Widening Hunt for Details of MF Global’s Collapse

Jon S. Corzine on the trading floor of MF Global. David Goldman for The New York TimesJon S. Corzine on the trading floor of MF Global in 2010.

Jon S. Corzine, MF Global’s former chief executive, is expected to testify in Congress next month about the firm’s collapse, having received requests to appear before the Senate Agriculture Committee on Dec. 13 and a House Financial Services subcommittee two days later. Questions continue to swirl around missing customer money totaling $1 billion or more that might have been used to shore up the firm’s own trading position, and there are multiple investigations of its operations.

If he appears at the hearings, Mr. Corzine, a former senator and governor who once served as co-chief executive of Goldman Sachs, is sure to be queried about his decision to invest in European sovereign debt, and whether customer money was misused to keep those investments afloat as MF Global slid into bankruptcy. An interesting issue for both Congressional hearings may be Mr. Corzine’s lobbying efforts to stop changes in a Commodity Futures Trading Commission rule, Regulation 1.25, which allows futures brokers to borrow customer money from segregated accounts to invest in short-term securities. These included buying debt obligations of other countries.

Such transactions are known as an “internal repo” because the firm must use the investments to secure the client money, so that any borrowings can be repaid, supposedly with little risk. After passage of the Dodd-Frank Act, the Commodity Futures Trading Commissionproposed narrowing the range of permissible investments under Regulation 1.25 that, among other things, would have eliminated foreign government debt as eligible for these types of transactions.

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MF Global, like other futures brokers, opposed the effort to tighten up on permissible investments under Regulation 1.25. Mr. Corzine and other members of the firm met with the commission in July to discuss the proposed changes, along with other issues related to implementing the Dodd-Frank Act. At the same time, MF Global was also sparring with the Financial Industry Regulatory Authority over how much capital it needed in light of its investments in European sovereign debt. In September, it disclosed that it had increased its capital to account for those investments.

To the extent MF Global relied on internal repo transactions to finance its transactions in European sovereign debt, the proposed change in the rule, which was never adopted, would have required the firm to rely on other sources for financing because customer money would no longer be available. Lawmakers may be interested in learning the extent to which money from customers allowed MF Global to take on assets that proved to be highly risky and contributed to its eventual collapse into bankruptcy.

In the various investigations of MF Global, one potentially important source of information about the firm may come from its lawyers, which is typically off limits because of attorney-client privilege. But the proposed appointment of Louis J. Freeh, the former director of the Federal Bureau of Investigation, as the trustee for MF Global’s parent company could provide an additional avenue for gathering information about how the firm was operated in the months before its demise and the types of risks it was taking.

A bankruptcy trustee essentially takes over a debtor firm with all the authority that its directors and officers previously held for its management and operation. One power a trustee has is to waive a company’s attorney-client privilege, which is controlled by the organization. In Commodity Futures Trading Commission v. Weintraub, which involved a bankrupt futures firm, the Supreme Court held that a bankruptcy trustee has the power to waive the company’s attorney-client privilege to permit an examination of its former general counsel.

In petitioning the bankruptcy court for the appointment of Mr. Freeh, the lawyers for the firm and its creditors asked for a trustee with the credibility to deal with the different investigations into MF Global’s operations being pursued by the F.B.I., the Commodity Futures Trading Commission and the Securities and Exchange Commission. Satisfying their demands for information will make it easier to liquidate the firm and return money to investors and creditors.

As the Weintraub decision makes clear, corporate employees have no say over a trustee’s decision whether to waive the attorney-client privilege, even if they had considered their discussions with corporate lawyers to be confidential. Because it is the organization that holds the privilege, whoever controls it makes the decision regarding any waiver.

One focus of the investigations is MF Global’s compliance with the record-keeping obligations imposed on its futures and securities operations. The firm’s books have been described as “a disaster,” so any warnings given by the firm’s lawyers regarding whether it was in compliance with relevant regulatory requirements can help establish who might be held responsible for any shortcomings.

With the power to waive the attorney-client privilege, Mr. Freeh can make life for the investigators much easier by agreeing to disclose privileged communications to help sort out what management was told. It would also allow for Congress to question Mr. Corzine about any legal advice he received as MF Global struggled to stay afloat. While Mr. Freeh is not obligated to waive the privilege, he may be willing to do so if it will speed a resolution of the investigations.