reserve Bank of New York (FRBNY) loaned $28.82 billion to a new corporate entity it helped create called Maiden Lane, in which about $30 billion of the most toxic Bear Stearns assets were placed. The Fed sold the program to Congress and the public as a wind-down facility, yet when details finally began to be dribbled by the Fed and FRBNY over a year later (and only because of substantial Congressional and public pressure), it became apparent that Maiden Lane was being aggressively traded by BlackRock, as asset manager. Indeed, the value of the mortgage backed securities (MBS) portion of the portfolio, a potential profit center in contrast to other distressed assets, such as Red Roof Inn loans, swelled from $11.4 billion as of September 30, 2008 to $19.9 billion as of June 30, 2010.

In addition to the FRBNY loan, JPM had also loaned Maiden Lane $1.15 billion and was first in line to take a loss. Inasmuch as BlackRock was also trading MBS securities on behalf of the Fed as part of its $1.25 trillion MBS purchase program, there are significant potential conflicts of interest that arise. Indeed, the Government Accountability Office (GAO) found numerous conflicts of interest in the way no-bid contracts were awarded by FRBNY during the crisis. Personal research, which will be happily shared should you request, reveals that FRBNY outright lied to the GAO with respect to one of the largest no-bid contracts. In a follow up report, the GAO noted that the Fed did not provide adequate guidance to its Federal Reserve Banks to ensure that emergency program participants were treated equally. Clearly, the Fed was not treating everyone equally and has much to hide.

Bernanke continues:

It is true that, generally, the names of the counterparties and borrowers from the emergency facilities were not immediately disclosed, consistent with general central banking practice. Releasing the names of these institutions in real-time, in the midst of the financial crisis, would have seriously undermined the effectiveness of the emergency lending and the confidence of investors and borrowers. These matters were discussed extensively at the time in the press, and the Chairman and other members of the Board discussed them numerous times in hearings before the Congress.

In point of fact, the Federal Reserve took great care to ensure that Congress was well-informed of the magnitude and manner of its lending. As required by the Emergency Economic Stabilization Act, passed in late 2008, the Federal Reserve reported regularly on the outstanding balances in its Sec. 13(3) lending facilities as well as on collateral (by type and quality) for the loans. Beginning in June 2009, the Federal Reserve went well beyond these legal requirements in the information it made available in its monthly public reports to the Congress, which were also posted on the Federal Reserve's website.

It bears repeating that the Fed is only forthcoming when it faces substantial pressure or when it is outright compelled to because of Congressional or Judicial action. When Mr. Bernanke thumps his chest about the details released on these programs, be assured these disclosures were not his preferred choice.

Moreover, Congress was well informed of the volume of borrowing by large banks. For instance, the monthly reports showed the daily average borrowing during the month in the aggregate for the five largest discount window borrowers, the next five, and the rest. Similar information was also provided for lending at the emergency facilities.

In addition, the issue of counterparty disclosure was well-known to the Congress and was addressed as part of the Dodd-Frank Act. Under provisions of the Sanders Amendment, the names of all counterparties and borrowers from the emergency lending facilities and the Term Auction Facility (TAF) were disclosed on December 1, 2010. Data provided included the names of the borrowers, the date that credit was extended, the interest rate, information about the collateral, and other relevant terms. Similar information is supplied for swap line draws and repayments. Details for each agency MBS purchase included the counterparty to the transaction, the date of the transaction, the amount of the transaction, and the price at which each transaction was conducted. Additional disclosures of discount window borrowers and transactions information were made on March 31, 2011.

As Bloomberg notes in its refutation, without proper detail of all the transactions, you and your colleagues in Congress were indeed in the dark. Also, Mr. Bernanke uses a subtle deception to imply complete disclosure has been made regarding the Fed's MBS transactions, which constitute its largest asset class of purchases. Details released by the Fed (and only because of Congressional mandate) were made only for the period January, 2009 through August, 2009, when actual MBS purchases and sales began in late 2008 and continued through mid-2010, having again restarted recently.

In addition, all such disclosures were made only with respect to the Fed's $1.25 trillion MBS purchase program. Few details of the MBS transactions in the Maiden Lane "wind down" portfolio of Bear Stearns assets have been made. And when they have been disclosed, they are for different windows in time. Accordingly, it is possible (though not possible to prove based on the incomplete public record) that BlackRock was trading both sides to generate profits for Maiden Lane to avoid a $1.15 billion loss by JPM. This by itself suggests the Fed deserves more, not less, scrutiny, the self-serving, deceptive pleas of Mr. Bernanke notwithstanding.

Skipping ahead:

Although the articles do not stress this point, it is important to note that nearly all of the emergency assistance has, in fact, been fully repaid or is on track to be fully repaid. This fact has been verified both by the Board's independent auditors and the Government Accountability Office (GAO).

Importantly, Federal Reserve lending should in no way be compared with government spending. Federal Reserve lending is repaid, with interest, and the Federal Reserve has never suffered a credit loss. As provided in the Dodd-Frank Act, the GAO conducted a review of all of the emergency lending facilities and confirmed in its report on July 21, 2011, that not only were there no material issues with respect to the design, implementation and operation of the facilities, but that all loans to the facilities were fully repaid or expected to be fully repaid.

Mr. Bernanke touts the fact that the emergency lending facilities are (or are on track to be) repaid. With respect to Maiden Lane, that is indeed thanks to the aggressive trading performed by BlackRock, contrary to the Fed's public disclosures made in early to mid 2008 in your chambers. More importantly, in mentioning that the Fed has never suffered a credit loss, Mr. Bernanke evades a more important point--that it will likely take substantial capital losses on many of its purchases. That is, the Fed bought many of the securities in its portfolio above prevailing market prices, which itself is a subsidy for its primary dealers, and it will lose money on a substantial number of these purchases when they mature. This is especially so with its more than $1 trillion portfolio of MBS securities, which lose money when mortgage rates fall (as they have done several times over the last year and a half). More on this in a bit.

Third, the articles make no mention that the emergency loans and other assistance have generated considerable income for the American taxpayers. As reported in the Annual Report of the Board of Governors, alongside the Board's audited financial statements, the emergency lending programs have generated an estimated $20 billion in interest income for the Treasury. Moreover, in 2009 and 2010, the Federal Reserve returned to the taxpayers over $125 billion in excess earnings on its operations, including emergency lending. These amounts have been publicly announced and are reflected in the Office of Management and Budget's financial statements for the government and have been verified by the Federal Reserve's independent outside auditors. The Federal Reserve is on track to return a comparable amount to taxpayers this year as well.

