Long before the brokerage firm MF Global collapsed into bankruptcy and prompted a frantic search for missing customer money, the company had already established a checkered history.
An analysis of regulatory enforcement actions shows MF Global has drawn more sanctions from the U.S. commodity futures regulator than each of its 14 closest peers in that market over the past decade. MF Global has also drawn the second-highest amount in fines, for alleged lapses in risk supervision and recordkeeping.
MF Global and the U.S. Commodity Futures Trading Commission both declined to comment.
And five private lawsuits against the firm allege, among other things, that MF Global was a vehicle used by two Ponzi schemes, including one that was later dubbed mini-Madoff.
None of the violations took place on the watch of Jon Corzine who took the helm of MF Global in 2010. A former chief of Goldman Sachs and a one-term New Jersey governor, Corzine resigned from MF Global last week, expressing great sadness over the firm's collapse.
The broader issue of internal control and risk-taking at MF Global before its meltdown is emerging as a central avenue of inquiry both for lawyers filing claims on behalf of investors, and for regulators seeking to find some $600 million missing from MF Global.
The issue of internal controls will be part of our independent investigation, said Kent Jarrell, a spokesman for the trustee overseeing MF Global's bankruptcy.
While MF Global clients headed for the exits in the final weeks as fears grew about risky bets on European debt, regulators and investors had already raised concerns about how the company was run. Among them was the CFTC, which repeatedly sanctioned the company for risk supervision failures.
Among more than a hundred brokers overseen by the CFTC, MF Global ranked eighth largest by customer money, with $7.2 billion in segregated client accounts, according to an August 2011 CFTC database. Larger brokers in the top 15 included heavyweights such as Goldman Sachs, Newedge USA and JP Morgan Securities. And smaller merchants in the top 15 included Barclays Capital Inc, Credit Suisse and Jefferies Bache.
Between 2000 and early 2011, the CFTC sanctioned MF Global for six alleged violations, involving lax supervision and recordkeeping, and levied penalties totaling more than $12 million, according to the agency's data. Only Morgan Stanley drew a higher penalty -- a $14 million fine in 2010 for an alleged attempt to hide a large oil futures trade from regulators.
In the same time period, the CFTC sanctioned Citigroup, Merrill Lynch, Newedge, JP Morgan and ADM Investor Services one time each for separate alleged violations, and imposed penalties not exceeding $500,000 in each case, according to the agency's enforcement records. UBS was reprimanded twice, and fined for a total of $250,000. And in 2011, a former Citigroup trader was ordered to pay nearly $1.5 million in civil penalties and in compensation to Citigroup, for allegedly unauthorized trading.
CFTC's public records between 2000 and 2011 do not list any enforcement actions for the eight other firms among the top 15 futures brokerages in the country, as ranked by the agency.
(For a graphic ranking the largest futures brokerage click: http://link.reuters.com/maw84s )
These records cover only civil actions brought by the CFTC. Because many of the larger firms on the list do business across several asset classes that fall under the purview of other regulators, the CFTC data does not include enforcement efforts by other agencies.
Separately, many of the big financial firms on the list have also been a target of private lawsuits questioning their business practices.
Asked to comment on MF Global's record with the CFTC, a former veteran agency official, who declined to be identified by name, said: The violations reveal a pattern of weakness in MF Global's (internal) supervision as compared to its peers. A CFTC spokesman declined to comment on how MF Global's record may compare to that of the other firms regulated by the agency.
MINI-MADOFF RED FLAGS
In several lawsuits, trustees of failed businesses that traded through MF Global have also alleged lax oversight at the brokerage.
Among them is a lawsuit involving Nicholas Cosmo, a Long Island financial manager dubbed mini-Madoff.
To keep his $400 million Ponzi scheme from unraveling, Cosmo made thousands of disastrous trades through his account at MF Global, according to a lawsuit filed by the trustee of Cosmo's bankrupt operation against the brokerage earlier this year.
Cosmo had already had run-ins with the law by the time he opened an account at MF Global in 2008. In the late 1990s, Cosmo had been convicted of fraud, barred from the securities business and ordered to seek therapy for a gambling problem.
But MF Global's background checks failed to spot those problems, the lawsuit says. Cosmo went on to lose more than $19 million of his investors' money in futures bets placed through his MF Global account, according to the complaint.
MF Global's failure to detect and limit Cosmo's trading appears to be part of a corporate pattern of lax controls that failed to detect fraudulent activities, says the complaint, filed in a U.S. bankruptcy court on Long Island.
MF Global says it is not liable for Cosmo's losses, arguing it had no reason to know that Cosmo was running a Ponzi scheme. Cosmo was sentenced to 25 years in prison in October for defrauding his clients.
