MF Global’s liquidation plan approved

May 2013 | FEATURE | BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

On 5 April a Manhattan bankruptcy judge approved the liquidation plan of commodities brokerage MF Global Holdings Ltd., finalising one of the largest and most controversial bankruptcies in US history.

The confirmation of the plan, which came nearly 18 months after the firm collapsed in October 2011, is a significant step on the road to completing MF Global’s Chapter 11 filing. The approved plan will allow the company to liquidate its remaining assets and pay back its outstanding creditors. In a court document, Judge Martin Glenn noted that “after due deliberation” the plan was “adjudged and decreed”. “The plan proponents have proposed the plan in good faith”, the document continued. “The plan was proposed with the legitimate and honest purpose of maximising the value of the Debtors’ Estates and effectuating an orderly liquidation of the Debtors”.

Under the stewardship of the former senator and governor of New Jersey, Jon Corzine, MF Global collapsed into bankruptcy after investors became startled by the firm’s exposure to $6.3bn of European sovereign debt.

The failure of the firm, the eighth largest bankruptcy in US history, became all the more controversial when it emerged that $1.6bn was missing from the accounts of MF Global’s commodities customers. According to federal investigators, the money was misappropriated by MF Global in desperate last minute trading as the firm battled to cover liquidity gaps.

In the aftermath of MF Global’s insolvency, Mr Corzine and a number of other executives were ordered to appear at multiple congressional hearings. Furthermore, the Federal Bureau of Investigation (FBI), the Securities & Exchange Commission and a congressional committee all launched investigations into the bankruptcy.

A long road

Judge Glenn approved the plan, which lays out how the company intends to pay back its corporate creditors, noting that “It’s been a long road to get to this point” and “While there have been some very strongly held views and differences, counsel have worked exceedingly well together to resolve most of them, limited what the court had to decide.”

Louis Freeh, the former director of the FBI, was appointed trustee by the court to sell off the company’s remaining assets. After the judge’s ruling he stated “I do firmly believe that the customers in this case will be made whole, as a result of a lot of good work.”

Under the terms of the scheme, Mr Freeh will now begin to wind down his role at the firm. Once the plan comes into full effect, a committee of MF Global’s creditors will partially take control of the business.

The plan will see a pot of around $300m used to return 34 percent of claims to corporate clients, hedge funds and any other unsecured creditors that owned bonds in the company. Unsecured creditors have a maximum projected recovery of roughly 34 percent.

MF Global’s creditor pay out scheme was proposed by a group of the firm’s hedge fund creditors which hold roughly $1bn in unsecured bonds. The group includes Silver Point Capital, Knighthead Capital and Cyrus Capital Partners.

The majority of the firm’s retail customers in the US have already been reimbursed between 89 and 93 percent of the value of their accounts. The bulk of retail customers’ money was recovered from MF Global’s banks and clearing houses by the other court appointed trustee working on the case, James Giddens.

Mr Giddens sought separate court approval for his plan which created an agreement between MF Global and JPMorgan Chase & Co. JPMorgan had provided MF Global with a $1.2bn revolving credit facility, and was also one of MF Global’s primary clearing banks before the company collapsed.

Under the terms of this deal, which cleared up a dispute over the value of intercompany claims, JPMorgan will receive 76 percent of its claim; in exchange it will make $100m available for distribution to MF Global customers, as well as returning $29m to the brokerage relating to a previous credit facility. JPMorgan will also give up its claims on $417m of funds that it had already returned to Mr Giddens. This money will now be distributed to MF Global’s customers. Those customers who hold a claim on the $1.2bn revolving loan will receive between 27 and 80 cents on the dollar.

It was essential that a separate deal was reached with JPMorgan as any objections raised by the company could have derailed MF Global’s attempts to win the approval of the court. There were some objections raised by other parties, however. The US trustee program and Preet Bharara, the US attorney for the Southern District of New York, were both concerned about some of the language used in the bankruptcy plan which released certain third parties for particular types of legal claims. These objections were later removed, MF Global agreed, under orders from Judge Glenn, to insert language into the plan which narrowed the releases. Judge Glenn decreed that the releases must not obstruct the “government’s criminal, police and regulatory powers”.

Disastrous appointment

Mr Corzine was brought into the firm as chief executive officer in 2010 to help turn around its fortunes, yet once he took control of the company MF Global began to increase its proprietary trading, a move which Mr Freeh described as “disastrous” in a 174 page investigative report to the court.