Because of its massive purchase programs and balance sheet expansion, the Fed has indeed remitted $125 billion over the last two years to the US Treasury from the proceeds of interest on its securities (after payment of the Fed's own, largely non-disclosed expenses). If I can hammer one thing home, Congress, that serves your vital interest, it is the following: large payments by the Fed to the Treasury are a temporal anomaly and will not last. In fact, it is more likely that the member banks of the Fed, disproportionately, the larger banks, will end up with this cash instead. Read on, as to why.

After the Fed massively expanded its balance sheet through the creation of reserves (printing digital money), it has attempted to mitigate price inflation by encouraging banks to keep such reserves parked at the Fed. This program, accelerated by you, Congress, in October, 2008, approved the payment of interest on reserves. As long as short term rates are exceptionally low (and Mr. Bernanke said they would be through mid-2013), this is a minor expense. Meanwhile, the Fed is earning higher interest rates on the $2 trillion+ in securities it bought as part of its so-called QE programs. It is the spread between what it earns and what it must pay that allows the Fed to remit funds to the Treasury, and by extension the taxpayers.

When (and not if) short term interest rates rise (and the markets might force this in a violent fashion long before Mr. Bernanke would prefer), the Fed could easily go cash flow (or carry) negative. That is when the cost of paying banks interest on reserves (to reign in price inflation) exceeds the Fed's interest income it receives on the securities it holds. Consider that just under three decades ago, short term rates quickly reached nearly 20%.

In response, the Fed could outright sell assets that it holds, but I urge you to consider what happens when the world's largest holder of Treasury securities switches from being a net buyer to a net seller of Treasurys and what it would do to the United States' long term borrowing rates. Mr. Bernanke believes that he can blissfully guide the Fed to a graceful exit from its $2 trillion+ balance sheet expansion. You might not wish to give him the benefit of the doubt.

This scenario is not lost on the Fed, which is why in March, 2009, its Board of Governors concocted a fraudulent accounting scheme (implemented retroactively to include the year 2008), which allows it to operate with negative income. It also prevents its member banks from having to pony up the difference, which was the case prior to the accounting change. Instead, in this scenario, the interest that the Treasury pays on securities held by the Fed will go to the banks, instead of back to the Treasury.

It's beyond the scope of this response to discuss all the details. However, in brief, the Fed allows a line item on the liability side of its balance sheet (specifically, the one that covers remittances to the US Treasury) to go negative. It creates a deferred asset from a hypothetical amount it will be remitting to the Treasury at some non-specified time in the future.

The heads of anyone with accounting knowledge ought to be spinning right now. For everyone else, it's as though you or I could log into our bank account and increase our balance in any given month in which expenses exceed income, with the promise that we will correspondingly lower our balance the next time we have a surplus. Only, there is no guarantee that you or I would ever again generate a surplus--meaning, we would have printed ourselves money not to be repaid. Similarly, there is not any reason to believe that once the Fed goes cash flow negative that it will ever again generate a surplus.

This creates the absurd scenario that the Fed could end up printing money as a tightening measure to reign in price inflation. Welcome to the grave that Mr. Bernanke continues to dig deeper for us. He assures us there will be nothing but an orderly withdrawal from this unprecedented activity. However, markets have a way of punishing central banker hubris.

Fourth, the articles discuss the lending made to large banks but never note that Federal Reserve lending programs went far beyond such institutions--all in furtherance of supporting the provision of credit to U.S. households and businesses. Literally hundreds of institutions borrowed from the Federal Reserve--not just large banks. The TAF had some 400 borrowers and the discount window some 2,100 borrowers. The TALF made more than 2,000 loans, while the commercial paper funding facility provided direct assistance to some 120 American businesses.

The articles also fail to note that the lending directly helped support American businesses by providing emergency funding so that they could meet weekly payrolls and on-going expenses. The commercial paper funding facility, for example, provided support to businesses as diverse as Harley-Davidson and National Rural Utilities, when the usual market mechanism for their day-

to-day funding completely dried up.

Not surprisingly, not once in Mr. Bernanke's missive does he even allude to the primary cause of the freezing of the very funding markets he takes credit for saving. Namely, his yo-yo manipulation of the money supply, noted by Austrian economist Robert Wenzel at EconomicPolicyJournal.com in real time, just prior to the onset of the crisis. To be sure, this might not be the position of most "mainstream" economists. Yet, if it is their guidance upon which you are relying, consider the article quoted in the prior link by FRBNY's own Simon Potter, Executive Vice President and Director of Economic Research at FRBNY, wherein he candidly admits the failures of mainstream economic forecasts.

While loans in certain programs might be broad-based and cover many industries, it is beyond dispute that the bulk of the loans went to the banks, and to some in particular, in disproportionate amounts.

Skipping ahead, again:

Fifth, the articles misleadingly depict financial institutions receiving liquidity assistance as insolvent and in "deep trouble." During a financial panic, otherwise solvent banks and other financial institutions can be forced to sell assets at fire-sale prices in order to meet the demands of depositors and other sources of funding. Central bank liquidity lending is designed to stem the panic by giving financial institutions a source of financing that permits them to refrain from selling assets during the panic. Again, unmentioned in these articles--but a central point--all discount window loans extended during the crisis were fully repaid with interest, indicating that, with rare exceptions, recipients of these loans generally suffered from temporary liquidity problems rather than being fundamentally insolvent. In the handful of instances when discount window loans were extended to troubled institutions, it was in consultation with the Federal Deposit Insurance Corporation to facilitate a least-cost resolution; in these instances also, the Federal Reserve was fully repaid.

Because of the nature of fractional reserve banking, what constitutes a "solvent" versus an "insolvent" bank, especially in the realm of the too-big-to-fail size is an imprecise, subjective, moving target. Even granting regulator omniscience over events, it is dishonest to assert that one can judge a liquidity versus a solvency problem with the application of 20/20 hindsight when only one option was realized.

For instance, in the maelstrom of the Fall 2008, had the regulators decided to not close Wachovia or WaMu, and had such banks received as much temporary liquidity as the many European banks not subject to those same regulators (such as Belgian bank Dexia and French bank SocGen), who is to say if Wachovia and WaMu might not have emerged "solvent" after months of liquidity injections? It simply displays a lack of imagination for Mr. Bernanke to assert, "well, they didn't fail because we propped them up with liquidity until they could repay the loans, unlike certain other firms that were unilaterally told or allowed to fail based on metrics that are impossible to apply consistently across all firms".

Based on the Fed's own loan disclosures that Mr. Bernanke reluctantly embraced only when faced with the frightening alternative of a full scale audit, the Fed allowed banks to pledge junk-grade collateral for cash at as little as 0.25% over the Fed's Federal Funds target interest rate. Indeed on many days in certain emergency programs, by far the largest asset class pledged as collateral were stocks, including those of bankrupt companies. In other words, the banks with largest trading books had the most assets to pledge to get Fed cash at below market interest rates. This fact, ignored by Mr. Bernanke, disproportionately favored the largest banks that had taken on the largest amount of leverage.

