Bloomberg News

MF Global Creditors to Form Committee, Seek Recoveries

November 15, 2011

(Updates with Wilmington Trust in 20th paragraph.)

Nov. 7 (Bloomberg) -- MF Global Holdings Ltd. creditors looking to recover from the eighth largest bankruptcy in U.S. history may sue the company’s advisers, search for assets overseas and seek information from a probe into the commingling of customer accounts at the brokerage, a bankruptcy lawyer said.

Creditors seeking a position on a committee that could shape the approach to recoveries met today at the Millennium Hilton hotel at 55 Church Street in Manhattan. A trustee overseeing the liquidation of the company’s operating unit, MF Global Inc., started his investigation into possible fraud or misconduct on Nov. 4. The FBI has also started a probe, according to a person familiar with the matter. MF Global has until Jan. 30 to report a detailed list of its assets and debt.

“In a situation such as this where there seems to be building a view that asset values are not sufficient to provide a recovery, creditors will look to assert claims against various third parties either at MF Global, and its agents,” said Lorenzo Marinuzzi, a partner at Morrison & Foerster LLP in New York, who isn’t involved in the case.

MF Global listed $39.7 billion in debt and $41 billion in assets and said it has about $26 million in cash. About $593 million of MF customer funds are unaccounted for, according to a person with knowledge of regulatory probes into the firm’s collapse. The FBI’s formal criminal investigation began late last week, the person familiar with that matter said. It is in its preliminary stages and no documents had been requested as of Nov. 4, said the person, who didn’t specify the focus or scope of the investigation.

Jon Corzine, the former co-chief executive officer of Goldman Sachs Group Inc., quit as MF Global’s CEO that same day.

Investor

An MF Global Holdings investor, Joseph DeAngelis, sued Corzine and the company’s board for allegedly making misleading statements about the firm’s financial condition before its collapse.

Creditors and bankruptcy lawyers may hesitate to get involved in the case because of worries it may not have enough money to pay the committee’s legal fees.

Fred Hodara, a partner at Akin Gump Strauss Hauer & Feld LLP said his firm is interested in representing the creditors’ committee though he said he doesn’t know enough about the cash situation to have a view of the risks.

“It’s not out of the realm of possibility that large bits of cash are lurking in the system today, and that leads you to one set of conclusions,” Hodara said. “And it’s not out of the realm of possibility that significant funds have left the system.”

Customers Organizing

Customers are also organizing, and a lawsuit may seek to recover money lost by the members of exchanges who provided liquidity for MF Global trades, said David Rosen, 32, an energy broker who works at the New York Mercantile Exchange. Rosen, who is organizing a meeting at 3 p.m. today, said the meeting is open to members of the NYMEX, COMAX, and Intercontinental Exchange, and the group will seek to hire counsel.

“We didn’t think we were just customers,” said Rosen, who had more than $100,000 in an MF Global account. “We’re the ones in the pits providing liquidity so everyone around the world can trade these products.”

Court Permission

James Giddens, the trustee overseeing the liquidation of the company’s brokerage, on Nov. 4 won court permission to probe the company’s directors and officers, lenders and other investors. That probe will focus on customer recoveries.

Other regulators including the Commodity Futures Trading Commission and the Securities and Exchange Commission are investigating as well. On its first day in court, New York-based MF Global asked for an extension of the usual 14-day window in which to disclose its full lists of assets and debts.

CFTC Chairman Gary Gensler will recuse himself from the agency’s investigation amid concern his ties to Corzine may give the appearance of a conflict of interest, two people with direct knowledge of the decision said. Corzine worked with Gensler at New York-based Goldman Sachs and during his term in the U.S. Senate, where Gensler served as an aide.

Subsidiaries

While many of the company’s overseas operating units are also unwinding under administrators, including its U.K. unit, other subsidiaries could also end up under Chapter 11 protection within weeks or months, Marinuzzi said.

