This book is the fourth in a series of compilations from re: The Auditors. This volume focuses on the failure of MF Global on October 31, 2011. MF Global was a broker-dealer and futures commission merchant (FCM).

All of these essays and columns have been previously published in re: The Auditors, Forbes.com, or American Banker. This version does include extensive links to other articles and resources both on and off the sites. Please visit the original columns to view reader comments. The community conversation and information sharing is one of the most valuable parts of the online experience.

Future volumes will cover the business of the Big Four audit firms, corporate governance, risk management and the intersection of financial services and professional services.

The price is $3.99.

Also available : re: The Auditors On Careers: Being A Big Four Partner

This book is the third volume of compilations from re: The Auditors and the second in a series on careers. This volume focuses on the role of the partner in the Big Four public accounting firm and how that person is developed, evaluated, and compensated.

All of these essays have been previously published in re: The Auditors but have been selected and arranged chronologically for your convenience. This version does include extensive links to other articles and resources both on and off the site. Please visit the original posts to view reader comments. The community conversation and information sharing is one of the most valuable parts of the re: The Auditors site.

Future career volumes will cover diversity and inclusiveness, ethics, independence, and professional skepticism, layoffs, and the overtime lawsuits.

Future compilations will cover special topics in auditor litigation, the Ernst & Young/Lehman case, consulting in the Big Four, and a behind the scenes look at the global network construct.

Also available:

re: The Auditors on Careers: A Compilation On Recruiting, Salaries, and the Competitive Employment Landscape

And:  “Unholy Alliance: PricewaterhouseCoopers And Its Relationship With AIG and Goldman Sachs During The Crisis.”

This is not a traditional book but a compilation of all of my writing from 2007 until January of this year on AIG, Hank Greenberg, the asset valuation and collateral conflict between Goldman Sachs and AIG, and PwC’s relationship with two of its most important clients.

All of the chapters are available as posts on this site and Forbes.com, but I thought it might be helpful for some to see them in chronological order, all together.

The package includes thirty-three (33) essays including extensive links, almost 41,000 words, and 180 pages of stories about such characters as Arthur Levitt, Joe Cassano, Eliot Spitzer, and Hank Greenberg. There’s extensive coverage of the litigation related to the earlier AIG crisis for accounting issues occurring between 2002-2005.

You can go here to subscribe to this site via Kindle.

Your feedback and ideas for future e-books will be appreciated.

The articles, a feature and a sidebar, are also posted on my blog at Forbes.com.

Groupon: Ernst & Young’s Accounting Challenged Client is the sidebar to the feature article, How Zynga, Facebook and Groupon’s Go-To Auditor Rewrites Accounting Rules.

I had lots of help from wonderful professionals who generously offered advice, resources and quotes, including at the last minute over Easter/Passover weekend.  Some of those quotes, unfortunately, did not make it to print.  I will put together an outtakes reel later so you can also see that thought leadership on the subject.

If you like what I’ve done under the Forbes Investigations banner, please let them know.  I’ve got three more features planned for this year and hope to do more.

Tim Carmody, a staff writer at Wired, called and asked for my thoughts on the Facebook S-1, their IPO filing with the SEC dated February 1, 2012.

Carmody, I think, expected me to have some criticisms about Facebook’s accounting. After all…

so much depends

upon

being more

open

connected with

the world

don’t be chicken

livered.

Most initial news accounts of the Facebook S-1 focused on CEO Mark Zuckerberg’s Stalinist-like stranglehold on the stock, the strategy, and the board. Carmody waited a few weeks to file his story, after recording an hour of our conversation on the phone a few Saturday afternoons ago, and got lucky. Apple announced some significant to changes in their corporate governance that contrast sharply with Facebook and Zukerberg’s one-man band approach.

Apple has bowed to investor demands to give shareholders greater influence over the election of directors, a move that will make it far harder for other leading US companies to ignore calls to improve corporate governance standards.

The technology group had disregarded a shareholder vote at last year’s annual meeting calling for the change, but faced renewed pressure from Calpers, the largest US public pension fund, to introduce majority voting for seats in the boardroom at its Thursday meeting…Calpers’ push for change at one of the fastest growing and most popular US companies had become the centrepiece of a campaign for boardroom accountability. Its victory reflects a growing investor consensus in favour of the corporate governance agenda.

