CME's Duffy: MF Global Broke Rules, Tapped Customer Funds

Officials at MF Global Holdings Inc. (MFGLQ) illegally used customers' money for the firm's own benefit in its final days of life, according to the executive chairman of exchange operator CME Group Inc. (CME).

The now-bankrupt broker-dealer in the past year was also found to have violated some guidelines for investing customer money held on deposit, and was told to tighten up certain accounting practices following examinations by CME and other overseers, said Terry Duffy, CME's chairman, in prepared remarks Thursday.

MF Global "appears to have broken a number of rules and obligations to protect customer collateral resulting in customer losses," Duffy said in testimony prepared for a hearing on MF Global's downfall, called by the U.S. House of Representatives Committee on Agriculture, which oversees U.S. futures market matters.

CME has come under focus in the MF Global matter because it presides over nearly all U.S. futures trading, where MF Global was a major broker for asset managers and hedgers. CME also was MF Global's primary regulator at the exchange level, responsible for auditing the firm's books.

The trustee liquidating MF Global's brokerage has estimated that as much as $1.2 billion in customer funds remain missing five weeks after the firm's collapse.

Duffy defended CME's oversight of MF Global, including several audits in the days prior to its Oct. 31 bankruptcy filing, which he said left an "unprecedented" blemish on the U.S. futures-trading business.

"Indeed, this is the first time in the industry's history that a customer has suffered a loss as a result of a clearing members' improper handling of customer funds," Duffy said in his prepared remarks.

Duffy traced for lawmakers a timeline of MF Global's final days, which included an unannounced Thursday, Oct. 27 audit by CME officials who examined MF Global's customer money held at close of business the prior day. That examination turned up only "immaterial discrepancies" and no funds missing as of Wednesday, Oct. 26, he said.

But MF Global's condition grew more dire and CME returned to conduct a second audit on Sunday, Oct. 30, after the exchange operator was told by the Commodity Futures Trading Commission that an internal report from MF Global then showed a $900 million shortfall in client funds driven by an "accounting error." A day's worth of investigation found no such error, Duffy said, and at 2:00 a.m. Monday morning, MF Global disclosed to its regulators that customers' money had been transferred into the firm's own accounts.

"Transfers of customer funds for the benefit of the firm constitute serious violations of our rules and of the Commodity Exchange Act," Duffy said.

MF Global later on Oct. 31 corrected figures reported days earlier, showing a $200 million shortfall in segregated funds as of Thursday, Oct. 27, that suggested money had been moved out of customers' accounts that Friday, Duffy said.

Duffy said that CME's most recent regulatory audit of MF Global commenced Jan. 31, 2011, and wrapped up with a final report date of Aug. 4. After the investigation CME required MF Global to change the way it had been investing some customers' money held on deposit, alongside other "relatively minor" infractions, he said. These were immediately corrected, Duffy said.

At the same time, according to Duffy's testimony, securities regulators looked over MF Global's books and records and notified the firm that it needed to alter some accounting practices.

Duffy told lawmakers in his remarks that no number of rules or regulations could stop someone intent on breaking the law.

"While it is clear that action is necessary to restore customer confidence and protect against future failures, the fact is that [MF Global] broke rules by moving customer segregated funds out of an account over which it had control," Duffy said. "A firm failed to comply with applicable rules, but that does not mean the segregation system is a failed system."

-By Jacob Bunge, Dow Jones Newswires; 312 750 4117; jacob.bunge@dowjones.com

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