Mr. Bernanke closes with more falsehoods:

Finally, one article incorrectly asserted that banks "reaped an estimated $13 billion of income by taking advantage of the Fed's below-market rates." Most of the Federal Reserve's lending facilities were priced at a penalty over normal market rates so that borrowers had economic incentives to exit the facilities as market conditions normalized, and the rates that the Federal Reserve charged on its lending programs did not provide a subsidy to borrowers.

Note that Mr. Bernanke does not directly challenge the fact that banks received loans at below prevailing market rates. He makes a temporal shift to say that the Fed loans were made at rates that would pay a penalty under normal conditions. This is irrelevant because it is precisely the ability of those banks chosen to succeed to get loans at below market rates that allowed the rapid and considerable consolidation of the too-big-to fail banks during the crisis period. To deny this was not an outright subsidy to certain borrowers, particularly those with large trading books, is simply a lie.

Conclusion

Being practical, I fear that what will emerge from the populist anti-Fed sentiment might be worse than the present situation. However, this does not mean that the Fed and Mr. Bernanke, in particular, should continue to be given carte blanche to toy with the economy and the lives of billions based on theoretical models that have a history of nothing but failure.

That Mr. Bernanke would feel compelled to respond to Congress in response to a few media articles indicates he is still hiding much, much more than he has been compelled to disclose. It is time to up the ante and mandate a full scale audit of the Federal Reserve System.

Pollock: So that's why you're calling Jon Corzine a chicken on CNN? Koutoulas: Yes, where's the money, Jon?

Today's Senate hearings into the MF Global debacle demonstrate that conflicted Chairman (and ex-Goldman Sachs CEO) Gary Gensler is unwilling to provide anything more than mere lip service to the beleagured customers whose funds remain inaccessible more than one month from the bankruptcy filing. Further, the issue of just why exactly SIPC, a securities resolution agency, is "managing" a futures commission merchant liquidation is among the more salient issues being completely ignored--except by various customer advocacy sites, such as MFGFacts and MyInvestorsPlace.

However, MF Global customers can take a bit of solace knowing they have a voice in front of Judge Glenn in the liquidation proceedings in the form of the Commodity Customer Coalition (#CCC) and its team of hard working attorneys (working largely pro bono, we might add). The synoganists remain Trustee James W. Giddens, earning $891 per hour and seemingly doing his best to drag out the proceedings, along with JP Morgan's attoneys, who are "dictating the agenda", according to CCC attorney James Koutoulas. [Update: for an expose of the conflicts of interest arising from Giddens' firm, Hughes Hubbard, vis a vis JP Morgan Chase, MF Global's largest creditor, see this excellent piece by MFGFacts.]

Is it too little too late? We hope not, as continuance after continuance increases the odds that looting of customer funds continues to this day. In a brief but compelling video (below), Warren E. Pollock of Inflection Points goes head to head with a few journalists outside the bankruptcy court in lower Manhattan, then conducts a candid, must-watch interview with Mr. Koutoulas.

A few choice excerpts:

at 3:30 in:

Koutoulas: We were the first group to object to JP Morgan's use of the cash collateral. I think over the weekend, three or four other parties have joined our objection. And they keep continuing it...I'm going to get up and say, "Judge, there are some issues we have to talk about. We can't just keep continuing this ad infinitum." One of those is--you probably saw on ZeroHedge--the way that Order is written, it makes it possible...if these [repo-to-maturity] trades are still on, we have to know about it.

Pollack: You don't know if the trades are on right now--normally they'd have to wind down positions. But they could still be tapping into customer money at this very moment and there's no way to...recognize that.

Koutoulas: And if they did do that...that is the ultimate epitome of enabling someone to fall in love with their trade....These trades bankrupted MF Global, and the fact that there's even a possibility that they could still be on and still be using customer money to back them, it's beyond the pale.

at 5:25 in:

Koutoulas: The problem here is JP Morgan's lawyers are running the show...and they're running the agenda...Judge, the fox is in the hen house. JP Morgan cannot be dictating the agenda.

at 5:50 in:

Pollack: So that's why you're calling Jon Corzine a chicken on CNN?

Koutoulas: Yes...stand up...where's the money, Jon?

The Outcome:

In the course of the hearing that followed, the Judge asked the CCC to file a motion to formally make its case against the JP Morgan super priority status and the continued trading of customer funds. A hearing was set for December 7, 2011. Let's hope there's still money left by then.

Are MF Global Customer Funds Being Looted to This Day Through the Same Risky Trading That Sunk the Firm?

As MF Global customers approach the one month anniversary of the cluster-circus that has become the liquidation proceedings, replete with unnecessary delays, half-measures, and outright deceptive statements by Trustee James W. Giddens (that will only ensure the proliferation of hours billable at $890 each), we wish to highlight an order entered just days after the bankruptcy that gave MF Global Holdings and its affiliates carte blanche to continue the very risky and suspicious trading that led to its demise. A hearing is set for Wednesday, November 30, 2011 at 3:00 pm on this and other germane matters, including the super priority status of JP Morgan Chase (the conflicted first-lien holder) afforded to it ahead of the customers whose segregated accounts were putatively to have been held sacrosanct.

_

On November 2, 2011, the bankruptcy judge entered a seemingly innocuous order that granted an extension of time to the Debtors (MF Global Holdings Ltd. and MF Global Finance USA Inc.) to comply with the requirements of Section 345(b) of the Bankruptcy Code and an authorization of the continuation of intercompany transactions among the Debtors and non-Debtor affiliates. Detailed arguments were provided in the 19 page Motion of the Debtors filed the day of their October 31, 2011 bankruptcy.

_

Of particular interest are the arguments for allowance of the continuation of extant investment practices. When reading the pleading, note that "Company" refers specifically to MF Global Inc., the broker dealer/futures commission merchant unit that did NOT file for bankruptcy, while "Debtors" refers to MF Global Holdings and MF Global Finance, which did file for bankruptcy. "Debtors" and "Company" are frequently mixed within paragraphs, which either causes confusion as to intent or allows for an expansive interpretation that justifies the continued looting of customer accounts. All emphasis herein is ours, except for headings:

D. The Debtors Should Be Authorized to Continue Their Investment Practices

_

23...The Deposit and Investment Practices are governed by an investment policy, which provides that such investment activities must comply with federal and state regulations, as well as any regulations imposed by its regulators. In addition, the investment policy describes the Company’s permissible investments, which include: (a) government securities and government guaranteed securities; (b) money funds; (c) United States Treasury and government money funds; (d) federal agency obligations; (e) corporate obligations; (f) money market instruments; and (g) other permissible investments approved by the Company’s investment committee from time to time.