Facebook, on the other hand, is a “controlled company.”

Carmody explains:

Between his own stock holdings and agreements with early investors including DST Global Ltd and Accel Partners, CEO/founder Mark Zuckerberg controls a majority interest in the company. This gives him total control over approving the board of directors as well as any acquisition or mergers. He also has the ability to appoint his own successor, even after his death.

Because of Zuckerberg’s control, Facebook qualifies as a “controlled company,” meaning that it is not required to have a majority of independent directors or a separate nominating committee. Zuckerberg effectively has the ability to select anyone he chooses inside or outside Facebook to serve on the board, and then use his controlling interest to approve his own choices.

Facebook has two-tiered stock; private Class B shareholders hold ten times the voting power per share accorded to publicly-traded Class A stock. If Class B shareholders ever lose a controlling interest in the company, the governance structure shifts again; only the board of directors will be able to fill vacancies within its own body, director elections will become staggered (making it even more difficult to vote in an all-new-board), and it will take a supermajority vote to change the company’s by-laws.

Anyone who invests in Facebook under these terms is basically putting their money into a blind trust. They have no say over strategy, over the board – not that shareholders have much influence over the Board of Directors anyway but we can pretend – and there is no dividend. One can only hope for capital appreciation. Like Berkshire Hathaway. Except unlike Warren Buffett, Mark Zuckerberg is probably not kicking the bucket any time soon.

It doesn’t make a hill of beans what the accounting looks like. Investors in the social media/social gaming IPOs are looking for the “pop”, the short term price rise, or medium terms share price appreciation that makes them all smug and satisfied about getting in on a good thing. And in the long term we’re all dead.

What’s really changed from more than a year ago when the private placement by Goldman Sachs fell apart other than we now know Ernst & Young has been with them for a while as auditor and IPO guide? Not much.

So let’s summarize Facebook’s strategy of being a private public company from the perspective of the investor:

• Facebook limits access to their financial information.

• Goldman will manage the SPV used to market “shares” of Facebook to outside investors. Goldman has access to Facebook’s books but your access is through Goldman.

• Facebook likes to say they have $2 billion in revenues but who is testing the quality and veracity of those revenues?  Advertising revenue is one thing – although notoriously easily manipulated from an accounting perspective as we saw in the Time-Warner case.  But “transaction revenue” from equally opaque companies such as Zynga is like cotton candy – potentially all fluff.

• Facebook’s CEO wants absolute control of the company so he can “realize his vision.”

• Facebook thinks regulatory control over the securities markets, accounting requirements that protect investors, and legal compliance with these laws and regulations is a “distraction.”

• Facebook’s CFO is not an accountant, not a CPA and has no public accounting experience. What’s wrong with that? It may be barely tolerable when a company is in startup mode, but this is a big global company that has to be run, run well, and run according to GAAP.

• Facebook has no requirement to have independent directors on its board who protect the interests and rights of this growing class of outside investors.  Oh, wait… Goldman Sachs can look out for them.

• Facebook has no requirement to be audited as long as it’s a private public company. It’s notoriously difficult for outsiders to find out who their service providers are – the audit firm or consultant that’s currently reviewing financial and IT controls over the production of financial reporting for investors. Given the amount of outside investment, I’m sure one of the largest global audit firms is advising them. But their reports, and any concerns they may have about controls or corporate governance, are not public nor do they go to the SEC. Facebook is not subject to Sarbanes-Oxley including whistleblower and CEO/CFO certification requirements. Given estimates of Facebook’s “valuation” and expected market capitalization post-IPO, isn’t it a good idea to make sure they’re ready for prime-time?

In the S-1, Zuckerberg describes the “unique culture and management approach” of Facebook as “The Hacker Way.”

I don’t know about you, but I’m skeptical of this approach as it applies to finance, accounting, corporate governance, and internal controls.

But that’s not what this company or its board is focused on.

Carmody quotes me:

“Their audit committee chairman, Erskine Bowles, is a politician,” McKenna added. “That tells you a lot about how they plan to resolve any differences in opinion” with the SEC, IRS or other investigative bodies.

