On Halloween, MF Global filed for bankruptcy in a move that will liquidate the brokerage unit after problems arising from investments in European bonds. According to BankruptcyData.com, the bankruptcy is the seventh-largest in US history, and the company is the first American victim of the European sovereign debt crisis. On October 25, the firm reported a $191.6 million quarterly loss as a result of trading European government bonds. Quickly after this news was released, credit rating agency Moody and Fitch downgraded the company’s corporate credit rating to junk, a grade associated with ultra-high risk.
Despite knowing the troublesome waters MF Global was treading in, PriceWaterhouseCoopers (PwC), MF Global’s auditors, never issued a going concern opinion in which accountants express doubts about the company’s ability to remain in business. This is surprising given an auditor’s responsibility to evaluate whether a company can continue to operate.
MF Global experienced four years of massive losses, severely negative free cash flows for three of the last four years, an unhealthy exposure to the European debt markets, and several downgrades in the corporate credit ratings, yet no going concern opinion was issued by PwC. In addition, MF’s debt-to-equity ratio was approximately 30-1, based on $40 billion of assets and just $1.4 billion of equity. Perhaps part of the reason is that MF Global could have disguised its debt levels by temporarily slashing obligations before issuing its financial statements each quarter. A report from the Wall Street Journal suggests MF Global participated in “window dressing”, a technique in which a company misleads shareholders by not reporting the true levels of risk in its investments.
Furthermore, window dressing masks the actual levels of risk and borrowing of a financial institution. For instance, third quarter of 2010, MF’s short-term borrowings were reported at $18.7 billion, but those loans peaked at $28.4 billion (34% higher) during the period.
On Friday, Jon Corzine stepped down as MF Global’s chairman and chief executive after reports surfaced about the whereabouts of $633 million of missing customer money. A former executive at Goldman Sachs from 1994 to 1999, Corzine described his departure from MF as difficult. He joined MF Global in March 2010 after serving as a U.S. Senator and governor of New Jersey.
The downfall of MF Global is a sober reminder of what can happen when a firm takes aggressive, risky bets in one market using excessive leverage. Investors lost trust in the company, and credit nearly evaporated. Somewhere along the line, MF Global either ignored or failed to implement risk management controls, and it came back to haunt them on Halloween. However, the writing on the wall was evident long before the day of Jack-O-Lanterns.
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