Nov. 2, 2011 — -- The story of MF Global's downward spiral, with former New Jersey governor Jon Corzine at the helm, is only starting to unfold, though some may say it was a predictable one.
With news that federal regulators, including the FBI, are investigating whether the broker-dealer is missing customer money, the company's failure may have larger repercussions to the financial system.
"I think it will add to the complexity of the situation and will add to more skeletons," Jody Lurie, corporate credit analyst at Janney Capital Markets, said. "This won't be as much of an open-and-shut case as we would expect."
On Tuesday, the Associated Press reported that the FBI is expected to investigate whether customer money is missing and if criminal activity was involved.
The Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) said on Monday that MF Global "reported possible deficiencies in customer futures segregated accounts held at the firm."
The two agencies determined that a bankruptcy proceeding led by the Securities Investor Protection Corporation (SIPC), as opposed to a bankrutpcy trustee, "would be the safest and most prudent course of action to protect customer accounts and assets."
MF Global's problems are mostly related to its exposure of $6 billion to European sovereign debt, part of $41 billion in total assets, according to Janney Capital Markets. The company's stock price declined more than two thirds last week after Moody's and Fitch downgraded the firm's debt. The company's board had met this weekend in New York to consider its options, including a sale, which ultimately failed.
"It's a bit unusual how the event unfolded," Patrick O'Shaughnessy, equity research analyst with Raymond James & Associates, said.
O'Shaugnessy said he agreed that the bankruptcy unfolded relatively quickly.
How much blame can be placed on Corzine is unclear, though he did have an "aggressive" plan during a volatile period, said Lurie.
The problem was that MF Global, initially a "middle-man" in trading, had too much risk relative to its size, she added.
"MF Global has more narrowed business focus. Their exposure to Europe was a lot bigger than their size," she said. "Their liquidity levels were not robust enough to handle that risk."
Describing MF Global's second quarter results on Oct. 25, Corzine expressed some optimism in the company's future, despite a drop in revenues to $205.9 million for the second quarter, compared with $240.3 million for the same period last year.
"Over the course of the past year, we have seen opportunities in short-dated European sovereign credit markets and built a fully financed, laddered maturity portfolio that we actively manage," Corzine said at the time. "We remain confident that we have the resources and expertise to continue to successfully manage these exposures to what we believe will be a positive conclusion in December 2012."
Brought on to lead MF Global into the next level as a financial institution, Corzine had come from politics after being ousted as CEO of Goldman Sachs. His career as CEO of Goldman Sachs spanned from 1994 until 1999.
An article in New York magazine from July 2005 reported that he was booted out of the company in a coup that took place after he had gotten the bank's gigantic IPO approved and had gone skiing with his family.
"While he was away, three members of Goldman's five-member executive committee, led by Corzine's co–chief executive, Hank Paulson (the man he appointed and who still runs the company), staged a palace coup, stripping him of his CEO title and his power," the magazine reported in 2005. (Paulson is no longer Goldman's CEO; from 2006-08, he served as Secretary of the Treasury under George W. Bush.)
Corzine was devastated and humiliated, so much so that he was determined to stay on for several months but worked from his car, the magazine reported.
He eventually left Goldman a richer man in terms of dollars, but "like an athlete who suddenly finds himself out of sports, Corzine needed to satisfy his continuing hunger to compete," the magazine wrote.
He became New Jersey senator from 2001 to 2006, then governor from 2006, leading the state through a government shutdown and a crisis in municipal funding that many localities and states had to endure. His tenure ended when current Gov. Chris Christie defeated him in 2009.
Lurie said it is anybody's guess what Corzine will do next.
"I don't think he's necessarily crying for money. If he wanted to throw in the towel, he very well could. But I think it leaves it up to what people make of it," she said.
Like Corzine's, the futures of the company's 2,900 employees are unclear, though the Financial Times reported employees in the office in London were told not to work but were not sent home.
Lurie said MF Global's bankruptcy has spooked the financial system, even diminishing the positive effect of the Greek debt deal last week.
"But now with this news from MF global falling apart in two weeks of being in the spotlight reminds us it's easy for financials to get caught up in market skepticism," Lurie said.
The bankruptcy demonstrates that while many financial institutions are in better positions now than they were in 2008, a liquidity scare can still cause a firm to deteriorate very quickly. It took only two weeks since the first discussion about MF Global's inadequate capital for the company to file for bankruptcy, she said, though there were earlier warnings.
In August, the Financial Industry Regulatory Authority (FINRA), an independent securities-firms regulator, instructed MF Global to boost its required net capital because of its exposure in Europe. And ahead of the company's second quarter results on Oct. 25, Moody's downgraded the company's debt to "Baa3" from "Baa2."
"Once Moody's downgraded the company and after the company posted a very poor quarter, the rest was a very quick process, somewhat akin to a run on the bank where perception of weakness becomes the reality," Patrick O'Shaughnessy, equity research analyst with Raymond James & Associates, said.
On Tuesday, Moody's downgraded the company further to "Caa1."
MF Global had disclosed its European sovereign debt position as early as its May 2011 10-K filing with the SEC, but it wasn't until Moody's downgraded MF's debt rating in late October that investor and client concern really started to rise, said O'Shaughnessy.
O'Shaughnessy said what was most surprising was the inability of Corzine and MF Global to "be on the same page" with the ratings agencies in terms of what level of risk and leverage was appropriate.
"A downgrade to junk for a firm with MF's profile and funding structure is essentially a death knell, so one would have expected MF to do everything possible to retain its investment grade rating," he said.
The SIPC announced Monday it is initiating the liquidation of MF Global, headquartered in New York City, under the Securities Investor Protection Act of 1970, as opposed to the federal bankruptcy code.
The SIPC can arrange the transfer of MF Global's brokerage accounts to a different securities brokerage firm, according to the Administrative Office of the U.S. Courts. If the SIPC is unable to arrange the transfer, the failed firm can be liquidated and the SIPC could send investors certificates for the stock that was lost or a check for the market value of the shares.