The blanket generalization in (g) opens the door to any of the investments that the Company, MF Global Inc., had engaged in previously, including the famed $6.3 billion in European debt [off balance sheet] repo-to-maturity trades. Ordinarily, any such investments not guaranteed directly or indirectly by the US government would be subject to a performance bond:

_

24. Bankruptcy Code section 345(a) authorizes a debtor-in-possession to make deposits or investments of estate money in a manner “as will yield the maximum reasonable net return on such money, taking into account the safety of such deposit or investment.” 11 U.S.C. § 345(a). If a deposit or investment is not “insured or guaranteed by the United States or by a department, agency, or instrumentality of the United States or backed by the full faith and credit of the United States,” Bankruptcy Code section 345(b) provides that the debtor must require that the entity with which the deposit or investment is made obtain a bond in favor of the United States that is secured by the undertaking of an adequate corporate surety. Id. § 345(b).

_

However, arguments would be made for an exemption:

_

25. The Court has discretion to modify the section 345(b) requirements “for cause.” 11 U.S.C. § 345(b). Indeed, while these requirements may be “‘wise in the case of a smaller debtor with limited funds that cannot afford a risky investment to be lost, [they] can work to needlessly handcuff larger, more sophisticated debtors...

_

Sophisticated, indeed. The pleading continues with a rather confusing paragraph that implies the exemption from a performance bond is required for investments that would be in bank accounts, the balances of which exceed FDIC insurance limits. Yet, the final sentence implies there is more going on than simple bank account sweeps when it mentions "[investments and deposits] made by non-Debtor affiliates engaging in the Company's core investments businesses." (Again, "Company" refers to the broker dealer/futures commission merchant unit, while "Debtors" refers to MF Global Holdings and MF Global Finance.)

_

26. The Debtors submit that the circumstances of this case warrant such relief. The Company is a large, sophisticated entity with a complex Cash Management System that relies on multiple Banks and Bank Accounts on a daily basis. The Bank Accounts used by the Debtors are maintained in the United States and are with stable financial institutions that are insured by the FDIC. Furthermore, in light of the regular deposits and sweeps of the Bank Accounts, requiring the Debtors, or any entity with which money is deposited or invested by the Debtors in accordance with the Deposit and Investment Practices, to incur the expense of posting a bond to the extent that the balances of these accounts exceed FDIC insurance limits at a given time would be especially burdensome and wasteful. Finally, in addition to the Company’s own investment policies that serve as a safeguard of the Debtors’ funds, there is a significant distinction between the Debtors’ own investments and deposits—which support the Debtors’ cash-management function—and those made by non-Debtor affiliates engaging in the Company’s core investments businesses.

_

27. Accordingly, the Court should authorize the Debtors to continue to deposit funds and invest in accordance with the Deposit and Investment Practices and grant the Debtors a 60-day extension, without prejudice to seek further extensions, to either comply with Bankruptcy Code section 345(b) or to make other arrangements that would be acceptable to the U.S. Trustee.

_

The Debtors then argue, through a series of complex legal arguments, to be explicitly allowed to continue with intercompany transactions, the relevance of which will be explained following the excerpts.

_

E. The Debtors Should Be Authorized to Continue Intercompany Transactions

28. The Debtors’ books and records also reflect numerous other intercompany

account balances among various Debtors as of the Petition Date. All prepetition intercompany

account balances have been frozen, as of the Petition Date, and the treatment of such claims will

be determined as part of an overall reorganization plan for the Debtors.

_

29. To ensure that each individual Debtor will not, at the expense of its creditors, fund the operations of another Debtor entity, the Debtors respectfully request that, pursuant to section 364(c)(1) of the Bankruptcy Code, all intercompany claims against a Debtor by another Debtor arising after the Petition Date as a result of intercompany transactions and allocations (“Postpetition Intercompany Claims”) be accorded superpriority status, with priority over any and all administrative expenses of the kind specified in sections 503(b) and 507(b) of the Bankruptcy Code, subject and subordinate only to (a) any order granting adequate protection to the prepetition secured lenders and (b) other valid liens...

_

30. In addition, in connection with their role under the Cash Management System facilitating the operations of the non-Debtor affiliates, the Debtors may, in the ordinary course of business, periodically infuse capital into certain of their subsidiaries and affiliates, including non-Debtor non-U.S. affiliates. These infusions of capital generally are accomplished through the making of intercompany loans. The Debtors use repayments of such loans as a tax efficient method of managing cash throughout their worldwide business enterprise. Because the non-Debtor affiliates are part of the same group of affiliated entities as the Debtors, the entirety of intercompany transactions among Debtors and non-Debtor affiliates alike remain within the spectrum of the Debtors’ control.

_

31. The relief requested herein is necessary because certain non-Debtor affiliates may require intercompany advances in order to maintain their liquidity and going concern value. Courts frequently have granted such superpriority status to postpetition intercompany claims in cases such as this. ...

_

33. The Cash Management System allows the Debtors to track all obligations owing between related entities and thereby ensures that all setoffs of intercompany transactions will meet both the mutuality and timing requirements of section 553 of the Bankruptcy Code. Therefore, the Debtors respectfully request that the Debtors and their non-Debtor affiliates be expressly authorized to set off prepetition obligations arising on account of intercompany transactions between a Debtor and another Debtor or between a Debtor and a non-Debtor affiliate. Further, the Intercompany Transactions provide numerous benefits to the Debtors. The Debtors therefore seek to continue the Intercompany Transactions postpetition in the ordinary course of their businesses.

_

While it might be desirable under a "normal" financial company bankruptcy to seek maximization of benefits to the Debtors such that creditors be paid as much as possible during recovery, MF Global Inc customers (who are NOT creditors) can currently expect at best a 60% recovery going into mid-December and should be placed first in line until 100% recovery is obtained. Further, from the numerous conflations and generalizations in the paragraphs above that allow, for among other things, payments to non-US affiliates, it is possible that the looting of MF Global customer funds continues to this day. We wonder if this is why the MF Global trustee continually revises upwards the estimated maximum loss of customer funds.

_

As to exactly how this might be possible, we pointed out as early as November 9 that the Euro debt repo-to-maturity trades were performed by MF Global Inc. with an affiliate (not Goldman or JP Morgan, as was hypothesized in the media), with the affiliate to receive 80% of profits from the transactions. Inasmuch as J. Christopher Flowers and friends were among MF Global Holdings' larges shareholders, it is conceivable that outflows continue to this day to an affiliate of Jon Corzine's good friend.

