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On the failure of MF Global and the role of NEDs

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The horrifying thing about MF Global is you can bring in someone with huge experience like John Corzine, who has seen what’s gone on in the past three years, and yet he goes in and completely fails to prevent what has become the biggest blow-up since Lehman’s – indeed, it has been suggested that he instigated the disastrous trade, says Dermot Butler (pictured), chairman, Custom House Global Fund Services…

He’s due to appear before a congressional House committee today – 8 December – and in a prepared testimony he plans on saying “I simply do not know where the money is, or why the accounts have not been reconciled to date”.

You go to MF Global because they’re a solid company, who have been around a long time. Unfortunately, Corzine has demonstrated extreme irresponsibility and clearly hasn’t learned a thing. It’s like 2008 never happened. 

I feel sorry for all MF Global’s clients and especially the farmers and ranchers who used MF Global to hedge their crops against future price volatility. Unfortunately a run-on-the-bank syndrome appears to have affected an awful lot of people who put their faith in MF Global.

It was triggered by the fact that someone at the firm made a serious error of judgement. This is, I think, a classic case of hubris.

My understanding is that those MF Global clients with cash in their account at the start of day on 31 October have been paid or have applied to the judge to allow them to receive 60 per cent of what they had there.  However, I know of one fund that liquidated all their positions on 31st October and although they had cash at the end of the day they’re not getting the same treatment as those who had cash at the beginning of the day. Hopefully it’ll all get ironed out but it might take a long time to work through the bankruptcy courts.

The need to allocate blame in these disastrous situations is both obvious and understandable. Take the Walkers’ non-executive directors (NEDs) of the doomed Bear Stearns hedge fund that folded in 2007.  I gather they’re being sued because they didn’t pick up on style drift.  Subject to their Directors Service Agreement, I personally have some sympathy for them. I sit on the board of several funds and receive reports from administrators, investment managers etc, confirming they’ve done what they are contracted to do. Am I allowed to rely on that or do I actually have to go and check every single transaction? That’s not what a NED is supposed to do. He/she is supposed to interrogate and get comfortable answers.

I don’t know what went wrong at MF Global, or where the money went, but it seems possible that during the day they were putting up margins against their own positions, which they were taking out of client accounts. If, at the end of the day, when they closed their trading books, they put the money back, anyone looking at their balance on a daily basis would think that’s okay – they’re covered. No problem. And then one day they can’t put it back and they’re not covered.  However, the only way to discover the on-going problem would have been be to perform checks on a real-time, intraday basis.

As I’ve said for many years now: No regulation stops a crook.

Certainly, there’s a strong argument for regulators having real-time access to fast-moving markets like futures. If it happens it’ll put more of a burden on administrators to do things in real-time. At the moment, the majority would be stretched to do this. We could do it with a couple of clients but not all.

I’d like to go back to the earlier point on the role that NEDs play. There have been various noises in the media recently about the efficacy of NEDs and whether they sit on too many funds. Well, it’s a very easy argument to make but it depends how the NED operates. Even the most diligent NED could not have known about the intra-day irregularities at MF Global.

I know one Cayman corporate director who sits on about 100 funds. He has a team of support staff who read the reports that come in and highlight any problems. If there are any they simply say ‘the administrator’s report is clean except there was a minor price error on page x due to the following’. The Director can look at that straight away and get to the bottom of the issue.

Granted, the Weavering case hasn’t helped but it was extreme. To throw it back on all NEDs and suggest there’s a fundamental issue with the governance of all fund’s boards is unjustified in my view.

Another point that has cropped up recently is whether representatives of a fund’s administrators should sit on the board of the fund because of perceived conflicts of interest.

Halfway through a meeting I attended the other day, someone from a major and very vocal institution said that no administrator should sit on the board, but was quite happy to let the investment manager do so. Doesn’t that represent even more of a conflict of interest? He wants more independent investment managers on the board of funds, rather than administrators.  But because the majority of investment managers will inevitably be traditional long-only managers, many won’t have the slightest idea what a complex derivative is.

How is that more preferable to using administrators who have experience at working with a wide range of hedge fund strategies and understand exactly what they’re doing? They’re going to pick anomalies up and act on them far quicker than, say, an investment manager from Edinburgh, who’s never had to spell “hedge”.

Even if there are conflicts of interest, which may happen from time to time, it’s not as if they’re difficult to resolve or manage.

Don’t get me wrong – I am in favour of greater corporate governance for Directors of all companies – not just funds – but pendulums can swing too far.

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