Deficiency. Shortfall. A rose by any other name means the money is long gone.

On Thursday, lawmakers will hold the third in a series of hearings on the collapse of MF Global. I advise the members of the House Financial Services Committee to cut to the chase with their questions.

Tuesday’s testimony in the U.S. Senate by customers and executives of MF Global, the firm’s regulators, and the bankruptcy trustee was a mess of details, acronyms, industry jargon, and complicated timelines. Witness after witness attempted to explain how MF Global could have come up short of more than $1 billion dollars in customers’ segregated funds on Oct. 30. As a result, the Securities Investor Protection Corp had no choice but to force the firm into involuntary bankruptcy the next day, Halloween.

Bankruptcy clearly was not what MF Global Chairman and CEO Jon Corzine, President and COO Bradley Abelow, and CFO Henri Steenkamp had in mind. They hired every other kind of advisor – Evercore to find a buyer and BlackRock to sell assets – except a bankruptcy lawyer. A sale would have been an acceptable solution to the crisis for MF Global’s major investor Chris Flowers.

The Senate hearing and an earlier one in the House last week have produced reams of written and oral testimony. CME Chairman Terry Duffy dropped a bomb Tuesday when he contradicted earlier testimony by Jon Corzine about the former CEO’s knowledge of the use of customer segregated funds. Duffy said new evidence suggests the MF Global chief was aware of the diversion of customer funds to meet the firm’s liquidity needs. That revelation may or may not prove fruitful in assigning responsibility for the loss of customer funds, a difficult and frustrating task for all involved.

More interesting to me was when late Tuesday, long past the point of exhaustion [the 1:01:30 mark] , Senator John Hoeven asked Duffy whether it was “fair to say” the mystery could be explained one of three ways:

  • Customer money was moved from segregated accounts for use by the company;
  • There was an accounting error; or
  • We’re going to find the dollars.

Duffy emphatically insisted everyone finally drop the pretense of an innocent explanation or an “accounting error” to explain the missing customer money. “I don’t know if I can say that. We were told there is no accounting error. We were told money moved from customer segregated accounts to the broker dealer account.”
So if I were one of the lawmakers on the House panel, I’d ask the following questions on Thursday:

To Corzine and Abelow:

  • Did you pledge customer assets to obtain a last-minute line of credit from a private investor intended to hold the firm over until a sale was completed over the weekend?
  • Were those customer assets liquidated when MF Global filed for bankruptcy on Oct. 31? If so, which firm or individual lent money to MF Global using customer assets as collateral? Who authorized the movement of customer assets to a house account for this purpose?
  • Was the account inside or outside the U.S.? Which custodian enabled this illegal transfer of assets? Who in MF Global arranged this financing with the intention of repaying the loan and replacing the assets when a sale of the firm was completed?

Such an arrangement is not beyond the imagination. MF Global could have gotten the idea from firms it has done business with.
In August of 2007, the SEC used an emergency temporary restraining order to stop Illinois-based managed futures advisor Sentinel Management Group from continuing to loot customer accounts after declaring bankruptcy. Sentinel claimed to have $1.2 billion in assets under management prior to filing for Chapter 11 protection. Sentinel defrauded its clients by improperly commingling, misappropriating and leveraging those clients' securities without their knowledge, the SEC said.

Sentinel transferred at least $460 million in securities from client investment accounts to a "house" account, the agency said. Sentinel also used securities from client accounts as collateral to obtain a $321 million line of credit as well as additional leveraged financing.

MF Global was a customer of Sentinel. According to the most recent annual report, Sentinel’s bankruptcy trustee sued MF Global to claw back a late withdrawal from Sentinel.

The Sentinel trustee also sued Bank of New York for enabling the commingling of customer assets with firm assets. MF Global also has a relationship with Bank of New York. The firm transferred UK customer assets to BNY in August. It did so after FINRA pushed MF Global to increase capital in its U.S. brokerage unit as a result of a $6.3 billion repo-to-maturity transaction backed by European sovereign debt. Taking the assets off MF Global’s U.S. brokerage firm books reduced regulatory capital requirements.

  • Did MF Global have sufficient internal controls over financial reporting given the breach of segregated funds that occurred subsequent to the Sarbanes-Oxley certifications signed for the fiscal year ended March 31 and the quarters ended June 30 and Sept. 30?
  • Were you and MF Global CFO Steenkamp being truthful with your auditor, PricewaterhouseCoopers, when you signed the Sarbanes-Oxley certifications and assured investors and regulators of the adequacy of internal controls over financial reporting?

To MF Global auditor PricewaterhouseCoopers:

  • Your firm certified that, “in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2011.” Why did PwC allow MF Global financial statements to be issued (and used to back MF Global’s August bond issue) with a clean audit opinion?

No deficiencies in internal control over financial reporting or in controls over segregated assets were noted even though, given the breach of customer segregated funds and the reports of accounting and systems disarray, there were obviously serious ones present.

  • Why didn’t PwC issue a “going concern” qualification to the March 31 annual financial statements?

Given everything that’s been going badly inside and outside of MF Global, it sure looks like PwC could have raised doubts about the brokerage’s ability to survive the next 12 months, which is the threshold for issuing a “qualified” accounting opinion.
MF Global had lost money since its IPO in 2007. Structural problems – a low interest rate environment and lower trading volumes – apparently could not be fixed or, at least, not fixed on a timely basis to restore profitability under the primary business model. Free cash flow was severely negative in 2009 and 2011. The firm had embarked on a highly risky proprietary trading strategy to quickly restore profitability that added significant market and concentration risk.

To the CFTC, SEC, and FINRA:

  • Why did the agencies allow Corzine to serve as CEO and Chairman of MF Global and simultaneously a partner at Flowers’ firm J.C. Flowers?

Corzine’s loyalty seems to have been biased, in my opinion, towards recouping Flowers’ investment rather than protecting shareholders.

  • Did PwC identify any material inadequacies in MF Global’s controls over safeguarding customer assets in any of the required reports submitted to your agencies under the Commodity Exchange Act? Did your agencies follow up on those reports?

MF Global recently settled five class actions brought on behalf of purchasers of MF Global stock between the 2007 IPO and Feb. 28, 2008 regarding alleged misrepresentations and omissions related to risk management and monitoring practices and procedures.
PwC must review the procedures for safeguarding customer and firm assets in accordance with the Commodity Exchange Act on an annual basis. The annual audit, completed most recently for the fiscal year ended March 31, must include a review of a firm’s practices and procedures for computing the amounts that, by law, have to be set aside in clients’ accounts each day. MF Global also had to send regulators an annual supplemental report from PwC. The report would describe any material inadequacies existing since the date of the previous audit and any corrective action taken or proposed.

To James Kobak, Chief Counsel to James Giddens, bankruptcy trustee for MF Global Inc.:

  • Can you and Giddens continue to serve as bankruptcy trustee and counsel in light of the significant conflicts your law firm, Hughes Hubbard & Reed, has from your work with JP Morgan and PwC?

PwC is MF Global’s auditor and a creditor of MF Global. The audit firm is the auditor of HHR, Giddens’ law firm, and it is a client of the law firm. PwC is also auditor of JPMorgan Chase, MF Global’s largest creditor. JPMorgan has also been a client of HHR. PwC in particular could have been tempted to use its significant knowledge of MF Global, its flaws and its sins, to help its viable clients, HHR and JP Morgan, rather than MF Global shareholders.
Francine McKenna writes the blog re: The Auditors, about the Big Four accounting firms. She worked in consulting, professional services, accounting and financial management for more than 25 years.