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MF Global shortfall worsened as bankruptcy neared

By Nick Brown

(Reuters) - In its chaotic final days, MF Global's floundering brokerage used increasingly large chunks of customer money in an effort to keep the company afloat, creating a massive shortfall in customer funds, the trustee liquidating the brokerage has found.

The activity occurred while a flurry of cash transactions, totaling more than $105 billion, took place in the five days leading up to the October 31 bankruptcy of its parent, MF Global Holdings Ltd , the trustee James Giddens said in a statement.

That suggests that customer cash could be scattered among hundreds of affiliates, exchanges, clearing houses and banks on the other end of those transactions, Kent Jarrell, a spokesman for Giddens, said in an interview on Monday.

The shortfall first appeared on October 26 and grew until MF Global went bankrupt, Giddens said.

About $1.2 billion remains missing from customer accounts, and recovering that amount could require lengthy court battles, Jarrell said.

Customers have long been frustrated with the inability of MF Global and investigators examining the futures and commodities brokerage's collapse to determine where their money went.

Giddens said he will now focus on determining which transactions were funded with customer cash and, where possible, submit claims to get that money back.

MOVING CUSTOMER CASH

In his investigation, Giddens said he found that MF Global regularly used customer money in small amounts of less than $50 million for corporate needs.

But as MF Global's financial position worsened last fall, with exposure to $6.3 billion in risky European debt, "much larger amounts" of customer money were used, "apparently with the assumption that funds would be restored by the end of the day."

That didn't happen, he said. Rather, as MF Global's finances grew more dire and its credit ratings dropped, there was an "unprecedented" swell in transaction activity, including billions of dollars in securities sales, draws on credit facilities and a web of inter-company loans, Giddens said.

"The heightened risk and apparent loss of confidence drove customers to close their accounts and withdraw funds, resulting in even greater demands on a relatively limited amount of available cash," Giddens said in the statement.

In the end, he said MF Global was unable to replenish customer accounts, and its parent filed for Chapter 11 protection with the shortfall still unresolved.

Amid the chaos and flurry of transactions, workers may not have been aware that they were operating with a customer pool that had a deficit, Giddens said.

The trustee said the company's computer systems had a hard time keeping up with the flood of transfers.

"A number of transactions were recorded erroneously or not at all," Giddens said.

So-called 'fail' transactions -- where either the buyer or seller fails to deliver the cash or the security -- were five times the normal volume during the firm's final week, he said.

Giddens said he is working with third parties to seek more complete information about transfers to "select" parties prior to that bankruptcy.

Bart Chilton, a democratic commissioner at the Commodity Futures Trading Commission, said Giddens' statement shows how bankruptcies are inherently messy and that MF Global was no different. "The question now is what sort of job can the clean up crews do to get customers their money back and to fully punish those that may have broken the law," Chilton said in an emailed statement.

SHORTFALL STANDS PAT

The $1.2 billion shortfall figure is the same estimate Giddens first released in November. Other regulators have challenged the figure as too high, including CME Group Inc , MF Global's primary exchange, whose chairman Terry Duffy pegged the deficit between $700 million and $900 million.

Jarrell told Reuters last month it was possible Giddens would "sharpen" the estimate once his team finished processing claims from customers. That process is ongoing, according to the statement.

Customers have received about $3.8 billion of the amounts in their accounts when the broker-dealer's parent filed for bankruptcy, about 72 percent of the total value. The trustee said it remains unclear when they might receive any more.

"We're just about out of money to give back," Jarrell said. "We have a reserve, but we have to keep it in case claims come against us."

The cases are In re: MF Global Inc, U.S. Bankruptcy Court, Southern District of New York, No. 11-2790; and In re: MF Global Holdings Ltd et al in the same court, No. 11-15059.

(Reporting Nick Brown; Additional reporting by Jonathan Stempel; Editing by Phil Berlowitz, Tim Dobbyn and Bernard Orr)

(This story corrects paragraph 2 in Feb. 6 story to clarify that customer money not used to fund all cash transfers in days leading up to bankruptcy)

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