As MF Global customers approach the one month anniversary of the cluster-circus that has become the liquidation proceedings, replete with unnecessary delays, half-measures, and outright deceptive statements by Trustee James W. Giddens (that will only ensure the proliferation of hours billable at $890 each), we wish to highlight an order entered just days after the bankruptcy that gave MF Global Holdings and its affiliates carte blanche to continue the very risky and suspicious trading that led to its demise. A hearing is set for Wednesday, November 30, 2011 at 3:00 pm on this and other germane matters, including the super priority status of JP Morgan Chase (the conflicted first-lien holder) afforded to it ahead of the customers whose segregated accounts were putatively to have been held sacrosanct.
On November 2, 2011, the bankruptcy judge entered a seemingly innocuous order that granted an extension of time to the Debtors (MF Global Holdings Ltd. and MF Global Finance USA Inc.) to comply with the requirements of Section 345(b) of the Bankruptcy Code and an authorization of the continuation of intercompany transactions among the Debtors and non-Debtor affiliates. Detailed arguments were provided in the 19 page Motion of the Debtors filed the day of their October 31, 2011 bankruptcy.
Of particular interest are the arguments for allowance of the continuation of extant investment practices. When reading the pleading, note that "Company" refers specifically to MF Global Inc., the broker dealer/futures commission merchant unit that did NOT file for bankruptcy, while "Debtors" refers to MF Global Holdings and MF Global Finance, which did file for bankruptcy. "Debtors" and "Company" are frequently mixed within paragraphs, which either causes confusion as to intent or allows for an expansive interpretation that justifies the continued looting of customer accounts. All emphasis herein is ours, except for headings:
D. The Debtors Should Be Authorized to Continue Their Investment Practices
23...The Deposit and Investment Practices are governed by an investment policy, which provides that such investment activities must comply with federal and state regulations, as well as any regulations imposed by its regulators. In addition, the investment policy describes the Company’s permissible investments, which include: (a) government securities and government guaranteed securities; (b) money funds; (c) United States Treasury and government money funds; (d) federal agency obligations; (e) corporate obligations; (f) money market instruments; and (g) other permissible investments approved by the Company’s investment committee from time to time.
The blanket generalization in (g) opens the door to any of the investments that the Company, MF Global Inc., had engaged in previously, including the famed $6.3 billion in European debt [off balance sheet] repo-to-maturity trades. Ordinarily, any such investments not guaranteed directly or indirectly by the US government would be subject to a performance bond:
24. Bankruptcy Code section 345(a) authorizes a debtor-in-possession to make deposits or investments of estate money in a manner “as will yield the maximum reasonable net return on such money, taking into account the safety of such deposit or investment.” 11 U.S.C. § 345(a). If a deposit or investment is not “insured or guaranteed by the United States or by a department, agency, or instrumentality of the United States or backed by the full faith and credit of the United States,” Bankruptcy Code section 345(b) provides that the debtor must require that the entity with which the deposit or investment is made obtain a bond in favor of the United States that is secured by the undertaking of an adequate corporate surety. Id. § 345(b).
However, arguments would be made for an exemption:
25. The Court has discretion to modify the section 345(b) requirements “for cause.” 11 U.S.C. § 345(b). Indeed, while these requirements may be “‘wise in the case of a smaller debtor with limited funds that cannot afford a risky investment to be lost, [they] can work to needlessly handcuff larger, more sophisticated debtors...
Sophisticated, indeed. The pleading continues with a rather confusing paragraph that implies the exemption from a performance bond is required for investments that would be in bank accounts, the balances of which exceed FDIC insurance limits. Yet, the final sentence implies there is more going on than simple bank account sweeps when it mentions "[investments and deposits] made by non-Debtor affiliates engaging in the Company's core investments businesses." (Again, "Company" refers to the broker dealer/futures commission merchant unit, while "Debtors" refers to MF Global Holdings and MF Global Finance.)
26. The Debtors submit that the circumstances of this case warrant such relief. The Company is a large, sophisticated entity with a complex Cash Management System that relies on multiple Banks and Bank Accounts on a daily basis. The Bank Accounts used by the Debtors are maintained in the United States and are with stable financial institutions that are insured by the FDIC. Furthermore, in light of the regular deposits and sweeps of the Bank Accounts, requiring the Debtors, or any entity with which money is deposited or invested by the Debtors in accordance with the Deposit and Investment Practices, to incur the expense of posting a bond to the extent that the balances of these accounts exceed FDIC insurance limits at a given time would be especially burdensome and wasteful. Finally, in addition to the Company’s own investment policies that serve as a safeguard of the Debtors’ funds, there is a significant distinction between the Debtors’ own investments and deposits—which support the Debtors’ cash-management function—and those made by non-Debtor affiliates engaging in the Company’s core investments businesses.