Until Mr Corzine assumed control of the firm it was relatively risk averse, and according to Mr Corzine’s spokesperson, the firm had lost money for three consecutive years prior to his taking control in 2010. Despite the risk averse nature of MF Global at that time, Mr Corzine began applying strategies he had employed while he was chairman of Goldman Sachs; accordingly, the level of risk at the firm was ratcheted up considerably. Analysts have suggested that Mr Corzine was attempting to transform MF Global into asophisticated broker-dealer and investment bank, likening the moves to an attempt to create a mini-Goldman Sachs.

The highly leveraged bets on European governmental debt made by MF Global have been cited by senators and the media alike as examples of the importance of the Volcker Rule which came into effect in 2012. However, MF Global itself would not have been affected by the implementation of the rule. The firm, which can trace its roots back around 230 years, acquired debts issued by a number of economically unstable European nations including Italy, Portugal, Spain and Ireland; as Europe’s economies weakened further in mid-2011, MF Global was required to meet margin calls on its trades.

Once regulators forced the firm to reveal the nature of the bets it had taken on debt issued by the troubled European nations, MF Global began to collapse with no buyers willing to come forward and assume control of the troubled firm. “The risky business strategy engineered and executed by Corzine and other officers and their failure to improve the company’s inadequate systems and procedures so that the company could accommodate that business strategy contributed to the company’s collapse,” stated Mr Freeh.

The controversial European bonds purchased by the firm were not, however, the only reason behind the collapse of MF Global. Indeed, the bonds which so distressed investors, customers and ratings agencies recently matured, finally paying out.

Fierce criticism

Mr Freeh claims in his report that Mr Corzine was made aware of the deficiencies in the firm’s internal controls at a board meeting in May 2010, where it is alleged that he and other key executives received documentation detailing the growing number of gaps between the firm’s written policies surrounding risk and its practices. The report contends that, despite these obvious flaws, Mr Corzine moved ahead with his risky European debt move.

In light of these claims, Mr Corzine has come under fierce criticism. Mr Freeh has attributed much of the blame for MF Global’s collapse to Mr Corzine. According to Mr Freeh, Mr Corzine and his senior management team engaged in a great deal of “negligent conduct”.

The decision by Mr Corzine to transform MF Global into a high-powered trading firm and expand the company’s proprietary trading was doomed to fail. According to Mr Freeh’s third and likely final report on the collapse of MF Global, the firm lacked the cash management procedures, risk controls and manpower to oversee itself. All three of Mr Freeh’s reports have identified Mr Corzine as one of the primary causes of the firm’s collapse, while also making it clear that he was well aware of the firm’s internal shortcomings.

MF Global, Mr Freeh noted, placed “unnecessarily high reliance on key employees” to manage the firm’s liquidity reporting, namely a single employee in the firm’s Chicago office, Edith O’Brien. Following the collapse of the firm, Ms O’Brien emerged as a crucial figure, as emails surfaced suggesting that, under the orders of Mr Corzine, she had transferred $175m in customer money to an account atJPMorgan. This transaction occurred just days before the firm collapsed into bankruptcy.JPMorgan immediately contacted MF Global, seeking a written declaration that the funds did not belong to customers, however those assurances were never received. “These glaring deficiencies were long known to Corzine and management, yet they failed to implement sufficient corrective measures promptly,” said Mr Freeh in the report.

Ms O’Brien, a former assistant treasurer at MF Global, was subpoenaed to testify before the House Financial Services oversight subcommittee hearing but she invoked her Fifth Amendment right against self-incrimination and, accordingly, has refused to cooperate with the proceedings.

Although at the time of writing no criminal charges have been filed against Mr Corzine or any other MF Global officials, the former Goldman Sachs chairman will face a number of civil lawsuits from trustee Mr Giddens and other former MF Global customers. Mr Corzine denies any wrongdoing in the case.

In a statement, a spokesman for Mr Corzine, who left MF Global just days after the firm collapsed, said he had “worked tirelessly and in good faith to turn the business around”. The statement continued “There is simply no basis for the suggestion that Mr Corzine breached his fiduciary duties or was negligent”.

Mr Freehhas prepared a lawsuit primarily against Mr Corzine and other former MF Global executives, but according to a footnote in his report he has agreed to delay the filing of the case “pending the completion of mediation”.

Conclusion

When news of the firm’s demise first emerged, some analysts compared the collapse of MF Global to the catastrophic demise of Lehman Brothers, which occurred at the height of the financial crisis. Thankfully for the financial sector, however, the impact of MF Global’s insolvency has not been as disastrous as originally feared. Despite this, there is still some work to be done before the sector can truly draw a line under the MF Global meltdown, a $40bn corporate bankruptcy which did send shockwaves through the financial sector. However, while the bankruptcy plan’s approval sees the case slowly drawing to a close, Mr Corzine’s struggles may only just have started.

Richard Summerfield