_

Given the extension granted by the judge allows these potential shenanigans to continue throughout the end of 2012, it is imperative that immediate disclosure of all trading and intercompany transfers be obtained, especially if they are being conducted to the derogation of the customers.

* * *

MF Global Customer Resources:

_

Commodity Customer Coalition (7,000 members and growing)

MFGFacts.com

MyInvestorsPlace.com

EBatEPJ (website, twitter feed, email: english (at) economicpolicyjournal (dot) com)

_

* * *

Inteview with James Koutoulas of Typhon Capital Management and the Commodity Customer Coalition

Interview with Elaine of MFGFacts.com

Futures Regulators Sanctioned, Then Delayed Rule Changes Regarding Ability of Firms, Such as MF Global, to Bet With Customer Funds

EconomicPolicyJournal.com has learned that in 2003, the National Futures Association (NFA), a futures industry self-regulatory organization, wrote a letter to the Commodity Futures Trading Commission (CFTC), the industry's governmental regulator, successfully arguing for rule changes that would lift restrictions on trading with customer segregated funds by clearing firms, such as MF Global Inc.

Six years later, after substantial restrictions on trading with customer funds were proposed in 2010 pursuant to Dodd-Frank, MF Global lobbied the CFTC through public comment letters and private meetings. Ultimately, the CFTC would choose to delay implementation of the reforms only months before MF Global's demise and bankruptcy.

Sweeping regulatory changes in the futures industry were made in the year 2000, including to CFTC Rule 1.25, which governs the ability of firms to invest customer segregated funds. But, an obscure CFTC letter from 1984 limited the ability of clearing firms to loan customer funds and securities outright, through what are called repurchase (or repo) contracts, unless the clearing firm had explicit permission from the customer. In 2003, the CFTC proposed a revision to the rule to eliminate these and other restrictions.

In the NFA's 2003 comment letter to the CFTC, archived on its website, it said, "NFA supports the proposed amendment to CFTC Rule 1.25 allowing [futures clearing firms] to engage in repurchase agreements with collateral deposited by customers. The safeguards included in the proposal...provide ample protection for customer deposited securities. The amendment provides greater flexibility, requires less paperwork, and reduces the burden on [futures clearing firms] and their customers." The NFA also argued, "it is not necessary to provide an opt-out mechanism...[which would be] costly and burdensome...without a corresponding regulatory benefit."

MF Global filed for bankruptcy on October 31, 2011 after $6.3 billion in risky bets on European debt (so-called repo-to-maturity trades) were required by regulators to be made public, leading to ratings downgrades of the firm. Other investment firms and banks then requested more collateral as insurance for trades they had made with MF Global, which were unable to be met.

While it is alleged that the $6.3 billion in European debt repurchase trades were conducted with MF Global's own firm money, it is unknown how an estimated $600 million in customer segregated funds went missing. If MF Global had lent customer cash or securities through repurchase contracts, it is possible a counterparty to the trade kept the cash or securities as collateral for other trades with MF Global.

Pursuant to the the Dodd-Frank bill signed into law on July 21, 2010, the CFTC proposed reforms to Rule 1.25 that would have limited investment in customer funds. In a letter to the CFTC, MF Global's general counsel, Laurie Ferber, formerly managing director Goldman Sachs, objected to many of the proposed changes, including what were to be severe restrictions on repurchase transactions, including those with customer funds and with affiliates of the firm.

Ms. Ferber's influence in futures regulation is substantial and spans over two decades. As general counsel to a commodity firm owned by Goldman Sachs, in 1991, she was able to secure a secret letter from the CFTC (made public only in 2008) that granted exceptions to limitations designed to curb speculation in commodity futures.

On July 20, 2010, Ms. Ferber, along with MF Global president and former Goldman Sachs CEO, Jon Corzine, appeared in two private meetings with high level CFTC officials, including another former Goldman Sachs CEO, Gary Gensler, to discuss the proposed rule changes. The same day, the CFTC announced in the Federal Register (footnote 4) that the proposed changes to Rule 1.25 governing customer funds would not be addressed and "may be subject to future [CFTC] rulemaking."

It was only three months later that MF Global would admit to regulators that over $600 million in customer funds could not be accounted for. Over $800 million in cash remains frozen in customer accounts, including those of bona fide hedgers, such as farmers and bread producers.

Dither, MF Global Trustee Giddens

Yesterday, MF Global Inc. liquidation trustee James W. Giddens, filed an application to the bankruptcy court to establish claims procedures for MF Global brokerage customers who have had their cash frozen for over two weeks now, as well as the broker's general creditors. While this would seem a step in the right direction, the proposal falls far short of what could be done to provide relief for MF Global customers, while imposing further unnecessary delays. The proposal was filed with a motion for an expedited hearing on the matter to be conducted the very next day (today, in fact, at 3:30 pm), which was granted minutes later by the bankruptcy judge, according to the docket.

_

Per the proposal, claim forms would be mailed to MF Global customer on November 28 and be posted on the trustee's website, whereafter customers would have two months, extended up to six months in some cases, to file claims. Other documents filed suggest there would be a 60% payout, but the trustee's proposal does not outline any specific timeline or payout percentage. [Update: In a separate motion, the Trustee has requested expedited payment of 60% of customer funds.] Indeed, his proposal says interim distributions would be made "if possible". This is wholely unacceptable. Based on current estimated missing funds of $600 million, or approximately 12% of segregated account assets, the assumed 60% payout is well below any reasonable threshold, especially considering the CME Group has pledged $250 million to backstop any overpayment by the trustee.

_

Trustee Giddens cited the "relatively poor state of the Debtor’s books and records", as we noted yesterday. However, as the below press release of the Commodity Customer Coalition points out, this is irrelevant to the delay of an immediate payout. Per futures industry regulations, each futures customer receives a daily statement of cash and open positions, marked to market. Such statements were produced even on October 31, 2011, the day of the MF Global bankruptcy filing. Many customers continued to receive electronic statements for days afterwards. Thus, what should be in the futures customers' accounts is known to the penny. What assets actually back those statements up is another matter. But, again, estimated losses support a much higher initial payout than 60%, especially with the CME's backstop.

_

In the meantime, trustee Giddens will continue to charge $891 per hour against MF Global assets (in addition to research fees of 1% for misdirected wires), and SIPC, inexperienced with futures broker liquidations (and still managing the Lehman liquidation three years and counting), is all the customers have to represent their interests. It is critical that MF Global customers obtain proper representation on what might currently be a compromised creditor committee.

_

Full press release of the Commodity Customer Coalition follows.

