Bloomberg News

MF Global’s Repo Transactions Drew Regulator Attention in March

November 07, 2011

Nov. 4 (Bloomberg) -- U.S. regulators questioned MF Global Inc.’s use of so-called repo-to-maturity transactions as early as March, concerns that eventually led them to demand the brokerage come up with more capital.

The Securities and Exchange Commission sent a letter to MF Global on March 16 asking the firm to justify how it accounted for the repo-to-maturity transactions in the year ending March 31, 2010, according to the letter signed by Jennifer Monick, an SEC senior staff accountant. Monick also asked the firm to disclose how the accounting treatment affected its financial metrics and ratios, according to the letter, which was included in MF Global’s public filings with the agency.

MF Global, which was run by former Goldman Sachs Group Inc. co-chairman and New Jersey governor Jon Corzine, treated the repo transactions as sales under U.S. accounting rules, letting the firm remove the assets it pledged as collateral from its balance sheet while maintaining exposure to the creditworthiness of the bonds’ issuers.

In a March 30 response, MF Global said its repo-to-maturity transactions for that year increased net revenue by $2 million and the underlying collateral for such trades were U.S. Treasury securities, according to the letter, also filed with the SEC.

In June, the Financial Industry Regulatory Authority, the brokerage industry’s self-funded regulator, noticed the company’s use of European sovereign debt as collateral in similar repo-to-maturity transactions, according to a person with direct knowledge of the situation. Finra objected and told the firm to build up its capital, the person said.

Three-Way Discussion

Instead of immediately meeting Finra’s request, the firm started a three-way discussion with Finra and the SEC. In August, the regulators required MF Global to strengthen its cushion, the person said.

Repurchase agreements, or repos, are a form of collateralized borrowing in which the borrower sells the lender a security with an agreement to buy it back at a later date. Most repos are accounted for as borrowings and not as sales, with the assets pledged remaining on the borrower’s balance sheet.

The majority of repo borrowings are short-term, with many done on an overnight basis. MF’s repo-to-maturity deal matched the duration of the European bonds it pledged, which had a weighted average maturity of October 2012.

MF Global had $7.6 billion of such repo-to-maturity transactions related to European sovereign debt as of March 31, according to the firm’s annual filing in May. The firm, which disclosed Finra’s call for more capital in a Sept. 1 filing, listed as one of its risks that it might be forced to post margin to its counterparties if the value of the European sovereign debt fell.

$11.5 Billion

By June 30, the $7.6 billion had climbed to $11.5 billion, while resale transactions accounted for as purchases that involved European debt jumped to $4.9 billion from $1.1 billion in March, according to a quarterly filing.

MF Global Holdings Ltd., the brokerage’s parent company, filed for bankruptcy protection on Oct. 31. The brokerage’s commodity customer funds had a shortfall of $633 million, or about 11.6 percent, out of a segregated fund requirement of about $5.4 billion, the Commodity Futures Trading Commission said.

The CFTC has subpoenaed MF Global’s auditor, PricewaterhouseCoopers LLP, requesting information on the segregation of assets belonging to clients trading on U.S. commodity exchanges, according to a person briefed on the matter. The accounting firm’s spokesman, Chris Atkins, declined to comment, and it was unclear what contact the firm had with MF Global after its last clean audit opinion in May.

As MF Global slid toward bankruptcy, regulators determined that any shortfall in customer accounts was on the futures side of the business and didn’t affect the firm’s securities customers, the person said. Finra is working to verify the segregated customer funds on the broker-dealer side of the business, the person said.

SEC staff has been working around the clock at the firm and with other regulators since last week, Chairman Mary Schapiro said at an event yesterday in Washington, according to John Nester, an agency spokesman. The agency is also reviewing trades in the firm’s convertible bonds to determine whether some investors sold the debt based on confidential information before the firm’s demise, according to two people with direct knowledge of the matter.

Regulators are reviewing whether some investors learned in advance and traded on news that pushed the company closer to bankruptcy, the people said.

--With assistance from Joshua Gallu in New Orleans. Editors: Maura Reynolds, Lawrence Roberts

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net.

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net.


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