Many others were critical of the board composition. There are no women and, gee, think about all those women playing Farmville and Mafia Wars and sharing recipes, photos of their kids and complaints about their husbands, and passing along news from their high school reunions.

Carmody quotes me again:

“Notice I didn’t say anything about how there are no women on the board,” McKenna told Wired. “I’d much rather have another guy with real financial knowledge than a token woman.”

There’s more, including my comments about Facebook’s auditor Ernst & Young. Please read the rest of Tim’s excellent piece at Wired, “Apple Gives Shareholders More Input; Will Facebook Get the Message?”

Photo Source

I hope you all take the title of the column in stride. First of all, as often happens, it’s a title chosen by the editors, not me. Once in a blue moon I come up with an inspired title for my columns that’s both punchy and SEO friendly. That means the title catches your eye and catches the eye of the Google-bot.  More often my title choices lack one or both qualities.

Secondly, I do not believe the measure of a man or a woman is what they make. But in the case of the two MF Global CROs, the testimony they gave about their salaries, coming at the end in response to a question from a cranky Congressman from New Mexico, offered the perfect punchline.

The job of CRO is one of the toughest in financial services. In these difficult times, what’s needed is a CRO who will raise concerns, back them up with enough facts to convince even those most skeptical and take the consequences of his convictions. But if the CRO doesn’t have the right independence, expertise and stature in the organization, his objections will most likely be ignored and perhaps cost him a career.

Please read the rest at American Banker, “Judge Chief Risk Officers by Their Paychecks.”

Last Monday in Forbes, I gave readers a link to some very interesting facts uncovered by Bob English, an independent trader and blogger who has been following the MF Global story on his blog, Economic Policy Journal. His findings raise serious questions about the Securities and Exchange Commission’s regulation of MF Global and all broker/dealers.

A summary of that post and some additional developments after press time is here.

It seems the SEC, maybe by design, maybe by careless default, is keeping the truth from the public about what went wrong at MF Global.

PwC’s report to the SEC of internal control discrepancies at the broker-dealer for 2010 – and there is one according to the filing index – is private. None of the auditor’s reports specific to MF Global’s broker/dealer are available to the public on Edgar for 2011.

“…it appears the SEC has provided a little-known, yet easy way for broker dealers to keep a substantial portion of their annual filings non-public, without having to file a confidentiality request. Several smaller brokers we contacted were not aware of this.

If the internal controls report of MF Global Inc. made it into its 2010 public filing, yet the financial notes did not, was it simply a case of improper separation of the public and private bound filings on the part of the filer? If so, why is the SEC not enforcing substantive error checking, inasmuch as we have found this phenomenon to be quite common for broker filings?

Or, is the SEC selectively determining itself which portions will be public and private, and committing errors (intentional or not) in the process? Recalling the deleted filings of JPM, Goldman, BoA and others, is it possible that what was supposed to be confidential was inadvertently made public, and upon petition from the filer (or its auditor), the entire public filing was simply deleted?”

My column at Forbes also noted that it’s not just the SEC who’s holding back information about MF Global from the public:

The CFTC, who seems to be using leaks to the press to deflect attention from its own role and responsibility for keeping an eye on customers’ money, is doing it, too. There is no data regarding status of segregated customer assets for MF Global on the monthly required regulatory report for FCMs posted by the CFTC for September, 2011.

I asked the CFTC:

“Did MF Global submit their data as an FCM for September on time within your required timeframe? If the CFTC received the data on time, why did the CFTC decide not to publish MF Global’s numbers as of September 30th? The full report was posted to the website on November 10, after the October 31 bankruptcy, but the data is “as of” September 30 when the firm was still in business.”

The CFTC spokesperson would not go on record with his response. Based on our conversation and the policies published on the CFTC ebsite of handling this report, I’ve determined that the September 30, 2011 financial statement filings for all FCMs, FCM/BDs, and RFEDs were originally due October 26th. The CFTC gives itself 12 business days after the due date to publish. It appears that organizations were given additional time due to the Veteran’s Day holiday. The Commission states that it “generally” publishes data for active FCMs only.  MF Global Inc. declared bankruptcy October 31, 2011. At the time the September data was posted, MF Global Inc. was no longer an active FCM and, therefore, the firm and its data was deleted for the report.