Commodity Customer Coalition

190 South La Salle Street, Suite 3000

Chicago, IL 60603

www.commoditycustomercoalition.org

info@commoditycustomercoalition.org

FOR IMMEDIATE RELEASE

312-933-6564

November 16, 2011

CONTACT: John L. Roe (jroe@btrtrading.com)

Commodity Customer Coalition to Object to SIPC Trustee’s Claims Process for MF Global Bankruptcy, Propose Faster Alternative Claims Process

In response to the SIPC Trustee’s expedited application for an order from the court to put both securities and commodities customers of MF Global through the same claims process, the Commodity Customer Coalition (“CCC”) is filing an emergency objection to that application and proposing a faster, more efficient claims process to immediately release a majority of customer funds. The CCC issued the following statement:

The Commodity Customer Coalition applauds the Trustee’s recent motion to release 60% of assets held in cash on October 31, 2011. However, that simply isn’t good enough. This only represents a very small portion of the total assets frozen in the bankruptcy. Additionally, the Trustee has proposed a snail mail approach to collecting claims. He says they cannot use the books of MF Global to verify customer claims, but his process will only result in customers mailing him statements based on those books and it will do so over a period of months. Our proposal will streamline this process with a more commonsense approach, affirm the primacy of customer property over the claims of creditors and return funds to their rightful owners in a matter of days, not months.

The basis for the Trustee’s proposal is that he cannot give us an accurate accounting of the shortfall in customer funds. But MF Global’s estate has $1.2 billion in excess equity and the CME has thrown him a life line of $250 million if he sends home too much money. MF Global claimed under oath that only $600 million in funds is missing. So the shortfall in funds is irrelevant; the Trustee has 250% over the shortfall. That money is supposedly accounted for on a daily basis to the NFA, CFTC and MF’s DSRO, which was the CME. The Trustee has had over two weeks to sort through this and get clients their money. It’s time to truly expedite this process and make customers whole.

Mr. James Koutoulas, Esq. will appear in person tomorrow to argue the CCC motion before the court. He will make himself available to the press immediately following the hearing on the steps of the courthouse.

###

The Commodity Customer Coalition now represents over 7,000 former MF Global customers whose funds have been frozen by the SIPC Trustee. For more information, or to schedule interviews, please contact John L. Roe

(jroe@btrtrading.com, 312-933-6564).

The Commodity Customer Coalition Objects to JP Morgan's Super-Priority Protection Over MF Global Customers

Last week, we noted many peculiarities with respect to the MF Global bankruptcy, not the least of which is the first-lien protection granted to JP Morgan Chase only two days after the bankruptcy, which gives the bank (MF Global's largest creditor) priority claim over MF Global's own customers--an unprecedented act within the futures industry. To date, an estimated $600 million of what were supposed to be segregated customer funds remains missing, and the remaining cash in thousands of customer accounts, including that of farmers, producers and speculators alike, remains frozen.

Only yesterday, after collaboration with other customer attorneys, James Koutoulas filed an objection to JP Morgan's super-priority protection. Inquiries, including those of other MF Global customers and the media may made through the Commodity Customer Coalition website.

The text of the Objection follows. The full filing here:

Pg 1 of 12

James L. Koutoulas, Esq. 190

S. LaSalle St., #3000

Chicago, IL 60603

(312) 836-1180

James L. Koutoulas

Counsel for the Commodity Customer Coalition

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK

In re:

MF GLOBAL HOLDINGS LTD, et al.

Debtors

Chapter 11

Case No. 11-15059 (MG)

COMMODITY CUSTOMER COALITION’S OBJECTION TO THE

MOTION OF THE DEBTORS FOR INTERIM AND FINAL ORDERS UNDER

11 U.S.C. §§ 105, 361, 362, 363(c), AND 363(e) AND BANKRUPTCY RULES 2002, 4001,

6003, 6004 AND 9014 (I) AUTHORIZING THE DEBTORS TO USE CASH

COLLATERAL, (II) GRANTING ADEQUATE PROTECTION TO THE

LIQUIDITY FACILITY LENDERS, AND (III) SCHEDULING A FINAL

HEARING PURSUANT TO BANKRUPTCY RULES 4001(b) AND (c)

The Commodity Customer Coalition, which is made up of numerous MF Global, Inc. customers such as Phil Edgerley, a hog farmer from central Illinois, as well as those other customers listed on Exhibit A (and, on an informal basis, represents the interests of over 2,500 MF Global, Inc. customers who have indicated interest via email or through their brokers) (together, the “Customers”), objects to the Motion of the Debtors for Interim and Final Orders (“Motion”) on the following grounds:[1] (i) the Debtors have not provided adequate notice of the

1 Capitalized terms that are otherwise not defined in this Objection shall have the same meaning ascribed to them in Debtors’ Motion.

Pg 2 of 12

Motion to all interested parties; (ii) no one — not the Liquidity Facility Lenders or the professionals — is entitled to priority secured interests in assets that may belong to Customers; (iii) the Debtors have not proposed any protection for the priority interests of Customers; and (iv) the Liquidity Facility Lenders are not entitled to a finding of good faith at this stage in the proceedings.

INTRODUCTION

MF Global, Inc. was a registered broker-dealer, used by its Customers to trade commodities, futures and derivatives. Customers maintained accounts at MF Global, Inc., which were supposed to be held inviolate under CFTC Regulation 4.20(c), and which have a first-priority right of recovery under 11 U.S.C. § 766(h) and 17 C.F.R. § 190.08. Yet, it appears that over $600 million in Customer funds are unaccounted for at MF Global, Inc. (“Missing Funds”), due to poor internal controls, and may have been commingled with proprietary funds held by MF Global, Inc., and the Debtors.

Presently, the Securities and Exchange Commission (“SEC”), Commodity Futures Trading Commission (“CFTC”), the FBI, and the Trustee overseeing the liquidation of MF Global, Inc., are investigating the disposition of the Missing Funds. It could be that some or all of the missing funds are held by, or are tied up in assets owned by, the Debtors. According to Section 766(h) of Chapter 11 of the Bankruptcy Code, such funds would have to be returned to the Customers before any other creditor.

Pg 3 of 12

In the meantime, Debtors, the Liquidity Facility Lenders, and the professionals representing both, have sought approval to carve out funds for themselves — under a so-called super-priority protection — without regard to the Customers’ right to have their funds returned before any other money is spent from the bankruptcy estate. Yet, the Debtors have not provided notice to all MF Global, Inc. customers, nor have they apparently even notified the trustee for MF Global, Inc. of the potential impact of the Motion on potential Customer funds.

Indeed, if granted, such a super-priority right would abrogate sacrosanct protections for commodities account holders, depriving those who trade in commodities, futures, and derivatives, of their only protection and potentially chill economic activity. It is premature to enter such an order — particularly one that includes a “good faith” finding to a lender that may have benefitted from the improper transfer of the Customer Funds to pay down an outstanding loan.