A lawsuit filed just last week over MF Global's descent into bankruptcy also claims sloppy oversight.
Joseph DeAngelis, an MF Global shareholder, alleged that the firm's highly deficient internal controls left it dangerously exposed to the European debt crisis. A spokeswoman for MF Global declined to comment on the lawsuit.
Parsing the earlier litigation for clues about MF Global's business practices is tricky because alleged malfeasance by an account holder -- as was the case with Cosmo and several other traders -- doesn't necessarily imply liability for the brokerage. A brokerage serves as a vehicle for trades, and as long as the client puts up the money, there's no legal basis to deny the trade.
I don't think there's a consensus on this legally, said the former official with the CFTC. But if red flags are raised, you need to address them.
After initially raising Cosmo's trading limit, MF Global eventually closed his account as warning signs mounted. Cosmo also traded through several other brokerages.
Proceedings in the case have been stayed because MF Global is now in bankruptcy. A person familiar with MF Global said the firm did not aid or abet the Ponzi scheme, and that it serves as a mere conduit for traders. A brokerage like MF Global cannot be a policeman of the world, this person said.
In a similar case, MF Global agreed to pay $300,000 in March to settle allegations that it had served as a trading conduit for another Ponzi schemer.
In that case, a man named Michael Meisner had funneled nearly $3 million into his trading account at MF Global after raising $37 million from the clients in his company, Phoenix Diversified Investment Corp, according to a 2010 lawsuit filed by the Phoenix bankruptcy trustee against MF Global. As part of the settlement, the brokerage denied wrongdoing.
While promising high returns in the commodities markets, Meisner, who is serving a 15-year prison sentence, used his investors' money to buy at least 15 luxury cars and purchase or lease about eight luxury homes in Florida, according to his federal indictment.
MF Global's alleged role as a provider of a trading platform for unscrupulous clients has drawn a fine from the CFTC. A few years ago, MF Global hosted the accounts of a hedge fund called Philadelphia Alternative Asset Management Co.
To conceal mounting trading losses from its clients, the Cayman Islands-based hedge fund created a hidden account at MF Global, to which investors had no access, while simultaneously offering upbeat estimates of its profitability, the CFTC said.
The hedge fund ended up losing $133 million in its MF Global accounts, and its bankruptcy receiver settled with MF Global for $75 million in 2007. The CFTC added its own $2 million penalty and cautioned the brokerage that the commission and the courts consider failures of supervision and recordkeeping to be serious offenses that will have dramatic consequences. A person familiar with MF Global says the brokerage's oversight of clients' accounts has become more robust over the years.
ROGUE TRADER TRACK RECORD
This wasn't the only time federal regulators censured MF Global for alleged lapses in oversight.
In the space of a few hours on February 27, 2008, an MF Global broker in Mississippi made more than a hundred trades from his home computer, placing a bet of nearly $1 billion to buy thousands of wheat futures contracts, according to a lawsuit by several investors.
The next day, MF Global said it was taking a $141.5 million loss resulting from those trades. The brokerage's risk-control measures could have stopped the trades from going through, but those controls had been deactivated in certain cases to allow for greater speed, according to the complaint filed in the U.S. District Court in Manhattan in 2008.
Earlier this year, MF Global agreed to pay $90 million to settle the claims. The disclosures rattled analysts and investors, which included four large pension funds.
The magnitude of the loss is clearly disconcerting to us and calls into question the degree of risk taking and risk management at (MF Global), Credit Suisse said at the time, according to the lawsuit.
A person familiar with MF Global says the rogue trading happened because of a human error in configuring the software. The error has since been fixed. MF Global says it has since dramatically enhanced its risk operations, personnel and technology.
Shortly before the wheat-trader case, MF Global was accused in a lawsuit of having difficulty with another employee. In that case, a Bank of Montreal natural gas-futures trader needed to conceal his losses from his supervisors, according to the 2009 lawsuit filed by the bank against MF Global.
The trader, who was working through MF Global and another brokerage, arranged for his brokers to send Bank of Montreal erroneous price estimates, the pending lawsuit says. The alleged ruse kept the Canadian bank in the dark about the true state if its gas-options accounts. MF Global denies the charges and says the Canadian bank failed to supervise its own trader. The trader, who has since left the bank, pleaded guilty in 2008 to federal charges of wire fraud and obstruction of justice.
In 2009, the CFTC fined MF Global $10 million for significant supervision violations. The fine covered both the wheat-trader case and the Bank of Montreal case. (Reporting by Philip Shishkin; Editing by Tim Dobbyn)