In forming a committee of unsecured creditors, the U.S. trustee will look for creditors who represent the interests of all parties. Unsecured bondholders make up a large segment of such creditors. MF Global’s 6.25 percent notes due 2016 traded at 104 cents on the dollar as of Sept. 7 before dropping to 50 cents on the dollar in the week before its bankruptcy.

“The real question will be who’s on what committees and how will they handle things,” said Scott Peltz, the national leader of RSM McGladrey’s Financial Advisory Services Group in Chicago.

JPMorgan Chase & Co., agent to a $1.2 billion unsecured loan, also provided a $300 million secured loan to MF Global’s brokerage and may cause conflicts by seeking a seat on the creditors’ committee. The bank would have an interest in keeping money at the broker-dealer unit to satisfy its secured debt, while other creditors would have an interest in bringing the broker-dealer’s assets into the holding company’s bankrupt estate.

Senior Lien

JPMorgan Chase, based in New York, was given a senior lien on all MF Global’s available assets in exchange for letting it use $8 million in cash collateral during the company’s first day in bankruptcy court.

Wilmington Trust has taken over from Deutsche Bank AG, which resigned, as trustee to more than $1 billion in unsecured notes. Other unsecured creditors include Headstrong Services LLC, owed $3.9 million, New York-based law firm Sullivan & Cromwell LLP, owed $596,939, and Oracle Corp., owed $302,704.

JPMorgan Chase was also given rights to what a judge said may be the only asset for unsecured creditors: so-called avoidance actions, the lawsuits that let creditors win back assets transferred out of the estate 90 days before its bankruptcy filing. The judge said he doesn’t usually permit such extraordinary rights for a lender, and left the door open to re- evaluate JPMorgan’s request at a Nov. 14 hearing.

Bridge to Nowhere

“It’s potentially the only recoveries unsecureds have,” U.S. Bankruptcy Judge Martin Glenn said when he approved JPMorgan’s request at a Nov. 1 hearing. He said the company’s use of cash collateral could be “a bridge to nowhere.”

Shareholders, last in line to recover anything from a bankrupt estate, may get nothing if that’s the case. MF Global’s largest common shareholders as of Sept. 30 were Pyramis Global Advisors LLC, with 8.4 percent, and RS Investments in San Francisco, with 7.8 percent, according to court papers. RS has sold its entire stake, Erin Burke, a spokeswoman for the firm, said in an e-mail.

Fine Capital Partners LP held 7.4 percent and Cadian Capital Management LLC had 6.2 percent, the company said. J.C. Flowers & Co. owns 1.5 million preferred shares, MF Global said. Corzine, who joined MF Holdings in March 2010, is also an operating partner at J.C. Flowers.

Lawsuits

The $325 million in bonds that MF Global issued in August with an interest rate that would rise if Corzine were to receive a federal appointment from the U.S. president may now be trading more on expectation of lawsuits surrounding the former Goldman Sachs chief and his company.

U.S. regulators questioned MF Global’s use of so-called repo-to-maturity transactions as early as March, well before the company issued two tranches of $325 million in debt and the company disclosed the $6.3 billion bet on Europe’s most indebted nations that prompted regulatory concerns and ultimately its bankruptcy.

Kevin Starke, an analyst with CRT Capital Group LLC, said he’s seeing a preference for notes that MF Global issued in the months prior to its bankruptcy; trading in its $325 million of 6.25 percent notes due 2016, issued Aug. 8, rose on Oct. 26 and traded at above-average volume in the days leading up to, and immediately after, its bankruptcy filing. On Oct. 26, volume was 49,293 and on Oct. 28 and Oct. 31, it was about 180,000. The bonds, which traded as high as 92.50 cents on the dollar in the month prior to its bankruptcy, have traded in a range of 50 to 37.50 since MF Global’s Oct. 31 bankruptcy.

