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A Romance With Risk That Brought On a Panic

Soon after taking the reins of MF Global in 2010, Jon S. Corzine visited the Wall Street firm’s Chicago offices for the first time, greeting the brokers, analysts and sales staff there.

Jon Corzine
Getty Images
Jon Corzine

One broker, Cy Monley, caught Mr. Corzine’s eye. Unknown to MF Global’s top management in New York, the employee, whose job was to match buyers and sellers in energy derivatives, was also trading a small account on the side, using the firm’s capital.

“How are you making money on side bets? What else are you guys doing to make money here?” Mr. Corzine asked enthusiastically, his eyes widening, the broker recalled. The new chief executive grabbed a seat and spent an hour questioning Mr. Monley as other top executives from New York hovered impatiently nearby.

Although Mr. Corzine had been a United States senator, governor of New Jersey, co-head of Goldman Sachs and a confidant of leaders in Washington and Wall Street, he was at heart a trader, willing to gamble for a rich payoff.

Dozens of interviews reveal that Mr. Corzine played a much larger, hands-on role in the firm’s high-stakes risk-taking than has previously been known.

An examination of company documents and interviews with regulators, former employees and others close to MF Global portray a chief executive convinced that he could quickly turn the money-losing firm into a miniature Goldman Sachs .

In the final days before filing for bankruptcy, MF Global moved an estimated $1.2 billion of customer funds to other institutions.

He pushed through a $6.3 billion bet on European debt — a wager big enough to wipe out the firm five times over if it went bad — despite concerns from other executives and board members. And it is now clear that he personally lobbied regulators and auditors about the strategy.

His obsession with trading was apparent to MF Global insiders over his 19-month tenure. Mr. Corzine compulsively traded for the firm on his BlackBerry during meetings, sometimes dashing out to check on the markets. And unusually for a chief executive, he became a core member of the group that traded using the firm’s money. His profits and losses appeared on a separate line in documents with his initials: JSC.

Yet few appeared willing to check Mr. Corzine’s trading ambitions.

The review of his tenure also sheds new light on the lack of controls at the firm and the failure of its watchdogs to curb outsize risk-taking. The board, according to former employees, signed off on the European bet multiple times. And for the first time it is now clear that ratings agencies knew the risks for months but, as they did with subprime mortgages, looked the other way until it was too late, underscoring how three years after the financial crisis, little has changed on Wall Street.

MF Global filed for bankruptcy on Oct. 31. As the firm spun out of control, it improperly transferred some customer money on Oct. 21 — days sooner than previously thought, said people briefed on the matter. And investigators are now examining whether MF Global was getting away with such illicit transfers as early as August, one person said, a revelation that would point to wrongdoing even before the firm was struggling to survive.

The consequences of the firm’s collapse have been severe: Some $1 billion in customer money remains missing and thousands of clients, including small farmers in Kansas or hedge funds in Connecticut, still do not have nearly a third of their funds.

Some of that money may never be recovered if, as some regulators now fear, MF Global used it to cover trading losses and replenish overdrawn bank accounts.

The bet on European sovereign debt is not thought to be directly connected to the missing money. But the fears about the firm’s exposure to Europe tipped an anxious market, causing a run on MF Global that regulators suspect led the firm to fight for its life using customer money.

Mr. Corzine has not been accused of any wrongdoing. Through a spokesman, he declined to comment for this article.

While Mr. Corzine apologized for the firm’s collapse when he appeared before the House Agriculture Committee on Thursday, he has continued to defend the European trade, calling it “prudent” at the time.

The European trade was initiated by Mr. Corzine late in the summer of 2010. The new chief executive explained the bet to a small group of top traders, arguing that Europe would not let its brethren default. In just a few months, the trade swelled to $6.3 billion, from $1.5 billion.

Europe’s debt crisis, meanwhile, continued to flare, raising questions about whether some of the Continent’s bigger economies, Spain and Italy, might be ensnared in the maelstrom.

