25 January 2012

The MF Global Bankruptcy Filing: Did the Regulators Sell Out the Public for JP Morgan?

What seems fairly obvious is that the law calls for MF Global to file a Chapter 7 bankruptcy in which customers are given seniority to creditors, rather than a Chapter 11 non-broker bankruptcy in which the customer interests are not upheld.  The rationale for Chapter 11 has always seems to be contrived to favor a particular creditor bank.

Prior CFTC rulings and 'Rule 190' seems to have dealt with this in the past.  Statements by various CFTC commissioners of late also seem to suggest that customers absolutely have a senior claim to any assets.

Why then did the SEC, with Gary Gensler's purported assent, seem to ignore the precedent and their own rules and cut a deal in a secret meeting to favor the Banks, specifically JP Morgan?

The personal involvement of Gary Gensler seems a little ambiguous based on the facts at hand, but it is obvious that the bankruptcy filing is being mishandled, and the SEC and CFTC are doing too little to represent the interests of the customers.

Obviously this should be more explicitly addressed and the customers need to be relieved of this travesty of justice. 

President Obama may speak brave words in his speeches, but the actions of his Administration show that there is little teeth in their supposed championing of the public interest over the powerful interests of Wall Street.   Actions speak louder than words.

CFTC Warnings When Bankruptcy Codes Conflict: And a Still Secret Meeting

Last week we witnessed lawyers dueling in the bankruptcy court on the details of exactly what code of law supports customer priority in liquidation of the parts of MF Global Holdings, and gosh!….is the Holdings is even a broker ? Why are lawyers debating these questions at this late date?

First we’ll cover what started the fight and then move onto the genesis of why it has come to this so far into the proceedings. Do stick with the story as it might sound like legal minutiae, but does have everything to do with recovery of customer funds.

It started with the Sapere Wealth Management, LLC assertions (among others) that the MF Global estate must be administered under 17 C.F.R paragraph 190. Remember paragraph 190 as you will hear more about this in the next weeks. Applying this clause of the bankruptcy code to the liquidation of MF Global Holdings would assure customer priority in the liquidation of MFGH, which is also claimed to have taken customer assets out of MFGI, the commodity brokerage unit of the Holdings company, MFGH — before and after the bankruptcy.

That all customer property as defined in paragraph 190 of the code, must be returned to commodity customers free and clear of other claims is also supported by others parties, including the CFTC. The CFTC, however, also asserts that existing principles of law are available to ensure this, but first the court needs to make “antecedent determinations.” In other words, the CFTC legal team is playing the adult and indicating that we already have the laws on the books to deal with this once the court figures out what laws it wants to use.

So why is the question if MFGH is even a broker so important? Again, the key paragraph 190, which legally secures customer priority and distributions can only be applied to a brokerage Chapter 7 bankruptcy, which is used for brokerage bankruptcies, but was not used for MFGH, which is the holding company of MFGI. MFGH was filed as a Chapter 11 bankruptcy. This Bankruptcy Code is used for non-broker entities, seeking re-organization.

Also, and to use the words of the Sapere plea to the court, “A decision by the court that 17 C.F.R §190 applied to MFGH’s estate can, among other things, obviate the need for titan law firms representing MFGH and MFGI, respectively, to engage in battles with one another funded by “other people’s money,” i.e., at substantial costs to the estates of MFGH and MFGI.”

The ability to use many millions of customer funds locked in the estate to pay trustees and their “titan” law firms representing MFGH and MFGI is possible because the bankruptcy was filed as a Chapter 11 for the Holdings and Chapter 11 SIPC filing for MFGI, the commodity brokerage, and not under Chapter 7 for both.

As regular readers know, from the start of this sorry saga, MFGFacts.com has focused on the questions around why a Chapter 11 SIPC bankruptcy with almost non-existent securities accounts when neither SIPC nor Chapter 11 address brokerage liquidations. Additionally, Chapter 11 is the choice when a restructuring is planed, which is not so with MFGH.

A Breaking Investigative Report

Fortunately, these question are now receiving greater scrutiny in the industry press as we read in this investigation published last week by Mark Melin of Opalesque Futures Intelligence who contacted MFGFacts.com while conducting his investigation, Sold Out: How A Private Meeting Between Regulators Gave Away MF Global Investor Protections. In short, as Melin reports, “Deciding upon a Securities industry SIPA liquidation process for an FCM over the Commodity Exchange Act (CEA) liquidation and section 7 of the US Bankruptcy Code was a legal maneuver with far reaching consequences for customers with segregated funds and property with custodial banks. The selected SIPA liquidation does not recognize fund segregation or futures industry account regulations. The process considerably favors creditors.”

In other words, when the SEC threw the liquidation process to SIPC under for a Chapter 11 securities liquidation, and with the CFTC’s immediate agreement (under the conflicted Chairman Gensler who had not yet to recuse himself from MF Global issues), a framework of law was chosen where customers were — for the very first time ever — made creditors and their assets thrown into the entire MF Global estate. Many say what! And the industry is now asking how?

According to the report, the speculation is this: Robert Cook, SEC Director of Division and Trading and Markets is said to have been the lead regulator at the key meeting, the details of which are still not public. “Before joining the SEC, Mr. Cook was a partner at the powerful Washington D.C. law firm of Cleary Gottlieb Steen & Hamilton LLP, which represents JP Morgan, among other clients,” Melin reported. We all know that JP Morgan is the largest creditor to MF Global Holdings. Readers may reach their own conclusions about that. Yet, making the liquidation of MF Global Holdings and its parts a Chapter 11 and SIPC bankruptcy, set the stage for expensive dueling among lawyers over the fact if MF Global is even a broker or not. This also and — most importantly — tremendously enhanced the recovery position for non-customer creditors over all customers.

The CFTC Warned in the 1980s of Potential for Abuse and Problems when Bankruptcy Codes Conflict with a Duel Registered Entity

As Melin shares, that the CFTC – to the agency’s great credit — recognized and dealt with this problem: Citing the exemplary record in the futures industry in the event of bankruptcies, former CFTC Director of the CFTC Division of Trading, Andrea Corcoran writes in a January 1993 issue of Futures International Law Letter “As early as 1980, however, concerns were expressed about the ability to retain this record in the event of the bankruptcy of a dually-licensed firm – that is, a firm registered as both a futures commission merchant (FCM) and a securities broker-dealer.”

To rectify this, the CFTC then drafted rules we find under then now famous Part 190 where Corcoran writes, “In the final rules, the Commission noted that Section 7(b) of SIPA (read Securities Investors Protection Act) …proved that a trustee in a SIPA liquidation shall be subject to the same duties as a trustee in a commodity broker bankruptcy under Subchapter IV of Chapter 7 of the Code.”

The CFTC was well prepared for a MF Global-like event. Against this background, and as Melin also reports, the choice of a Chapter 11 SIPC bankruptcy code for the liquidation of a futures broker, makes Chairman’s Genslers “give away” even more baffling. We’d call it a throw away and ask if Chairman Gensler invited a single CFTC attorney into that early hour meeting before agreeing to file MFGI under MFGH as a Chapter 11 SIPC bankruptcy? Regardless, with that decision the fate was sealed. And not only were customers and the industry severely damaged, but there was a complete disregard of the decades of work, preparation and public service by the many professionals in the CFTC to which Chairman Gensler was entrusted.

And now we have the spectacle of “titanic” lawyers in one of the largest bankruptcies ever arguing if an entity is a broker or not.