BACKGROUND

MF Global customers represent a cross-section of people across America and the world, from farmers and ranchers who hedge their crops and herds, to oil producers and miners who use futures to lock-in prices and take delivery of physical commodities, to retirees who invest in futures to diversify their portfolios. For example, farmers who have crops in the field need to sell futures in commodity markets so they can lock in prices for their future yields today, instead of taking on market risk as they would otherwise be exposed to volatile price swings. Large corporations like Coca-Cola who make money in foreign markets do not want to lose

Pg 4 of 12

money when they repatriate revenue earned in foreign currency. They have to be able to forecast future expenses and profits accurately in the currency of their domicile and hedge that currency price risk in futures markets accordingly.

Investors add volume and liquidity to these markets which allow for better, more efficient pricing of commodities. This allows for stability in prices of commodities and predictability of future profit and loss, which in turn allows for stability in producer and consumer prices. These commodities include everything from grains like corn and wheat, to energy like oil and natural gas, to soft goods like cotton and sugar, to currencies like the US dollar and Euro, to financial instruments like bonds and stock indexes. Simply put, trading in commodity futures markets is a mainstay of the American economic engine.

Segregated Funds: Cornerstone of the Commodities Industry:

One of the big differences between commodities brokers and securities (stocks and bonds) brokers is that commodity brokers have an obligation to keep customer funds completely segregated from the firm’s own assets. This is to ensure that clients are completely protected from losses sustained by the firms’ trading and operations. It also is in contrast to the securities industry, as the Securities Investors Protection Act back-stops losses suffered by securities investors due to broker malfeasance, but does not similarly back-stop similar losses suffered by commodities investors.

Many industry groups and regulators have heralded segregated account protection, arguing that no client has ever lost a penny from a segregated account as the result of a broker bankruptcy, and this has been a key driver of volume and profitability for the Chicago

Pg 5 of 12

Mercantile Exchange. “However, all futures trading accounts, including managed futures, have the advantage of specific industry rules that require the segregation of customer funds from the firm's own funds. The practice of segregating customer funds protects investors in the event of default at the Futures Clearing Merchant (FCM, the industry term for futures brokerage firms licensed to trade on futures exchanges in the U.S.) holding their account. While FCM bankruptcies are rare, they do occur. 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.” See “Safeguarding Customers Through Segregated Funds” by CME Group, Inc. http://www.cmegroup.com/managedfutures/Feb2011/safeguarding-customers-through-segregated-funds.html.

So, whereas securities clients are afforded various insurance in the event of a broker bankruptcy, commodities clients are afforded none—which is economically rational only because their funds cannot be commingled with a broker's assets and cannot be used to pay creditors in a bankruptcy. Segregated funds are accounted for daily to the National Futures Association (“NFA”) and to the CFTC through the broker’s designated self-regulatory organization (“DSRO”), which in MF Global’s case was the Chicago Mercantile Exchange (“CME”).

MF Global Did Not Maintain Segregated Accounts

Despite the fact that MF Global was responsible for maintaining full segregation of customer funds on a daily basis, there remains $633M in unaccounted for customer segregated

Pg 6 of 12

funds two weeks after the firm filed bankruptcy. Moreover, the officers and directors of MF Global have thus far been uncooperative in aiding the court in ascertaining the whereabouts of these missing funds, despite a formal probe by the CFTC, the US futures regulator. This has driven the Trustee’s office to comment: “Our forensic investigators have been there since last week and nothing we have found so far causes us to think anything other than there is an apparent shortfall at MF.” See “MF Global Fund Frustration Grows, CFTC Confirms Probe,” by Reuters, November 10, 2011, http://www.reuters.com/article/2011/11/11/us-mfglobal-cftc-investigation-idUSTRE7A96C420111111

These failures to cooperate are consistent with the operating history of MF Global, which is fraught with examples of misconduct and disregard for regulations. “An analysis of regulatory enforcement actions shows MF Global has drawn more sanctions from the U.S. commodity futures regulator than each of its 14 closest peers in that market over the past decade. MF Global has also drawn the second highest amount in fines, for alleged lapses in risk supervision and recordkeeping.” See “Insight: Risk, Lax Oversight Riddle MF Global’s Past,” by Reuters, November 11, 2011, http://www.reuters.com/article/2011/11/11/us-mfglobal-legal-fidUSTRE7AA2KO20111111

As of today, it is not clear where the Missing Funds might be—although they may have been taken as part of one or more margin calls related to sovereign debt held by MF Global on its own account. See “MF Global May Have Used Customer Funds In The Losing $6.3 Billion Trade Without Informing Clients,” November 8, 2011, Forbes, at http://www.forbes.com/sites/robertlenzner/2011/11/08/mf-global-used-customer-funds-in-the-

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losing-6-3-billion-trade-without-informing-clients/. The CME has gone so far as to say that it appears MF Global moved funds immediately prior to bankruptcy from “segregated funds in a manner that may have been designed to avoid detection,” according to a CME statement on November 2, 2011. http://www.prnewswire.com/news-releases/cme-group-statement-regardingmf-global-133102203.html. It is equally possible that these funds were seized and used to pay down the line of credit held by MF Global Holdings, Ltd. or have otherwise been used to bolster cash held by the Debtors.

ARGUMENT

Due to the apparent shortfall of customer segregated funds and the lack of cooperation by MF Global officers and directors in determining its whereabouts, it is imperative that the Court does not grant any liens, encumbrances, priorities, or super-priorities of any assets in the Debtors without protection for customer funds at this time.2 To do so could allow Debtors and JPMorgan Chase Bank, N.A. (“JPMorgan”) to obtain a priority over Customers on Customer Funds, in derogation of the Bankruptcy Code and CFTC regulations. This would deprive commodity investors of the one protection they have — a right to priority payout — and possibly further chill economic activity in these troubled economic times. Accordingly, absent some protection for Customers, Debtors’ Motion must be denied.

2 Objectors realize that MF Global Holdings, Ltd. and the other Debtors wish to reorganize and that many thousands of jobs are at stake. Given the $1.2 billion in equity claimed by the Debtors in their Voluntary Petition, there should be a way to provide adequate protection without impacting the rights of segregated customer account holders. Also, if in fact $1.2 billion in equity exists, one would think that existing equity holders would provide protection to the proposed lender to protect their interests.

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I. Customers Have Absolute Priority Over Funds Implicated By The Motion.