Today the 6.25 percent notes fell 5 cents to 40 cents on the dollar with a yield of 30.3 percent at 10:51 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Refco

MF Global, which was spun off from Man Group Plc in 2007, was built up partly through an acquisition of Refco Inc.’s assets. Refco went bankrupt two months after its August 2005 initial public offering that raised $670 million, saying CEO Phillip Bennett had hidden hundreds of millions of dollars in bad debt.

In 2006, Bawag PSK Bank agreed to pay $683 million for its role in the collapse of Refco to avoid U.S. prosecution, with payments distributed to Refco creditors and investors.

“In Refco’s bankruptcy most recoveries came from lawsuits against Bawag, I think people are seeing parallels,” Starke said.

Lawsuits against underwriters of Refco’s IPO also succeeded, with securities units of Bank of America Corp., Credit Suisse Group AG and Goldman Sachs paying $49.2 million to settle an investor lawsuit alleging fraud.

On the Hook

“If the underwriters had done their jobs they would have flagged this, particularly as investments were made after Europe was in trouble,” said John P. Coffey, lead lawyer for shareholders and investors in Refco, speaking about MF Global’s August issue of $325 million in bonds. The threshold question for a lawsuit will be whether there was adequate disclosure of risks in the prospectus. If not, the banks that underwrote the offering are “on the hook, jointly and severally,” Coffey said.

Coffey, now a managing director at Blackrobe Capital Partners, noted that a suit against the board of MF Global is also possible, depending on the company’s audited financial statements.

Other officers at the company include Bradley Abelow, president and chief operating officer since Sept. 2010. Abelow, former chief of staff to Corzine during his tenure as New Jersey governor, oversees day-to-day operating and is directly responsible for risk, according to court papers. The company’s chief financial officer since April 2011, Henri Steenkamp, was formerly its chief accounting officer and global controller since 2006. Before that, he was with PricewaterhouseCoopers, MF Global’s accountant.

Remaining Collateral

Companies in bankruptcy typically get loans to finance operations while they reorganize from a lender who wants to protect its prior investment, or a potential buyer. MF Global tried to sell itself in the days prior to its bankruptcy, but failed. JPMorgan has asked for all the company’s remaining collateral.

“I would think that come Nov. 14, JPMorgan is going to decide if it has a better chance at maximizing value by keeping the company operating or trying to stop the company from using its cash collateral,” Marinuzzi said.

MF Global’s bankruptcy may face complications similar to those of Lehman Brothers Holdings Inc., where disputes arose over whether parties holding collateral for one transaction have a right to hold it because they have an unrelated claim against MF Global, Marinuzzi said.

“You could have collateral in the hands of third parties posted by MF Global which themselves may have claims against MF Global,” he said.

Damage Claims

Customers who may have damage claims against the estate not covered by the Securities Investor Protection Corp., or SIPC, could also seek to get involved in litigation with the holding company, Peltz said.

“Who allowed MF Global to dip into my account -- in essence -- and steal my funds?,” said Gary Mahoney, 64, of Las Vegas.

“Traders expect that the money they put up for margin call is always there, no matter what, thus the reason these funds are segregated,” said Mahoney, who said he doesn’t know what will become of the $3.5 million in cash collateral and about 200 positions he held in his MF Global account.

Customers are the most immediately affected by liquidation of MF Global’s brokerage, as all their accounts will be transferred today with only 60 percent of their collateral, or liquidated. SIPC, which has taken over customer accounts, reimburses only up to $500,000 in losses to investors.

The bankruptcy case is MF Global Holdings Ltd., 11-bk- 15059, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

--With assistance from Linda Sandler, Patricia Hurtado, Sapna Maheshwari and Matthew Leising in New York and Silla Brush in Washington. Editors: John Pickering, Michael Hytha

To contact the reporters on this story: Tiffany Kary in New York at tkary@bloomberg.net; Patricia Hurtado in New York at pathurtado@bloomberg.net;

To contact the editor responsible for this story: John Pickering at jpickering@bloomberg.net


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