Flag hangs on the wall of the JP Morgan company stall on the floor of the New York Stock Exchange in New York
A flag hangs on the wall of the JP Morgan company stall on the floor of the New York Stock Exchange in New York July 15, 2010. REUTERS

(Reuters) -- In late October, as MF Global Holdings Ltd teetered toward bankruptcy, Jon Corzine phoned his close-knit circle of Wall Street friends for help.

His firm, facing demands from customers and other firms for cash, needed to sell billions of dollars in securities to raise the money. As the week progressed, MF Global executives came to believe that JPMorgan Chase & Co., one of MF Global's primary bankers and a middleman moving that cash, was dragging its feet in forwarding the funds.

Corzine phoned Barry Zubrow, then JPMorgan's chief risk officer, to question the slow payments. Corzine also called William Dudley, president of the Federal Reserve Bank of New York, to update him on MF Global's status and told him that payments were slow to arrive from JPMorgan and others. Dudley said he'd monitor the situation.

The delays contributed to a serious cash shortage at MF Global, according to people familiar with the matter. These people say the firm started trading one day in late October with $600 million in cash and spent the whole day selling securities, only to end with just $200 million in cash.

By adhering to procedure and not cutting MF Global any slack, these people say, JPMorgan was able to slow the delivery of funds, worsening MF Global's distress. As a result, they note, hundreds of millions of dollars of MF Global money may be still stuck in accounts at JPMorgan.

The details of MF Global's trading, based on court documents and multiple interviews with people familiar with the situation, shed light on what could have happened to more than $600 million in customer funds at MF Global, which are still being sought by regulators nearly three months after the firm filed for bankruptcy protection on October 31.

An early sign that money was missing came as auditors from the CME Group Inc., which audited MF Global, combed through the company's books in Chicago and New York, according to congressional testimony by CME executive chairman Terrence Duffy. After MF Global reported a quarterly loss on October 25, the CME had dispatched two auditors to the Chicago office to review customer accounts on October 27 - the first of several confusing days as auditors and regulators, working in Chicago and New York, tried to understand whether funds were intact.

In a statement last week , a JPMorgan spokeswoman said, "Our firm lost money because of MFG's failure, and we are cooperating with the regulators with full transparency to assist their investigation."

Through a spokesman, Corzine declined to comment.

To be sure, regulators have made no allegation of wrongdoing against JPMorgan, and there is no evidence that JPMorgan did anything improper. Indeed, it seems to have been simply following banking procedure, according to people familiar with the matter.

Futures trading firms and brokers like MF Global are heavily dependent on borrowing, which then exposes the big banks that lend to them was well as their trades. That gives banks like JPMorgan the ability to protect themselves in a crisis.

The transactions that JPMorgan handled are drawing increased scrutiny from regulators, a bankruptcy trustee and MF Global because understanding MF Global's money flow could aid in identifying customer money flows, according to people familiar with the situation.

"They made things that are in normal times quite plain vanilla, easy things to do very difficult to do," said a person involved in MF Global's struggle, referring to JPMorgan. "What normally works well was taking forever because JPMorgan was dotting every 'i' and crossing every 't,' and they were holding on to as much money as they possibly could under the law."


The role that JPMorgan played as both a lender and middleman to MF Global illustrates the procedures banks can deploy to protect their own interests when dealing with weaker counterparties.

On one side of its ledger, JPMorgan and a syndicate of banks had lent MF Global $1.3 billion in its final week through a loan commitment the firm could draw down at any time. JPMorgan also was a primary banker for MF Global, a role that gave it significant insight into, and control over, MF Global's accounts.

On the other side, JPMorgan was clearing some of the asset sales MF Global was making. In this role, its job was to take the securities from MF Global and the cash from the buyer and pass them along to the other party when the deal was complete .

Normally such trades can settle within a day or two, if the back-office mechanics function smoothly. But that week, the money didn't arrive when MF Global executives expected, according to people familiar with the situation.

JPMorgan, a major lender to rival firms as well as one of Wall Street's biggest middlemen in settling trades, has previously drawn scrutiny for protecting its own interests when rival firms ran aground. In 2008, a week before Lehman Brothers Holdings Inc. sought bankruptcy protection, JPMorgan demanded collateral to protect its role as counterparty to Lehman. While the request was not improper, Lehman's bankruptcy estate later claimed Lehman posted the collateral because JPMorgan had threatened to withhold funding.

A Congressional panel that looked at the 2008 crisis, the Financial Crisis Inquiry Commission, investigated the events surrounding Lehman's fall in a 2011 report. A JPMorgan official told the FCIC that the bank didn't believe "the request put undue pressure on Lehman," the report said. The FCIC didn't draw a conclusion about the incident.


When Corzine took the helm in 2010, MF Global was a little-known boutique futures trading firm. Corzine, who joined Goldman Sachs as a bond trader in 1975 and ultimately became chairman, also was a former U.S. Senator and former governor of New Jersey. He brought star power to the CEO role, and sought to increase MF Global's profits. Among his trades was a series of purchases of deeply discounted European government debt. European Union leaders, he reasoned, would never allow the countries to default.

In September, MF Global said the Financial Industry Regulatory Authority had required the firm to bolster its capital.