The first private lawsuit naming PwC, the MF Global auditor, as well as several MF Global executives and JP Morgan, was filed last week by some Montana farmers. Here’s a copy of the original complaint.

Are the holding company trustee Louis Freeh and the broker dealer SIPA trustee James Giddens ever going to investigate JP Morgan and auditor PwC? As I wrote here on January 10, the trustees have already given themselves an easy legal out:

Unfortunately for those who will be looking for third-parties like the auditor PwC and the banker JP Morgan to make up the difference in the missing funds, these disclosed conflicts set up an easy out for the Trustees to decline to investigate claims against the parties they have a deep and fruitful business relationship with.  It happened before in a case that is too close for anyone involved here to claim ignorance of:  Refco.

Let’s look at the conflicts that the trustees have just with PwC:

• PwC is the external auditor for MF Global.
• PwC is the external auditor for Man Financial, the firm from which MF Global was spun off.
• PwC designed the internal controls for Refco, the firm Man Financial bought after Refco’s fraud drove it to bankruptcy and the firm that became MF Global after its IPO.
• PwC was not pursued as a third-party aider and abettor of the Refco fraud because the judge decided that a prexisting conflict between PwC and the trustee’s firm precluded the trustee from personally pursuing PwC. The judge decided not to select another non-conflicted trustee to pursue PwC.
• PwC is the auditor of JP Morgan, MF Global’s primary banker and largest creditor.
• PwC is the auditor and a client of the SIPA trustee’s law firm Hughes Hubbard.
• José R. Hernandez, the Chief Executive Officer of Freeh Group Europe, the consulting firm founded by MF Global Holding company trustee Louis Freeh, is a former European-based partner of PricewaterhouseCoopers (PwC) and PwC provides services to Freeh’s firm per his disclosures to the court.
• PwC is auditor to Goldman Sachs, Corzine, Abelow, and Ferber’s former firm and a firm that bought a significant amount of assets from MF Global in its last days when MF was desperate for liquidity.
• MF Global CFO Henri Steenkamp came to Man Financial, predecessor firm to MF Global, from PwC.

Don’t say I didn’t warn you when Judge Glenn allows Freeh and/or Giddens to say later, regarding pursuing claims against PwC, “Move along. Nothing to see here.” PwC is worth more to them alive than severely wounded.

In other news, I penned a somewhat provocative prediction for American Banker on January 3 regarding Jamie Dimon, CEO of JP Morgan.

Jamie Dimon will have the misfortune, I believe, of catching a significant amount of fallout from the MF Global mess. As MF Global’s primary banker, JPMorgan Chase has been consistently accused in the media and by the attorney representing a customer coalition of taking advantage of the firm’s vulnerable financial state. Bloomberg News reported that the MF Global trustee said “certain” actions of JP Morgan Chase “are likely to be the subject of investigation.”

What JP Morgan Chase may have allowed – the use of customer funds to meet MF Global’s corporate obligations – is something JP Morgan was recently severely sanctioned for in the U.K. The bank’s London unit was fined a record 33.3 million pounds by the FSA, Britain’s financial regulator, for commingling client funds in its futures operation.

Some commenters were not crazy about the tone of the column. Or the title. You be the judge. “Jamie Dimon Will Have His Comeuppance in 2012″ is at Forbes.

I’ve added this video at the request of commenter “Johnny Dangereaux”.

Bob English, an independent trader and contributing editor to the blog, Economic Policy Journal, wrote earlier Monday about some filings funny business over at the SEC.

On January 3, 2012, a copy of the missing audit reappeared under a different index number (the original, as of the time of writing, remains here). While it seems the replacement simply corrects what is an obviously wrong stamped receipt date on the face page of the original, there are a few curious annotations that we will explore. More importantly, after researching the SEC’s public database for scanned paper filings, which includes private offering Form D’s, exchange filings, firm advertising literature, and other filing types (including broker dealer audits themselves), we are left with more questions than answers.

