To Avoid Raising Capital, MF Global Moved Around Sovereign Debt

Facing pressure last summer to increase its capital cushion, MF Global moved some of its risky European debt holdings to an unregulated entity in an effort to avoid having to raise the extra money.

The revelation, detailed in a new report by the trustee overseeing the bankruptcy of the failed brokerage, raises questions about MF Global’s actions in its final months and its response to regulators. The firm had previously disclosed that it had met the capital requirements, but never mentioned that it had transferred some bonds rather than raising additional funds.

“This strategy allowed the MF Global Group to transfer the economic benefits and risks,” according the report from Louis J. Freeh, the trustee, in that way reducing the “regulatory capital requirements.”

Months before MF Global filed for bankruptcy, regulators raised concerns about its $6 billion bet on European sovereign debt. At the time, worries about highly indebted nations like Greece, Spain and Italy were creating extreme volatility in the financial markets.

Given the market problems, the Financial Industry Regulatory Authority demanded that MF Global set aside extra money in case the trades soured. But MF Global objected, appealing Finra’s ruling to the Securities and Exchange Commission. Jon S. Corzine, the firm’s chief executive, personally lobbied the S.E.C. to back down.

Ultimately, the S.E.C. sided with Finra, though MF Global continued to haggle over the size of the capital cushion. Regulators had wanted $200 million set aside to cover the positions.

In a September 2011 filing, MF Global said it had “increased its net capital and currently has net capital sufficient to exceed both the required minimum level and Finra’s early-warning notification level.” The disclosure spooked MF Global investors, inciting a crisis of confidence that would ultimately push the company to tap into customer money to stay afloat.

But the disclosure did not give the full picture. While MF Global did move some cash around to protect against losses, the firm also transferred its roughly $3 billion in holdings of Italian bonds from the brokerage arm of the company to the “FinCo,” according to the trustee’s report. By doing so, the firm met its requirements without having to raise money.

At the time, MF Global held about $6 billion in the debt of Belgium, Ireland, Italy, Spain and Portugal, representing about 14 percent of its assets and nearly five times the equity of the firm. The Italian bonds represented about half the firm’s risky European position.

The disclosure of the Financial Industry Regulatory Authority’s capital request set off a firestorm in the markets. After news reports first identified the request, the stock market began to hammer MF Global’s shares. Shortly after, ratings agencies put the firm on warning for a downgrade, causing further panic. The effect of downgrades from Moody’s Investors Service and Standard & Poor’s were exacerbated by a poor earnings report. Two months after the September filing, MF Global filed for bankruptcy.

In the final week before the bankruptcy, the firm improperly used customer money to stay afloat. The move left farmers, traders and hedge funds short about $1.6 billion.