The long nightmare of MF Global Holdings Ltd. is finally coming to an end. Most of the missing customer money has been located in bank accounts and clearinghouses, and a bankruptcy court judge last week approved a plan to liquidate what's left of the company.
What have we learned from the debacle? And what should happen to the former chairman and chief executive officer, Jon S. Corzine? These two big questions are closely related: Whether regulators, boards, shareholders and the rest of the financial industry absorb the lessons of MF Global's downfall depends in large part on Corzine's fate.
By most accounts, he will escape prosecution, though he remains in legal jeopardy while criminal and civil investigations continue. His reputation, however, may never recover, considering the conclusions in a report that Louis J. Freeh, the court-appointed trustee and former FBI director, filed last week.
Corzine, Goldman Sachs' onetime star government bond trader, thought he could convert MF Global, a sleepy commodities middleman whose roots reach back more than 200 years to a Thames River sugar broker, into a high-flying securities trading firm. Instead, he drove it into the ground in just 20 months.
Freeh is awaiting the outcome of mediation before deciding whether to sue Corzine for breach of fiduciary duty for pursuing a risky trading strategy without being able to measure what the trades did to MF Global's capital and liquidity.
Another route for prosecutors would involve charging him with false certification of Securities and Exchange Commission filings. The 2002 Sarbanes-Oxley law says that if a CEO knowingly signs off on false financial reports, he could be sentenced to 10 years in prison and ordered to pay $1 million in fines.
Even if no case materializes (the SEC has brought only a handful of such actions since 2002), the SEC should ask whether Corzine can be trusted to run a securities business again.
A Corzine spokesman dismisses the trustee's report as "a clear case of Monday morning quarterbacking." Monday morning quarterbacking can be instructive, however, so let's do some, too, using Freeh’s report as our chalkboard:
In 2010, when Corzine arrived at MF Global, its business model of earning commissions on trades and interest on client funds was faltering. He tried to make the company something it could never be: another Goldman Sachs, with an investment bank, a full-time broker-dealer and a high-stakes proprietary trading desk dealing mostly in European government bonds.
Corzine's bigger mistake was to appoint himself, in essence, chief trader. By the time he began gambling in European sovereign debt, it had been 15 years since he had overseen a trading desk.
That's lesson No. 1 for corporate boards and investors: Be skeptical of CEOs who preach wholesale transformation by doing what they'd done decades before.
Corzine, 66, went on to make casino-like bets on Irish, Italian, Portuguese and Spanish sovereign bonds that were trading at a discount because of their high default risk. He thought the bonds would eventually trade at par because the European Union's bailout fund would step in to prevent defaults.
To finance the debt purchases, Corzine entered into repurchase agreements in which MF Global "sold" the European bonds to banks and others (with a promise to buy them back), and immediately recognized that income on its financial statements. The debt purchases were simultaneously removed from the balance sheet, making the company appear more profitable than it was. U.S. accounting rules allow this.
The problem was, while euro-area officials endlessly debated whether to trigger the bailout fund, the bonds lost value, and MF Global lacked the money to meet expensive margin calls.
That brings us to lesson No. 2: Beware a chief executive who claims to have an intimate understanding of political and fiscal problems an ocean away.
Within months of his arrival, Corzine began seeking board permission to raise the company's trading-risk limits so he could expand a $400 million trading portfolio. When he hit the $2 billion mark, the company's chief risk officer became concerned. But Corzine got the board to okay a risk-limit increase to $4 billion.
He also downgraded the risk-officer's job by having him report to the chief operating officer, his former gubernatorial chief-of-staff, instead of the board.
Lesson No. 3: It's a bad idea for directors to degrade reporting lines, especially for a chief risk officer, without demanding that the chief executive provide good justification.
Corzine eventually fired the risk officer, clearing a path to win board approval of about 10 more increases in risk limits, until, in late 2011, the cap reached $8.4 billion. Even then, Corzine breached it, buying about $400 million more in Italian sovereign debt than the board had approved.
Lesson No. 4: If a CEO repeatedly thwarts a board, especially by overriding risk limits, it might be a good idea to end the relationship.
Another problem: From the beginning, Corzine failed to put in place proper internal controls to make sure employees, especially those in financial positions, weren't cheating or violating position limits. In 2008, before Corzine arrived, MF Global had suffered a $141 million loss because weak controls failed to catch a rogue trader. The risk officer Corzine fired had been brought on to prevent similar mishaps. Once Corzine arrived, the board directed him to further strengthen controls by installing a global system to measure liquidity and a process to stress-test the company's finances.
Corzine failed to do these things, even after auditors reminded him. Could that be because stronger controls would have ended his risky trading strategy?
Lesson No. 5: Board members must personally make sure controls are airtight, or the weakness will almost certainly come back to haunt them.
In MF Global's final weeks, the inadequate controls prevented the board from knowing that customer funds, which were supposed to be kept separate, were being used to satisfy margin calls.
While it doesn't appear from the trustee's report that Corzine instructed his staff to override rules for protecting customers' funds, the report says the company's glaring control deficiencies "were long known to Corzine and management, yet they failed to implement sufficient corrective measures promptly."
Lesson No. 6: The CEO is in charge. Corzine should have known and informed the board that customer funds were being tapped. For this reason alone, the SEC and its sister regulator, the Commodity Futures Trading Commission, would do well to question whether Corzine should ever be trusted to act in a fiduciary role again.
(Paula Dwyer is a member of the Bloomberg View editorial board. Follow her on Twitter.)