In August, some directors questioned the chief executive, asking him to reduce the size of the position. Mr. Corzine calmly assured them they had little to fear.

“If you want a smaller or different position, maybe you don’t have the right guy here,” he told them, according to a person familiar with the matter. He also told one senior board member that he would “be willing to step down” if they “had lost confidence in me,” Mr. Corzine told Congress on Thursday, although he said he had not intended to make a threat.

The board relented.

A Curious Career Move

Few would have guessed that Mr. Corzine, having led Goldman Sachs before serving in the Senate and as a governor of New Jersey, would wind up the chief executive of a little-known brokerage house.

At Goldman, which he joined in 1975, the young bond trader quickly gained a reputation as someone able to take big risks and generate big profits. Even after ascending to the top of the firm, he kept his own trading account to make bets with the firm’s capital. In 1999, Mr. Corzine was ousted from Goldman amid a power struggle.

By 2010, having suffered a stinging defeat in his bid for re-election as the Democratic governor of New Jersey, Mr. Corzine hoped to resume his career on Wall Street.

Work Ethic Made Corzine Popular

A friend, J. Christopher Flowers, one of MF Global’s largest investors, helped him get there. Mr. Corzine and Mr. Flowers worked at Goldman decades ago, and at one point, Mr. Flowers helped manage Mr. Corzine’s vast wealth while he was a senator, according to Congressional records.

Treasury Secretary Nominee Jon Corzine
CNBC.com
Treasury Secretary Nominee Jon Corzine

Mr. Corzine’s arrival was a coup. MF Global had hired an executive search firm, Westwood Partners, to hunt for a new leader. But some members of the board, including David I. Schamis, who worked for Mr. Flowers, were recruiting Mr. Corzine.

He was a popular manager, former employees say. An avuncular presence with a beard and sweater vest, he had a knack for remembering names. Even in the firm’s final hours, they recall that Mr. Corzine never lost his temper. His work ethic also impressed colleagues. He often started his day with a five-mile run, landing in the office by 6 a.m. and was regularly the last person to leave the office.

His intense routine was on par with his ambitions for the firm. With 15 top executives in the firm’s boardroom on his first day, March 23, 2010, he said, “I think this firm has tremendous potential and I can’t wait to get started,” one person who attended said.

Mr. Corzine faced a steep challenge.

For years, MF Global aligned buyers and sellers of futures contracts for commoditieslike wheat or metals, and took a small commission along the way. But over the last decade, that business had become endangered. By the time Mr. Corzine arrived, near zero-percent interest rates and paper-thin commissions had led to five consecutive quarters of losses.

Soon after taking the helm, Mr. Corzine oversaw a wave of job cuts and overhauled compensation, moving from steady commissions to salary and discretionary bonuses like the rest of Wall Street.

At the same time, Mr. Corzine filled the ranks with employees from Goldman Sachs and hedge funds like the Soros Fund Management. He recruited Bradley Abelow, a fellow Goldman alumnus and a top aide when he was governor, to be chief operating officer.

Mr. Corzine arrived just as Washington was pressing the big banks to curb their lucrative yet risky businesses. Spotting an opening, he fashioned new trading desks, including one just for mortgage securities and a separate unit to trade using the firm’s own capital, a business known as proprietary trading.

Not to be outdone, Mr. Corzine was the most profitable trader in that team, known as the Principal Strategies Group, according to a person briefed on the matter. Mr. Corzine traded oil, Treasury securitiesand currenciesand earned in excess of $10 million for the firm in 2011, the person said.

Some inside MF Global worried that the expansion of the profitable trading business in New York came at the expense of its futures clearing operation, which was centered in Chicago. To drum up sales, Chicago brokers were pushed to introduce longtime clients to their counterparts in New York, a move that raised tensions.

