WASHINGTON (Reuters) - Now bankrupt MF Global lobbied the New York Federal Reserve heavily to become a primary dealer, eventually succeeding after a delay sparked by a regulator flagging internal control problems.
Thomas Baxter, the New York Fed’s general counsel, revealed the regulator’s behind-the-scenes dealings with the futures brokerage, including a personal meeting with former MF Global chief Jon Corzine, in testimony prepared for a congressional hearing on Thursday.
The Fed delayed approving MF Global’s application for primary dealer status after the Commodity Futures Trading Commission warned the Fed in April 2009 it had uncovered major compliance issues.
Primary dealers are the financial firms authorized to deal directly with the government to help carry out monetary policy and distribute U.S. debt.
MF Global was eventually given primary dealer status in February of this year. Fed Chairman Ben Bernanke has previously said it did not constitute a “seal of approval.”
Baxter is expected to face questions at Thursday’s hearing by the House Financial Services oversight subcommittee about whether the Fed overlooked problems with the firm.
“We also have concerns with the apparent lack of due diligence conducted by the Federal Reserve Bank of New York in bestowing its primary dealer designation on MF Global - even as the firm consistently lost money,” panel chairman Randy Neugebauer said in a prepared opening statement.
In December of 2009, the CFTC took enforcement action against MF Global and imposed a $10 million civil money penalty for “significant supervision violations” involving rogue traders.
“The CFTC had ordered MF Global to overhaul its internal control structure with the assistance of an outside consultant,” said Baxter in his written testimony. “New York Fed staff decided to wait for the CFTC’s assessment before taking a view on the firm’s suitability as a primary dealer.
MF Global formally lost its primary dealer status after it filed for bankruptcy on October 31.
The firm collapsed after it was as forced to reveal it bet $6.3 billion on European sovereign debt. That disclosure led to market concerns and ratings downgrades that ultimately doomed the firm.
The search for hundreds of millions of dollars in missing customer funds has sent reverberations through the farm belt and trading floors, and has attracted the attention of the FBI and federal prosecutors.
The Federal Reserve was not a primary regulator for MF Global, which was jointly overseen by several market regulators including exchange operator CME Group, the CFTC and the Securities and Exchange Commission.
According to Baxter, after the New York Fed learned about the CFTC’s concerns with MF Global in April 2009, it delayed its decision on MF Global’s application for six months.
Around that same time, the New York Fed also tightened its policy for primary dealer qualifications by requiring firms facing litigation or regulatory actions to undergo a one-year “waiting period” before they could be considered.
From 2009 through 2010, Baxter said MF Global repeatedly tried to lobby the Fed to expedite the review of its application.
After MF Global learned in early 2009 that the New York Fed was delaying its primary dealer application and was tightening its qualifications, the firm requested a meeting with New York Fed President William Dudley.
The New York Fed, however, denied the request.
After the CFTC’s enforcement action was filed, former CEO Bernard Dan wrote a letter on January 27, 2010, asking the Fed to approve the primary dealer application, saying the CFTC’s action “was not material.”
The Fed denied MF Global’s requests and held its ground.
Corzine, a former senator, governor of New Jersey and who once led Goldman Sachs, did get a “courtesy meeting” on June 1, 2010, with Baxter and other New York Fed officials.
At that meeting, Corzine provided an update on MF Global’s business plans, emphasizing that the firm was raising additional capital, Baxter said. Corzine resigned as MF Global CEO early last month.
After a review process that included looking at audited financial reports, tax returns and an on-site visit, the New York Fed finally concluded in a January 2011 memo that MF Global “demonstrated a clear ability” to meet the Fed’s standards.
In MF Global’s final days before bankruptcy, Baxter said the New York Fed took a series of actions to limit its exposure to the firm, including margin calls.
He said the New York Fed had not sustained any losses as a result of MF Global’s collapse.
Reporting by Sarah N. Lynch; Editing by Tim Dobbyn