It seems that sloppy scanning and filing standards combined with preferential treatment for certain large brokers has substantially reduced the value of this part of the SEC’s public filing system…a look into all of 2011’s scanned paper filings reveals that only 45% of the sequentially indexed PDF files that were scanned from hard copies by the SEC remain public (7,949 out of 17,718). [The SEC has kindly left the source code to its PDF scrubbing program here, also archived here on Scribd.]

Many might think that with the demise of Arthur Andersen, the regulators and the public have gotten rid of the baddest apples in the bunch. Much has been written about whether Enron was an anomaly or whether there was something more institutionally perverse that had to be stopped. Andersen alumni felt vindicated and cheated when the Supreme Court overturned the conviction of the firm. Why then did it have to fail?

Well, there was more to the story and, of course, it did not end with the end of Andersen as a firm. There were many other times Andersen was called on the carpet by the SEC or sued by shareholders for bad audits.

In April of 2001, Arizona state officials and securities regulators jointly filed a lawsuit against Arthur Andersen LLP, alleging that the auditor willingly participated with a religious foundation in an investment fraud. The state sued the accounting firm over what it contended was Arthur Andersen’s involvement in an alleged cover-up of a securities fraud by the Baptist Foundation of Arizona.

“Any time senior management conspires to defraud investors, this kind of complicated fraud will be very difficult to detect,” the paper quoted Ed Novak, an outside attorney for Arthur Andersen at that time. (That’s a quote you’ll keep hearing from the remaining firms even today…)

In May 2001, Andersen also paid $110 million to Sunbeam shareholders to settle lawsuits stemming from its inflated earnings statements. Both Sunbeam and Waste Management restated their earnings after admitting fraud in their financial statements.

In April of 2002, AA announced that it was backing out of a $217 million settlement with victims of the Baptist Foundation of Arizona’s 1999 collapse. However, as the trial started a new agreement was reached to settle the case, when Andersen Worldwide, the company’s global organization, agreed to provide enough additional capital to enable the insurer to pay the $217 million originally agreed to.

In June of 2001, AA agreed to pay $7 million to settle the Waste Managment case. The Securities and Exchange Commission said that Arthur Andersen LLP’s audits of Waste Management Inc.’s financial statements were false and misleading. It was the largest civil penalty ever assessed against a Big Five accounting firm at that time.

In April 2005, Arthur Andersen LLP, the final defendant in the WorldCom securities class action, agreed to settle. Andersen will pay at least $65 million in cash and those funds have already been transferred to an escrow account. In addition, the class will receive 20 percent of any distribution to any of Andersen’s 1,700 partners from any funds remaining when all other claims are settled.

But the remaining Big 4 audit firms also have their share of outstanding and settled suits for improper audits and other claims. And in all cases, the remaining firms either bought, merged, or absorbed Arthur Andersen partners, staff and their clients all over the world. Where it seemed that former Andersen clients may have gotten new auditors and a fresh look, there may have been only more of the same, just operating under a new name.

The US Chamber of Commerce has warned recently that the auditing profession is “on the edge of disaster” if regulators, business and auditors do not tackle the enormous litigation liabilities faced by the “big four” firms.

This warning reflects concern over the possibility that one of them – PwC, Deloitte, KPMG or Ernst & Young – could collapse if multi-million dollar lawsuits brought for alleged negligence bring a firm’s partnership to its knees. Claims against auditors began to increase in number and size in the 1990s, particularly in the US.

We celebrate the traditional holidays like anyone else although, like anyone else, they have become inextricably tied to some form of consumerism. As our family has grown, we’ve outgrown the traditional gathering at Mom and Pop’s for something more planned and formal. We are blessed with immediate family members who belong to country clubs and, I confess, I have become an elitist snob and prefer going to the club on holidays rather than to someone’s house.

It has something to do with being single, since it does make for an easy exit afterward and limited exposure to thousands of children under the age of 14 high on sugar looking for something to do after we’ve force fed them meat they only eat once a year. It also means no clean-up and no fake interest in football. I’d rather talk to the men in my family than watch them watch football.