According to 11 U.S.C. § 766(h), a bankruptcy trustee “shall distribute customer property ratably to customers on the basis and to the extent of such customers’ allowed net equity claims, and in priority to all other claims, except [limited costs] attributable to the administration of customer property.” (emphasis added.) Under 17 C.F.R. 190.8, “customer property” includes (among other things) cash, securities or other property “received, acquired or held to margin, guarantee, secure, purchase or sell a commodity contract,” any “open commodity contracts,” and even cash, securities or property that “[w]as unlawfully converted but is part of the debtor’s estate.” The Motion implicates customer property in at least two ways.

First, it is unquestionable that there are well over $600 million in Customer funds that simply have not been accounted for. If speculation is true, the Missing Funds could have been seized in a margin call or otherwise improperly applied by the Debtors to their outstanding obligations. Commingling between MF Global, Inc. and Debtors could necessitate a finding of substantive consolidation. Such a finding would, in turn, merit treating Debtors like futures clearing merchants. Such a finding would obviate the protection of Chapter 11, necessitate Debtors’ immediate liquidation, and would unquestionably require priority return of assets to Customers. Until such time as the SEC, CFTC, FBI, and the trustee overseeing the MF Global, Inc. liquidation have completed their forensic analysis, the Court ought to treat the funds that the Debtors seek to use as if they include the Missing Funds.

Second, the Motion and Amended Interim Order each provide that JPMorgan can obtain a super-priority or first priority lien (JP Morgan currently is an unsecured creditor) on all

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property in which Debtors have an interest, including “intercompany indebtedness ... owed by MF Global, Inc. to each Debtor.” In other words, it is possible, under the Motion, for JPMorgan to obtain a seemingly preferred interest in payments that MF Global, Inc. owes to Debtors—and could use that priority to force MF Global, Inc. to pay JPMorgan rather than pay Customers. The Proposed Order, in Paragraph 5, also gives JPMorgan priority over any claims.

Put simply, given the unknowns at this stage in the proceeding, it is undeniable that the Motion may impact funds and/or assets that should first be paid out to Customers—not to lenders and professionals.

II. Customers Should Have Received Notice.

In this matter, notice has been given in haphazard fashion. Debtors sought and received interim rights over cash collateral and JPMorgan received its super-priority rights on an interim basis without any real notice being given. Then, a hearing was noticed for November 14, 2011. An amended notice, found at Dkt. No. 63, re-set the hearing for Thursday, November 16, 2011, at 3:30 p.m. It also set the objection date for November 11, 2011. Of course, the 16th is a Wednesday and November 11, 2011, was a federal holiday.

Even assuming Debtors have calendar-challenges rather than devious intent, Customers still should have received notice of the Motion. As first-priority claimants for whom over $600 million in collateral has vanished, it seems unquestionable that Customers of MF Global, Inc. potentially have rights that ought to be protected in the closely related bankruptcy of MF Global Holdings, Ltd. Yet, no effort was made even to post notice of the Motion on the SIPC trustee’s website in the related bankruptcy.

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http://dm.epiq11.com/MFG/Project/default.aspx. For this reason alone, the Motion ought to be denied at this time, until adequate (and accurate) notice can be provided to Customers.

III. The Court Ought To Protect Customer Funds.

As noted above, a finding of commingling between MF Global, Inc. and Debtors could necessitate a finding that MF Global, Inc. and the Debtors were substantively consolidated. Such a finding would, in turn, merit treating Debtors like futures clearing merchants. And, such a finding would require that the Court give first priority not to JPMorgan or the professionals in this matter, but to Customers.

It is not beyond the pale to expect that the massive investigation being undertaken by the SEC, CFTC, FBI, and SIPC trustee, will unearth facts that support such a finding. Accordingly, assuming the Court finds that Debtors provided adequate notice, the Court should protect the Customers’ funds. One such protection would be to release $633 million immediately from the estate of MF Global Holdings, Ltd., which reports excess equity of more than $1.3 Billion. (See Mot. at 5.) This would leave Debtors and their lenders with sufficient additional equity to wind-down Debtors’ business.

Absent such relief, Customers have no other recourse. Indeed, the SIPC cannot provide relief to the Customers, as its protections only inure to those trading in securities. The CME’s offer of $250,000,000 in liquidity does not staunch the bleeding, either. It is an insufficient band-aid, at best. As a result, hundreds, if not thousands, of commodity traders are being forced to liquidate trading positions, are losing opportunities to trade and to hedge market risk, and are losing trading positions because the cash they need in order to make margin calls is

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tied up with MF Global. These parties’ inability to trade, combined with the commodity market’s loss of confidence resulting from this collapse, will certainly have a chilling effect on the economy.

Accordingly, the Customers ask that the Court protect Customer funds by immediately releasing $633 million to them or, in the alternative, clearly providing — in any final order relating to the Motion—that: (i) Customers shall have a right to an ad hoc committee to monitor events in these bankruptcy proceedings; and (ii) any priority lien given to any party in this bankruptcy shall not be superior to the rights, if any, of the Customers to recover from this bankruptcy estate; and (iii) professionals have no right to recover for fees and expenses until such time as any funds deemed — by the SEC, CFTC, FBI, the SIPC trustee, or this Court — to be Customer funds have been released to the Customers.

IV. It Is Too Soon To Make A Good Faith Finding.

In the Interim Order, it specifically provides that JPMorgan is deemed to have acted in “good faith” and, accordingly, is entitled to the protection of Bankruptcy Code Sections 363(m) and 264(e). Simply put, until the SEC, CFTC and SIPC trustee have completed their investigations, it is simply too soon to determine whether JPMorgan bargained in good faith, at arms-length, for the right to super-priority liens in this matter. Accordingly, Customers respectfully request that the Court note, in any final order relating to the Motion, that it is withholding judgment as to whether JPMorgan has acted in good faith in these proceedings.

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V. Conclusion.

Were this Court to allow any party to have an interest superior to customer segregated funds, it would provide a loophole in the protections which are the bedrock of commodity trading. This Court should only provide for the use of Cash Collateral which protects customer funds as Congress, the CFTC, CME, and hundreds of thousands of commodity traders have, for over 100 years, believed to have been the case. The system of regulation in the commodities industry is based on this bedrock principle, and this proceeding should in no way affect it. Wherefore, Phil Edgerley, et al request this honorable Court to deny the request in its current form to utilize Cash Collateral, and only allow such use in a manner which protects segregated customer account holders.

Dated: November 14, 2011

By: /s/ James L. Koutoulas

James L. Koutoulas, Esq.

Pro Hac Vice Pending

On Behalf of Commodity Customer Coalition

and Plaintiffs Listed in Exhibit A

190 S. LaSalle St., #3000

Chicago, IL 60603

(312) 836-1180

Disclosure: Neither the author of this post nor his affiliates is represented by Mr. Koutoulas, nor are they members of the Commodity Customer Coalition.