JPMorgan Chase Knew MF Global All Too Well

I suspect that JPMorgan Chase (JPM) knows a lot more about MF Global than the bank's in-house lawyer let on in her Congressional testimony last week.

Diane Genova, deputy general counsel for JPM's investment bank, mostly answered lawmakers' questions about a much-discussed $200 million overdraft on a London account that MF Global allegedly used customer funds to cover. But JPM had an extensive relationship with Jon Corzine's brokerage, giving the megabank a bird's-eye view of the firm’s finances before and after it failed.

As such, JPM must have at least a clue about the other $1.4 billion of MF Global customer funds that have gone missing.

As MF Global's largest unsecured creditor, for example, JPM was first to the courthouse to protect its rights after the Oct. 31 bankruptcy filing. And as Genova told the House Financial Services Oversight and Investigations Committee on March 28, MF Global maintained a large number of cash demand deposit accounts at JPM. Four of these accounts in the U.S. were designated as customer segregated accounts.

MF Global also cleared agency securities through JPM, Genova said. The brokerage had two revolving credit facilities in which JPM was the administrative agent for a syndicate of other banks. And MF Global had securities lending and repurchase arrangements with JPM, the largest of which involved MF Global borrowing U.S. Treasuries from JPM's securities lending clients and posting agency securities as collateral.

JPMorgan even considered acquiring MF Global. But before anyone else outside of MF Global knew that there was a $1.6 billion hole in customer segregated funds, JPM passed on a deal. Rep. Francisco Canseco (R-Tex.) asked Genova why.

She testified: "After an extensive review, we determined that it was not a good business fit." Why am I not surprised?

Regarding that $200 million overdraft, Genova told lawmakers she asked MF Global General Counsel Laurie Ferber and Deputy Counsel and Chief Compliance Officer Dennis Klejna to put in writing that funds transferred from customer segregated accounts to cover the shortfall did not belong to customers. (Customer segregated funds can generate excess amounts from interest earned and fees charged that can be redirected, if needed, to cover the firm's needs or cover another customer's losses.) Genova testified that Ferber and Klejna verbally assured her that the transfers complied with the rules regarding protection of customer funds, but that JPM never received a signed letter.

JPM had a history with Dennis Klejna. He was the head of compliance at Refco when that firm failed. JPM was one of the underwriters of the Refco IPO and agreed in April 2010 to pay $49.5 million to settle a shareholder lawsuit over that firm's collapse less than two months after going public in 2005. Man Financial bought Refco’s broker/dealer out of the bankruptcy and turned it into MF Global, which then spun out as a separate public company in 2007.

Klejna was not criminally charged over his involvement in the Refco fraud, but he did sign a consent order with the Department of Justice and paid $1.25 million in disgorgement of his IPO gains. Then he went to work in the same job for MF Global.

JPM's Global Risk Officer Barry Zubrow called Jon Corzine directly early Friday morning, Oct. 28, to ask him to cover the $200 million overdraft in London. According to Genova's testimony, Corzine got that kind of personal attention because of MF Global’s downgrade by two ratings agencies to junk status earlier in the week. MF Global had also, during the week of Oct. 24, hit the limit on its lines of credit at JPM. Maybe JPM's past experience with Klejna also had something to do with JPM's desire to ask for written compliance assurance.

JPM could have been also feeling a bit skittish about being a beneficiary of inappropriate commingling. Its own broker/dealer recently committed the sin of not segregating customer funds in the U.K. JPM and its auditor PricewaterhouseCoopers – also MF Global’s auditor – recently admitted to UK regulators that for at least seven years, about $23 billion of JPM clients' assets had been inappropriately commingled. JPM was fined 33.3 million pounds.

I hope investigators from the FBI, Department of Justice, the regulators and the bankruptcy trustees will continue to dig into what JPM can tell us about the mystery of the missing $1.6 billion.

Francine McKenna writes the blog re: The Auditors, about the Big Four accounting firms. She worked in consulting, professional services, accounting and financial management for more than 25 years.