The only thing I miss is the lasagna. When my mother cooked Thanksgiving and Christmas, there was always more lasagna than turkey and always more food taken home afterward than eaten that afternoon. Take-away trays of lasagna, home-made ravioli, manicotti, or stuffed shells were the huge benefit of growing up half-Sicilian.

Unfortunately, those days are gone unless I’m willing to make the trek out to my Aunt Concetta and Uncle Salvatore’s and deal with even more small children and more distant relatives majority of whom don’t have much interest in the future of the Big 4 or my critique of their global regulatory infrastructure.

After having spent so much time in Mexico, especially Chiapas, and South America, I also have become sensitized to the anti-Thanksgiving and anti-Columbus Day movements. I’ll leave you with this quote from an alternative history of the celebration of Thanksgiving.

Lies, Half-Truths, and What a Nation Will Tell Itself

Perhaps, given the patent falsehood of the Story of Thanksgiving, one of the better questions to ask as the holiday approaches is what, in fact, it really stands for. As a Cherokee, I have never felt much like celebrating an event that essentially commemorates one of several stages in the genocide of Native Americans by European settlers, a process which continues to this day in the form of environmental racism, structural poverty, and lack of educational resources. There were times, to be sure, when I appreciated sitting with my family and devouring an embarrassment of culinary riches. But those I hold separate from the holiday itself.

For me, this now agreed upon Thanksgiving symbolizes first and foremost the alarmingly subjective nature of history, which, as Howard Zinn reminds us, is almost always written by the winners. It symbolizes the triumph of football over religion, and of American commercialism over virtually everything standing in its wasteful path. And perhaps most importantly, it symbolizes the lies and half-truths on which a profoundly diverse country must depend in order to prop up the specious concept of a broadly shared civil religion or national identity.

Thanksgiving, then, symbolizes that there is still great work to be done before a nation that readily prides itself in its goodness, honesty, and wholesome relationship with Divine Grace will actually resemble the stories it tells itself.

Thank God for all blessings. God bless all creatures on his greenish earth.

MF Global’s fall puts spotlight on CME Group, The Financial Times, November 2, 2011

The case of the missing customer funds at MF Global is putting a spotlight on the failed broker’s de facto supervisor, CME Group.

CME, the largest US futures exchange operator, is also the designated self-regulatory organisation for more than 50 futures brokers, including MF Global. As such, CME had direct responsibility for making sure MF Global’s books were square…

CME’s dual role puts it in a delicate position. MF Global, according to its website, was the top broker by volume at CME’s metals and energy exchanges in New York and in the top three at its Chicago exchanges. CME’s main source of revenue is clearing and transaction fees.

Brokers themselves have questioned letting exchan-ges be overseers. “Given their strong market knowledge and proximity to the trading markets, they provide the best forum for addressing many of the futures markets’ oversight functions,” the Futures Industry Association said in a 2004 letter to the CFTC. “However . . . we are concerned about potential conflicts of interest.”

There is an inherent conflict at every publicly-listed equities, futures, and commodity exchange. When the NYSE went public in early 2006 through a reverse merger with publicly-held Archipelago, there was some discussion of the conflict in roles that public ownership of the exchange presented.

The clearing firm is the first line of defense for a brokerage firm against unauthorized trading or exposures outside of risk limits. What’s comical is that the Department of Justice, via its letter to the Treasury regarding “vertical clearing house models” wants the US to implement a model for clearing firms like Europe’s, or the one that did not have enough weight or skin in the game to stop Kerviel and SocGen from racking up such big losses. The DOJ is saying that the Chicago Mercantile Exchange’s clearing operation and its relationships and tight straight-through processing model are a problem even though that model was able to put the brakes on the problem at MF Global in less than twelve hours.

I think the Department of Justice is wrong.

I have disclosed in various forms, but probably not often enough, that I give the CME Group the benefit of the doubt because I grew up in Chicago, the home of CME Group and the Chicago Board of Trade. I live here. The futures markets are in our blood. That being said, I will write the story as I see it. (I do not personally own any CME Group stock.)

I will call a spade a spade.

From the perspective of the individual trader and smaller brokerage firm member, the CME has not been the same since it went public. Higher fees, constantly changing margin requirements, and apparent favoritism towards large institutions grate on individual traders and bread-and-butter brokers. It’s a big public company now that focuses primarily on outside shareholders, not its “members”. And like any other public company, decisions may be made at times based on the self-interest of those who run it.