At times, Mr. Corzine seemed unfamiliar with some aspects of the futures division. In June, speaking at the Sandler O’Neill Financial Services Conference at the St. Regis Hotel in Manhattan, Mr. Corzine stumbled. “Right now, if you thought about MF Global’s retail business, you probably could only think of — ,” he said, then paused to recall the name of the division at MF Global that catered to individual investors.

He leaned over to an aide, who told him it was Lind-Waldock.

‘Chief Risk Officer’

“I consider one of my most important jobs to be chief risk officer of our firm,” Mr. Corzine told that conference.

Yet soon after joining MF Global, Mr. Corzine torpedoed an effort to build a new risk system, a much-needed overhaul, according to former employees. (A person familiar with Mr. Corzine’s thinking said that he saw the need to upgrade, but that the system being proposed was “unduly expensive” and was focused in part on things the firm didn’t trade.)

While risk at the firm had been sharply increased with the bet on European sovereign debt, there was a compelling argument for Mr. Corzine’s strategy.

MF Global had obtained loans to buy debt of Italy, Ireland and other troubled European nations, while simultaneously pledging the bonds as collateral to support the loans. The loans would come due when the bonds matured, which would happen no later than the end of 2012. MF Global, Mr. Corzine reckoned, would profit on the spread between the interest paid on the loans and the coupons earned from the bonds.

But the size of the European position was making the firm’s top risk officers, Michael Roseman and Talha Chaudhry, increasingly uncomfortable by late 2010, according to people familiar with the situation. They pushed Mr. Corzine to seek approval from the board if he wanted to expand it.

Mr. Roseman then gave a PowerPoint presentation for board members, explaining the sovereign debt trade as Mr. Corzine sat a few feet away. The presentation made clear the risks, which hinged on the nations not defaulting or the bonds losing so much value they caused a cash squeeze. The directors approved the increase. Mr. Roseman eventually left the firm.

Within MF Global, Mr. Corzine welcomed discussion about his bet and his reasons for it, though some senior managers said they feared confronting such a prominent figure. Those who did challenge him recall making little progress. One senior trader said that each time he addressed his concerns, the chief executive would nod with understanding but do nothing.

These concerns were only internal at first because, while MF Global had disclosed the existence of the transactions in at least one filing in 2010, it never mentioned the extent to which they were used to finance the purchase of European debt.

The firm bought its European sovereign bonds making use of an arcane transaction known as repurchase-to-maturity. Repo-to-maturity allowed the company to classify the purchase of the bonds as a sale, rather than a risky bet subject to the whims of the market. That called to mind an earlier era of trading when firms used repo-to-maturity to finance the purchase of risk-free assets like United States Treasury securities, Mr. Corzine’s specialty at Goldman many years earlier.

“It’s like a bond trader from 15 years agowent to sleep and suddenly awoke to make these trades,” one regulator who later reviewed the transactions remarked to a colleague.

Eventually, MF Global’s auditor, PricewaterhouseCoopers, asked Mr. Corzine to report the European debt exposure to his investors. He personally met with the accounting firm in December 2010, two people said, and it was agreed that the transactions would be mentioned in a footnote in the firm’s annual report, which was filed on May 20, 2011.

Early Warning Signs, Then a Panic

Earlier, one of MF Global’s many regulators noticed something curious. The Financial Industry Regulatory Authority, which helped watch over MF Global’s securities business, noticed a sharp swing in profits in a monthly report the firm filed to regulators. Finra asked MF Global executives about the volatile accounting line but did not get a satisfactory answer, say people familiar with the matter, until the annual report came out weeks later.

Gov. Jon Corzine of New Jersey
AP
Gov. Jon Corzine of New Jersey

When Finra realized what MF Global was doing, it grew concerned. The Wall Street self-regulator told MF Global to set aside enough money in case the trades went bad. But Finra didn’t have the authority to force the firm to do so — that power was in the hands of the Securities and Exchange Commission, whose rule Finra was citing.