On Monday, October 24, things took a turn for the worse when Moody's Investors Service downgraded MF Global's credit rating to one level above junk. A day later, MF Global reported its largest-ever quarterly loss.

By Wednesday, October 26, customers were demanding millions of dollars from accounts held at MF Global. To meet the sudden outflow, MF Global during the week of October 24 tapped the $1.3 billion loan commitment from a syndicate of banks led by JPMorgan.

MF Global also decided to sell $1.3 billion of IOUs known as commercial paper. The short-term debt was part of some $7 billion of securities the firm sold that week. But this sale was critical, people familiar with the situation said, because MF Global had used customer funds to invest in the short-term debt and now badly needed to liquidate the IOUs and move cash into the customer accounts to meet their demands. The investments in the IOUs were allowed by industry regulations, these people said.

For help, Corzine turned to his old employer, Goldman Sachs, which specializes in trading the short-term paper. Corzine phoned Goldman President Gary Cohn to ask him to buy the IOUs, offering a slight discount, according to people familiar with the situation.

Cohn agreed, and Goldman traders made the purchases, these people said. Because it needed the cash immediately, MF Global sought to settle the deal that day, according to Corzine's testimony in Congress.

JPMorgan, in its role as middleman, was able to control the speed with which MF Global's asset sales were processed, according to people familiar with the situation.

Two people familiar with the transaction say that JPMorgan was slow to process the trade. A spokeswoman for JPMorgan said the bank was not able to confirm the information about that specific trade. It remains unclear exactly whether cash from the sale was ultimately routed to MF Global.

On Thursday October 27, Moody's downgraded MF Global again, this time to junk. At that point, "we were finished," said a former employee in MF Global's New York office.

While MF Global waited for the funds from JPMorgan, it frenetically tried to avoid a second cash demand generated by the second Moody's downgrade. The downgrade sparked margin calls from trading partners. The New York Fed at one point issued its own margin calls.

To meet those demands, MF Global on October 28 undertook yet another set of asset sales totaling $4.5 billion. It sold the securities to JPMorgan, yet the bank was slow to settle this trade as well, according to people familiar with the situation. JPMorgan declined to confirm whether it bought the securities.


One thread regulators are now examining is how MF Global got hold of enough funds to cover an overdrawn account at JPMorgan. Corzine told a congressional panel that during the morning of October 28, "I was trying to sell billions of dollars of securities to JPMorgan Chase in order to reduce our balance sheet and generate liquidity. JPMorgan Chase told me that they would not engage in those transactions until overdrafts in London were cleaned up."

To clear that hurdle, Corzine contacted MF Global's back office in Chicago and told them to resolve the problem-ostensibly by routing money to JPMorgan. JPMorgan then asked whether a transfer of funds violated industry regulations. Corzine said that the Chicago office "explicitly confirmed to me that the funds were properly transferred." Corzine said he assumed JPMorgan signed off because the bank then executed billions of dollars in trades.

People familiar with JPMorgan say that the bank had to contend with numerous issues in assisting MF Global with the asset sales, including the fact that some MF Global assets couldn't immediately be sold.

As MF Global tried to complete the sales, MF Global officials and regulators, who were trying to untangle customer accounts in Chicago and New York, discovered a shortfall of cash in the customer accounts -- including those that had once held MF Global's commercial paper holdings.

"Despite our best efforts to sell assets and generate liquidity, the marketplace lost confidence in the firm," Corzine said at a congressional hearing.

While it may appear that records for the trades would be clear, regulators say they have been stymied in tracing the money flowing to and from MF Global.

"They are circuitous money trails," said Bart Chilton, a commissioner at the Commodity Futures Trading Commission, one of the agencies probing MF Global. "They are not simple linear transactions."

"There were an extraordinary number of transactions during MF Global's last few days and I do not know, for example, whether there were operational errors at MF Global?or whether banks and counterparties have held onto funds that should rightfully have been returned to MF Global," Corzine told a congressional panel in December.

The concern for a clearing bank like JPMorgan is over exposure when it is extending a lot of credit, according to Craig Pirrong, a finance professor at the University of Houston.

JPMorgan, as a clearing bank, has the ability to take some actions to protect itself, but the bank "is going to undergo a lot of scrutiny," Pirrong said. "Any action it takes to reduce its exposure comes into question when a bankruptcy is involved."


MF Global, during the weekend before it filed bankruptcy proceedings, made one final push to sell more assets. In London, it tried to sell off short-term European bonds, according to one trader at a London bank.

But by then, MF Global had run out of time, this trader said. Tagged with a junk credit rating and unable to meet margin calls, the firm could no longer effectively function in the markets.

The firm's stock, which hit $7.74 at the end of June, fell from $3.87 at the beginning of October to $1.20 on October 28, its final day of trading before it filed for bankruptcy protection.

"Their stock was toast," the trader said.

What remains unclear is whether JPMorgan held on to the funds, and where the funds are now. People familiar with the situation suggest that the funds are still at JPMorgan.

Regulators and the bankruptcy trustee have not said. They say they are still trying to verify which customer accounts may have been tapped for funds during MF Global's final hours.

(Additional reporting Paritosh Bansal; Editing by Alwyn Scott and Edward Tobin)