Any CME member who cleared MF Global is as angry as anyone else at the CME Group for the disruption, the confusion, and the lack of stewardship that allowed the failure of MF Global to occur. But the CME Group is owned, in large part, by its clearing firms and members who hold a large percentage of the open interest. Each clearing firm owns at least 6000 shares, multiplied by 80 clearing firm members of CME Group. That’s a lot of interested parties.

The recent announcement by CME Group of a $300 million backstop for the MF Global Trustee is something.

Though CME Clearing does not guarantee FCM-held assets, CME Group is willing to provide a $250 million financial guarantee to the Trustee to give the Trustee greater latitude to make an interim distribution of cash to customers now, given the monumental task he faces to sort through considerable data and claims in order to complete the MF Global liquidation and make distributions to creditors.  Additionally, CME Trust will provide $50 million to CME Group market participants in the event there is a shortfall at the conclusion of the Trustee’s distribution process…

This unprecedented guarantee offered by CME Group would be used by the Trustee in the event that a final accounting determines that the Trustee distributed more property than was permitted by the Bankruptcy Code and CFTC regulations.  In addition, if there is a shortfall at the conclusion of the distribution and the $50 million Trust has not been exhausted, the remainder of those funds will be used to restore the other CME Group customer accounts that suffered a shortfall in customer-segregated funds held at MF Global.  The Trust was designed to be used in cases such as this if customers lose money due to the failure of a clearing member.

But it may not be as great as it seems. An industry veteran explained it to me:

Is it really $300 million? It’s $50 million with a potential backstop of an additional $250 million. They may be trying to imply that they are coming up with half of the customer segregated funds shortfall. But what they are really guaranteeing is to make sure everyone is pari passu as an inducement to the trustee to free up money he is currently holding.  I’m not sure that the public (i.e., especially but not limited to MF customers) understands the distinction.

But until someone tells me otherwise – or I see otherwise – I am going with the fact that CME Group was in on the 24th of October and found the segregated funds they are responsible for to be accounted for. But there are ten clearing houses that were used by MF Global.  The CME is the largest, but not the only one, and their audit did not cover all the segregated funds. I’m going to dig into what and how their review was done. I’m going to make sure that we can say that everything that went wrong at MF Global probably went wrong after they left.

It’s especially important because the CFTC recently published the FCM information as of September 30 and MF Global’s numbers were conspicuously absent.  Is their excuse that the books are a mess? For MF Global’s auditor, PwC, that’s a terrible thing to say. It may just be a move by regulators to buy more time. Or it may be true.  Then what is PwC doing signing off on the 10Q as of September 30th or the annual report as recently as May?

What’s more troubling to me than any CME potential conflict as both a public company and a self-regulating organization (SRO) is the fact that former Refco executives who were fined for the Refco fraud were working in key positions at MF Global. They also hold, or have held, key positions in the Futures Industry Association, the CFTC, and a brokerage firm that will now benefit from MF Global’s demise.

When the U.S. Attorney for the Southern District of New York, Preet Bharara,announced the Refco enforcement actions in May of 2010 he spoke earnestly:  “More than just prosecuting criminals who engage in fraud, this Office strives to return as much as possible to their victims.  Justice has been rightly served for the victims of the Refco fraud.”

By that time, what was left of Refco post-fraud and post-bankruptcy had joined with Man Financial to become MF Global via a new IPO.

Bennett, Grant, Maggio, and Trosten faced criminal charges and all four are serving, or will serve, jail terms. Other Refco insiders, including Stephen Grady, Dennis Klejna, and Joseph Murphy, were not criminally charged but signed consent orders, or settlements, with the Department of Justice. Grady, Klenja, and Murphy paid $1 million, $1.25 million, and $5 million respectively – and then went back to work for the firm that became MF Global.

Not only did those three executives get to come back, they took on roles that gave them a bird’s-eye view of MF Global’s implosion – and, perhaps, of the transactions that were made, legitimately or not, in an ultimately futile attempt to keep the firm alive as it sought a buyer in the last days.