27. Accordingly, the Court should authorize the Debtors to continue to deposit funds and invest in accordance with the Deposit and Investment Practices and grant the Debtors a 60-day extension, without prejudice to seek further extensions, to either comply with Bankruptcy Code section 345(b) or to make other arrangements that would be acceptable to the U.S. Trustee.
The Debtors then argue, through a series of complex legal arguments, to be explicitly allowed to continue with intercompany transactions, the relevance of which will be explained following the excerpts.
E. The Debtors Should Be Authorized to Continue Intercompany Transactions
28. The Debtors’ books and records also reflect numerous other intercompany account balances among various Debtors as of the Petition Date. All prepetition intercompany account balances have been frozen, as of the Petition Date, and the treatment of such claims will be determined as part of an overall reorganization plan for the Debtors.
29. To ensure that each individual Debtor will not, at the expense of its creditors, fund the operations of another Debtor entity, the Debtors respectfully request that, pursuant to section 364(c)(1) of the Bankruptcy Code, all intercompany claims against a Debtor by another Debtor arising after the Petition Date as a result of intercompany transactions and allocations (“Postpetition Intercompany Claims”) be accorded superpriority status, with priority over any and all administrative expenses of the kind specified in sections 503(b) and 507(b) of the Bankruptcy Code, subject and subordinate only to (a) any order granting adequate protection to the prepetition secured lenders and (b) other valid liens...
30. In addition, in connection with their role under the Cash Management System facilitating the operations of the non-Debtor affiliates, the Debtors may, in the ordinary course of business, periodically infuse capital into certain of their subsidiaries and affiliates, including non-Debtor non-U.S. affiliates. These infusions of capital generally are accomplished through the making of intercompany loans. The Debtors use repayments of such loans as a tax efficient method of managing cash throughout their worldwide business enterprise. Because the non-Debtor affiliates are part of the same group of affiliated entities as the Debtors, the entirety of intercompany transactions among Debtors and non-Debtor affiliates alike remain within the spectrum of the Debtors’ control.
31. The relief requested herein is necessary because certain non-Debtor affiliates may require intercompany advances in order to maintain their liquidity and going concern value. Courts frequently have granted such superpriority status to postpetition intercompany claims in cases such as this. ...
33. The Cash Management System allows the Debtors to track all obligations owing between related entities and thereby ensures that all setoffs of intercompany transactions will meet both the mutuality and timing requirements of section 553 of the Bankruptcy Code. Therefore, the Debtors respectfully request that the Debtors and their non-Debtor affiliates be expressly authorized to set off prepetition obligations arising on account of intercompany transactions between a Debtor and another Debtor or between a Debtor and a non-Debtor affiliate. Further, the Intercompany Transactions provide numerous benefits to the Debtors. The Debtors therefore seek to continue the Intercompany Transactions postpetition in the ordinary course of their businesses.
While it might be desirable under a "normal" financial company bankruptcy to seek maximization of benefits to the Debtors such that creditors be paid as much as possible during recovery, MF Global Inc customers (who are NOT creditors) can currently expect at best a 60% recovery going into mid-December and should be placed first in line until 100% recovery is obtained. Further, from the numerous conflations and generalizations in the paragraphs above that allow, for among other things, payments to non-US affiliates, it is possible that the looting of MF Global customer funds continues to this day. We wonder if this is why the MF Global trustee continually revises upwards the estimated maximum loss of customer funds.
As to exactly how this might be possible, we pointed out as early as November 9 that the Euro debt repo-to-maturity trades were performed by MF Global Inc. with an affiliate (not Goldman or JP Morgan, as was hypothesized in the media), with the affiliate to receive 80% of profits from the transactions. Inasmuch as J. Christopher Flowers and friends were among MF Global Holdings' larges shareholders, it is conceivable that outflows continue to this day to an affiliate of Jon Corzine's good friend.
Given the extension granted by the judge allows these potential shenanigans to continue throughout the end of 2012, it is imperative that immediate disclosure of all trading and intercompany transfers be obtained, especially if they are being conducted to the derogation of the customers.