WASHINGTON (Reuters) - The Securities and Exchange Commission is probing the accounting treatment that helped mask MF Global’s exposure to risky foreign sovereign debt, the head of the agency said on Thursday.
“We are investigating very carefully both the accounting treatment and the disclosure by the firm,” SEC Chairman Mary Schapiro told a Senate Agriculture Committee hearing in what were her most extensive comments to date about the SEC’s role in the MF Global probe.
“We’re pursuing an active investigation with the potential for enforcement action at the end of the process,” she also told the panel during her testimony.
In addition, she said the SEC, along with the Public Company Accounting Oversight Board which polices auditors, are both “looking very closely” at what role, if any, MF Global’s auditor PricewaterhouseCoopers may have played.
Commodity Futures Trading Commission Chairman Gary Gensler and Schapiro were both on hand to testify on Thursday at the first major congressional hearing about MF Global since it filed for bankruptcy on October 31.
MF Global collapsed after the firm was forced to reveal that it had made a $6.3 billion bet on European sovereign debt, spooking investors. An effort to sell the firm failed, partly because of the revelation that hundreds of millions of dollars in customer money was not where it should have been.
The CFTC is the primary regulator in charge of the search for the missing money, which so far has only been money from futures accounts. The Department of Justice, other regulators and the trustee overseeing the bankruptcy proceeding are also on the hunt for the missing money.
In the months leading up to MF Global’s collapse, the first regulator to flag problems was the Financial Industry Regulatory Authority, which self-polices securities brokers. In June, FINRA raised concerns that the firm had a substantial position in European sovereign debt and was not appropriately holding capital against it.
FINRA also questioned whether it was appropriate for MF Global to use Generally Accepted Accounting Principles to park the exposure off balance sheet.
MF Global was financing its European sovereign debt bets through “repo-to-maturity” transactions, which allowed it to move the exposure off its balance sheet, even though the firm still faced enormous risk in the case of a default.
FINRA and the SEC ultimately forced MF Global to increase its capital. The firm later disclosed the capital infusion in September.
Schapiro said regulators are exploring whether any new regulations are in order in the wake of MF Global’s collapse, including possible accounting changes.
She noted that the Financial Accounting Standards Board, which sets U.S. accounting standards, recently decided that repo-to maturity is the only kind of repo transaction that qualifies for off-balance sheet treatment. But in light of MF Global’s demise, regulators are now rethinking that approach.
“We are talking to FASB about whether that is a policy that ought to be changed,” she said. “They did improve the disclosure around it, but there is a question I think about whether repos-to-maturity should be included on the balance sheet.”
At least one senator seemed to think that was a good idea.
“That is a loophole so big you could drive a Mack Truck through it,” said Democratic Senator Kent Conrad. “If that’s not closed down, we really got to ask ourselves what we’re doing.”
Schapiro said MF Global did disclose its net exposure to sovereign debt in a regulatory filing. The company also disclosed its gross exposure, though “not as clearly,” she said. She told the lawmakers the SEC is looking at whether there was sufficient disclosure surrounding the repos, as well as “the hedges that were expiring” and the “window-dressing.”
“All of those issues are under investigation,” she said.
As for potential regulatory fixes, she said the SEC already proposed a rule earlier this year that would require brokerages that hold custody of customer money to undergo additional PCAOB audits. That rule, when finalized, will help “give us another set of eyes on the financial responsibility compliance of the firms,” she said.
She also was hopeful the SEC will soon approve a rule proposal by FINRA that would require additional financial reporting so the brokerage regulator can beef up its monitoring.
Editing by Phil Berlowitz, John Wallace, Lisa Von Ahn and Andre Grenon