Dennis Klejna was the head of compliance at Refco when it exploded. Refco had recruited him from the CFTC, the regulator now in charge of investigating the MF Global collapse, where he was Chief of Enforcement. Klejna is now MF Global’s head of compliance and senior vice president for legal matters. Operating under bankruptcy protection must be keeping him especially busy these days.

Stephen Grady moved from Refco to Man Financial after Refco’s bankruptcy and is CEO of MF Global Chicago.

Joseph Murphy joined R.J. O’Brien in November of 2008 after six years at Refco, where he served as President of Refco Futures. R.J. O’Brien is one of the brokerage firms that received some MF Global customer accounts from regulators after the bankruptcy.

I bet these guys, or other legacy Refco accounting and since professionals still working in MF Global, can give investigators some clues on what happened to the missing $600 million.

And let’s not forget PricewaterhouseCoopers, MF Global’s auditors.

When it comes to hands-on access to private information, the auditor has more than any other regulator mentioned. And they are supposed to be experts in that client’s business and in the accounting and auditing standards for that industry. PwC also audits JP Morgan, Bank of America Merrill Lynch, and Goldman Sachs. They are all large players in the futures brokerage industry and mixed up in the MF Global mess.

Last year JP Morgan Chase’s futures and options desk neglected to segregate billions of dollars of client money, largely belonging to hedge funds. PwC, the auditor of JPMorgan Chase, and the bank – which is also MF Global’s main banker – admitted to U.K. regulators that for at least seven years, about $23 billion dollars of clients’ assets had not been properly segregated. JPMorgan Chase was fined 33.3 million pounds and PwC is subject to sanctions.

The auditor is part of the regulatory structure for public companies. They serve that role for the benefit of shareholders and the markets and earn oligopolistic profits as a result of the lack of competition and the government’s mandate that all listed companies have an audit.

The audit does not happen only once a year. The auditor also provides “negative assurance” on the 10Qs. MF Global’s most recent quarter end was September 30. Unfortunately, they will not be filing that 10Q on time. PwC also authorized inclusion of the audited financial statements from the year end, March 31, 2011, in MF Global’s August bond issue prospectus. MF Global was not only complex but a relatively new client. They got a lot of service and constant attention. They have been public only since mid-2007 but PwC also audits MF Global’s predecessor firm, Man Group.

The auditor has complete access, at any time, including to financial systems and reports. They are responsible for issuing an independent opinion on internal controls over financial reporting and for issuing additional reports to the regulators – which they are dependent on – regarding controls over segregated assets per the Commodity Exchange Act.

So… When you think about frequency, access, independence, and the fact they get paid well for their services by the shareholders the auditor is in line as the first-responder.

Back in 2008, when the wheat trader took MF Global for $141 million, the firm was brand spankin’ new with a lot of old pros and even older systems running it.  I said this then about PwC:

MF Global is a spin-off from Man Group plc. MF Global IPO’d in July 2007 and inherited PricewaterhouseCoopers as their auditor, also.

MF Global has not been independent and publicly listed for very long, has not issued an audited annual report yet, and does not yet have an obligation to comply with Sarbanes-Oxley. They have issued quarterly financial reports to the SEC, carved out of the Man Group plc reports, but that are unaudited so far. Their CEO and CFO, however have made Sec. 302 certifications to the SEC regarding the firm’s internal controls.

From MF Global’s July 2007 prospectus:

We will be required by Section 404 of the Sarbanes-Oxley Act to evaluate the effectiveness of our internal controls by the end of fiscal 2009 and we cannot predict the outcome of that effort. As a U.S.-listed public company, we will be required to comply with Section 404 of the Sarbanes-Oxley Act by March 31, 2009. Section 404 will require that we evaluate our internal control over financial reporting to enable management to report on, and our independent auditors to audit, the effectiveness of those controls. While we have begun the lengthy process of evaluating our internal controls, we are in the early phases of our review and will not complete our review until well after this offering is completed.

Can’t wait to see how that works out…

I think we know now.

Here’s another good summary of the players and their games.  (It’s all good except the last shot at speculators.  The words “trader”, “speculator”, “hedge” and “derivative” are not pejoratives.)