Exclusive: MF Global's Compliance Systems Weren't Up to Speed

MF Global still hadn’t completed an upgrade of its “compliance” systems as the firm was taking outsized risks in the bond market that led to its eventual demise, the FOX Business Network has learned.

The compliance upgrade, according to people with direct knowledge of the matter, began in early 2011, at the time that the firm’s then-chief executive Jon Corzine began implementing a new strategy, where MF Global would move away from a business model that involved being a broker and executing trades largely in the futures market, to one in which it made bets with its own capital in various markets around the world.

However, these people say the compliance upgrade -- which was designed to monitor appropriate levels of risk taking at the firm -- wasn’t completed even as the firm began to increase its trading activities. Some on Wall Street are pointing to faulty compliance procedures as the root cause for the firm’s troubles and eventual bankruptcy filing.

It could not be determine how far along MF Global was in completing the compliance upgrade. One person at the firm tells FOX Business that MF Global was still in the process of hiring compliance personnel even as it ramped up its risk taking, and that the last major upgrade of compliance occurred before Corzine took over as CEO in 2010.

Bankers who studied the firm’s books in the days before its bankruptcy say the firm didn’t not have in place the proper controls not just regarding risk, but also regarding how to keep separate customer trading accounts from other firm activities.

Regulators say MF Global co-mingled customer accounts with other activities, which is the likely reason for nearly $600 million of customer assets missing from the firm. Sources close to the multiple investigations into the firm’s demise tell Fox Business that one of the key questions for regulators will be whether MF Global’s compliance systems were adequate to handle the increase in risk taking.

An MF Global spokeswoman would not deny that the firm’s compliance systems weren’t fully upgraded and had no further comment. An attorney for Corzine, who resigned as MF Global CEO late last week, didn’t return a telephone call for comment.

MF Global’s now infamous bet on the risky sovereign debt issued by Italy and Spain, accompanied another move to increase the firm’s “leverage,” which allows traders to enhance market gains through borrowed money. While leverage can increase returns, it can also compound losses when markets tumble, as they did in 2008 during the financial crisis. That’s when the nation’s big banks borrowed as much as 50X more than their capital on hand to finance money-losing investments tied to the real estate market, and were heading toward insolvency before a massive government bailout.

MF Global was leveraged close to 40X its capital, according to people close to the matter. News of its leverage was a major reason that trading partners and creditors to begin pulling away from the firm in recent weeks out of fear when it became clear that one of MF Global’s biggest bets involved debt of Italy and Spain.

Though neither country has defaulted, fears of a European market meltdown have grown particularly during the prolonged bailout efforts involving Greece. It was this fear that Italy and Spain might default—even if they hadn’t yet—that caused clients and credits to stop dealing with MF Global, thus hastening its demise.

People at MF Global say the market reaction was unfair since neither Italy nor Spain had defaulted, and eventually the firm’s bet would prove to be a winner. But market participants weren’t willing to take a chance, and began not just pulling away from MF Global, but also unloading the firm’s stock, causing its shares to fall just below $1.

The final straw for the firm was multiple downgrade by credit rating companies that declared MF Global’s debt to be below investment grade, or junk. With that, nearly all the firm’s funding from outside parties dried up and it was forced into liquidation and eventually, bankruptcy.