The Next Steps in the Investigation of MF Global

With the Federal Bureau of Investigation looking into possible missing customer money at MF Global, executives of the now-bankrupt commodities and securities firm will be hiring lawyers and dealing with questions that go beyond just how the firm will be liquidated. The issue of whether there were any financial improprieties means the government will be digging through the firm’s books to see where the money went, and whether any records or reports were falsified.

Here are some avenues of investigation the F.B.I. is likely to pursue, and the criminal statutes that could be invoked if there is evidence of intentional violations:

Follow the Money

The first step in any investigation of possible financial fraud is to follow the money. MF Global had both securities and commodities operations, so it was subject to strict accounting regulations imposed by the Securities and Exchange Commission and the Commodity Futures Trading Commission. Each regulator requires firms like MF Global to segregate customer money from their own, and a company official has acknowledged that there is a shortfall in those customer accounts. Meanwhile, the CME Group, which operates the giant futures exchange where MF Global did business, said Tuesday that the firm failed to keep customer money separate its own money.

The crucial question is where the customer money ended up, assuming it came into the firm and remained there. One potential area in which the money could have been used was to bolster MF Global’s net capital, which is the amount of money the firm must have available to support its trading operations. It is not unknown for trading firms to “borrow” money from accounts to plug a short-term gap in financing to keep the operation afloat.

In a filing on Oct. 2 with the Commodity Futures Trading Commission, MF Global reported that it was required to have $328.4 million in net capital, and that its total capital on hand was $495.6 million, so it had a surplus of approximately $167 million. A securities or commodities broker that does not have sufficient capital can be required to raise additional money quickly and may be shut down because of the risk that it will not be able to meet its obligations. So it was crucial for MF Global to maintain its capital level, especially at it fought to survive, and any shortfall would call into question whether it could continue.

MF Global had separate trading operations around the world, each with its own net capital requirements. Money could have been moved around its subsidiaries to make up shortfalls in different operations, and the bankruptcy may reveal that customer accounts were used to prop up its operations.

In the same filing with the futures regulator, MF Global reported that it held $7.2 billion in segregated customer accounts, but the potential shortfall in customers’ money that has been reported to involve as much as $600 million may call into question the veracity of that figure. The F.B.I. will have to determine whether and when the money was not put into the proper accounts, and how much was involved, because it is unlikely the issue arose all at once.

A more ominous possibility is that the money was siphoned out of the company — i.e. embezzled. If that is the case, then the issue will be identifying who was responsible, and how customer money could have been diverted from a heavily regulated broker without being noticed.

Tracing the money assumes that MF Global’s books and records are accurate, which will be another focus for the F.B.I. If they are inaccurate, then the investigation becomes much more complicated because efforts to track the money will have to rely on outside sources of information, like bank records and documents from other brokerage firms that traded with the firm. If money was improperly diverted from the firm, then it is unlikely the records will be reliable because thieves rarely leave behind an accurate accounting of their misconduct.

Once the money is traced, the next step is to determine who was responsible for any misuse or improper accounting of the money. At that point, a crucial issue is how far up the corporate ladder that awareness reached. If customer money was in fact misused or misappropriated, then the typical approach is to determine who is willing to cooperate in an investigation and whether they can identify those responsible.

Possible Criminal Violations

MF Global was required to maintain accurate records and to report correct information under regulations issued by the S.E.C. and the Commodity Futures Trading Commission. A failure to do so can be the basis for a criminal prosecution, along with a civil enforcement action, against those responsible for any inaccuracies. Under § 13 of the Commodity Exchange Act, 7 U.S.C. § 13, a person who knowingly files a false statement with the futures regulator can be punished by up to 10 years imprisonment, while a willful violation of an S.E.C. reporting rule can be punished by up to 20 years in prison (15 U.S.C. § 78ff).

MF Global’s shares were publicly traded, so its chief executive, Jon S. Corzine, and chief financial officer were required to file a certification with the S.E.C. attesting to the accuracy of the company’s quarterly and annual financial statements. Reports of possible shortfalls in customer accounts may mean those financial statements were misleading or incomplete, depending on when the problem arose.

If that is the case, then Mr. Corzine may find himself being scrutinized to determine the extent of his knowledge of any problems in the company’s books. Under 18 U.S.C. § 1350, an executive who knowingly or willfully certifies a financial statement the person knew was false could be prosecuted, although this provision has been used infrequently.

Should the investigation show that customer money was improperly diverted out of the firm, then a violation can be prosecuted as either a securities or commodities fraud. In addition, the mail and wire fraud statutes could be employed, and those provisions carry a potential punishment of up to 30 years in prison because a financial institution was involved.

As if often the case, there will be no shortage of statutes available for a federal prosecution if the investigation turns up evidence of significant wrongdoing. At this point, there is no evidence of criminal conduct by MF Global or Mr. Corzine,

An investigation of this type will be measured in months because pulling together the relevant records and finding where the potentially missing money ended up will not be an easy task.