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Clients who fled MF Global face clawback risk


NEW YORK (Reuters)—Former MF Global Inc. customers like Koch Industries Inc., who pulled billions of dollars out of the stricken broker's accounts weeks or months before its collapse, have counted their blessings in recent days.

But their relief may prove premature depending on the outcome of a separate, four-year-old bankruptcy case involving Sentinel Management Group Inc. The lawyer overseeing that case has gone to court to try to force some of Sentinel's former clients to take a share of the losses.

Thousands of MF Global's commodity clients have been clamoring over more than $1 billion in cash and collateral that is still frozen. Yet many customers pulled out a large sum of cash before the company declared bankruptcy on Oct. 31, regulatory data and exchange estimates show.

"Everybody and their brother started pulling money out early," said one commodity hedge fund manager who withdrew some of his funds prior to MF Global's fall. "People pulled money out of Lehman and Bear segregated accounts when they knew they were going bankrupt and nothing happened to them. It doesn't mean it can't happen, but I don't see it."

At issue is MF Global's "segregated accounts"—client money meant to be kept strictly separate from the broker's own funds, but which regulators say is now $600 million short. That pot of money shrank by $1.5 billion in August alone, government data showed. Another $1.8 billion fled over the following two months, according to preliminary estimates.

In total, customers pulled out more than a third of their accounts in the three months leading up to MF Global's downfall, much of that in the frenzied final days, traders reckon.

For instance, privately held Koch Industries—whose businesses make it a leading commodities trader—sent a letter to trading partners on Oct. 3 saying it was switching eight accounts from MF Global to Mizuho Securities USA.

Koch Industries did not comment on the reason for its move.

It remains unclear how many customers who withdrew funds from MF Global were influenced by the broker's financial condition or Chief Executive Jon Corzine's eurozone debt trades that led to its collapse. Whether they will be able to keep the money they withdrew may depend on the outcome of legal actions stemming from the Sentinel case.

Frederick Grede, trustee for the bankruptcy of futures commission merchant (FCM) Sentinel, has sued 50 of its former customers to recoup some $600 million in funds that were withdrawn prior to its bankruptcy.

He has already settled out of court with some customers and recovered about $25 million. The rest remains in litigation, filed before the two-year statute of limitations ran out.

His view is that the loss of funds should be shared equally, on a pro-rata basis, among all customers, not only those who were left holding the bag when Sentinel filed for bankruptcy.

Mr. Grede says his case differs from that of former customers of Bernard Madoff Investment Securities. For one thing, he insists that he does not have to prove fraud occurred in the 90 days preceding the Sentinel bankruptcy, the timeframe he is focusing on.

"Sentinel was a case of misappropriating funds," Mr. Grede said. "They used customer funds for speculation for their accounts. Ultimately it's my position that all customers should be treated equally. I don't have to prove that they knew the company was going bankrupt (before they took out the funds)."

Sentinel was a different type of FCM than MF Global, and served as a professional "broker for brokers", clearing trades on behalf of other brokerages—including MF Global itself.

But the Sentinel case still could set a precedent for MF Global if attorneys for former clients can show that MF Global used customer funds to trade its own book.

FCMs are strictly limited to what they can invest in using segregated customer funds, essentially the money that customers use to trade and post collateral.

Those monies are explicitly meant to be kept separate from those of the firm. The U.S. Commodity Futures Trading Commission permits segregated customer funds to be invested in certain liquid, high-investment grade securities such as corporate and government bonds.

In Sentinel's case, those bonds were removed from segregation and used to pledge for bank loans, Mr. Grede said.

Proceeds from the loans were then improperly used to trade in the firm's proprietary trading account.

Former MF Global customers are concerned that trustee James Giddens may seek a similar route to recoup funds unless he can find the roughly $600 million that is still missing.

Chris Hehmeyer, CEO of Chicago-based proprietary trading firm HTG and an advisor to futures brokerage Penson, moved "a chunk" of his business earlier this year to MF Global. But by June, he decided to take his business elsewhere because MF Global stopped offering a financing service that HTG needed.

"With the Sentinel bankruptcy, the industry did not pay nearly enough attention to the claw back issue, and it's still out there, four and a half years later," he said. "I understand I could still have some exposure because this issue hasn't been resolved."

Kent Jarrell, a spokesman for the MF Global bankruptcy trustee, told Reuters the trustee will "explore all possible causes of action.

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