Mr. Corzine then personally took the firm’s case to the S.E.C. in mid-August, taking the Delta Shuttle to Washington for a meeting with a top agency official.

The S.E.C. indicated it would side with Finra, but needed a few weeks to make a final determination. In the meantime, MF Global and Finra haggled over the size of the capital cushion: the regulator wanted $200 million set aside, while the firm pushed for a figure closer to $50 million. In late August, Finra won out.

It would be the beginning of the end for MF Global.

The Unwinding

MF Global’s investors may not have been fully informed about the European bet, but the firm’s executives had been explaining the strategy to the ratings agencies for months, according to two people with direct knowledge of the conservations. Indeed, Moody’s Investors Service and Standard & Poor’s had applauded Mr. Corzine’s effort to overhaul the firm, a move that included ratcheting up risk.

“We consider the most recent strategic plan of the new C.E.O. Jon Corzine to be sound,” S.& P. said in 2010, while acknowledging the plan “will incrementally increase the firm’s risk profile.”

But the move by Finra to force the extra capital cushion appeared to only unnerve the ratings agencies when news reports about it emerged in October. A week later, Moody’s cut its rating on MF Global to a notch above junk, pointing to the European debt holdings.

The reversal angered some executives at MF Global, who felt it was disingenuous for the agency to change its mind so suddenly. A spokesman for the ratings agency said, “Moody’s does not refrain from taking rating action when its opinion on the credit risk of an issuer has changed.”

The downgrade sent MF Global into free fall on Oct. 25. Its stock price plunged and trading partners and lenders demanded more capital to continue doing business with the company. At day’s end, rattled employees dialed into a conference call with Mr. Corzine, who tried to be encouraging.

“The sun will come out tomorrow,” he told them, according to one employee.

In truth, the company had just two options: sell itself or unload assets. Mr. Corzine organized two teams. Mr. Abelow, his deputy, began hunting for a buyer and decamped to the 40th floor of the firm’s Midtown Manhattan headquarters. On the 39th floor, where his office was next to the trading floor, Mr. Corzine took charge of selling the assets.

On Friday evening, Oct. 28, regulators and top executives trooped into Mr. Corzine’s office, joining a phone conference with Mary L. Schapiro, chairwoman of the S.E.C. Pictures of Mr. Corzine with Presidents Barack Obama and Bill Clinton sat on shelves near his desk. Towering stacks of paper lined the walls and windowsills of his modest office, partly obscuring the window view.

Dressed in his trademark sweater vest, Mr. Corzine expressed confidence a deal would be reached with one of the potential buyers, which included Interactive Brokers, JPMorgan Chase , the Jefferies Group and the Macquarie Group, according to people briefed on the call.

A deal became crucial as trading partners and lenders circled the firm. LCH. Clearnet, the firm responsible for clearing the vast majority of MF Global’s European sovereign debt trades, was also demanding $200 million to maintain the positions, atop $100 million it had claimed from MF Global earlier in the week, one person briefed on the situation said.

Other people close to the investigation, led by the Commodity Futures Trading Commission’senforcement division, have said that as the firm rushed to pay off creditors, MF Global dipped again and again into customer funds to meet the demands.

The bidders dropped out one by one, leaving just Interactive Brokers on Sunday, Oct. 30. Mr. Corzine and his team briefed regulators at 2 p.m. saying a sale looked likely to go through. About nine hours later, he got word that more than $950 million in customer funds was missing, making a merger impossible. The day after the bankruptcy, Mr. Corzine sifted through transactions in the hope of locating the missing money, one person said.

Ultimately, the bets Corzine placed wound up better than the firm itself. The European debt trades were profitable, though too late for MF Global.

Before Congress on Thursday, Mr. Corzine continued to emphasize how well his trades held up. “As of today, none of the foreign debt securities that MF Global used,” he said, “has defaulted or been restructured.”

“There actually were no losses.”

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