Frederick Grede, trustee for the bankruptcy of futures commission merchant (FCM) Sentinel, has sued 50 of its former customers to recoup some $600 million in funds that were withdrawn prior to its bankruptcy.
He has already settled out of court with some customers and recovered about $25 million. The rest remains in litigation, filed before the two-year statute of limitations ran out.
His view is that the loss of funds should be shared equally, on a pro-rata basis, among all customers, not only those who were left holding the bag when Sentinel filed for bankruptcy. …
But the Sentinel case still could set a precedent for MF Global if attorneys for former clients can show that MF Global used customer funds to trade its own book.
And if, y'know, Grede wins. I am not a bankruptcy lawyer but it seems like quite a stretch under the relevant bankruptcy section to claw back ordinary-course withdrawals of client money from their own segregated accounts. So I'm not too worried for the guys who got their money out, who of course include Koch Industries, which makes total sense because Koch is both a big commodities trader and a Zelig of conspiracy theories. This guy's not worried either:
"Everybody and their brother started pulling money out early," said one commodity hedge fund manager who withdrew some of his funds prior to MF Global's fall. "People pulled money out of Lehman and Bear segregated accounts when they knew they were going bankrupt and nothing happened to them. It doesn't mean it can't happen, but I don't see it."
He's probably not a bankruptcy lawyer either, but, yeah, agreed.
There is actually a whole lot to be said for Grede's theory; in general, it's the whole theory of the bankruptcy code. Not only is it maybe "fair" that everyone floating around Sentinel, or MF Global, in its last days should share the pain equally, whether or not they beat the buzzer on the way out. More importantly, taking away the prize for winning the race out of MFG should make customers less jumpy to run that race in the first place. When you're a 33:1-levered commodities dealer and things start to go pear-shaped, it makes total sense for anyone standing nearby to get out as quick as they can, since the sooner they get out the better their chances of getting all their money back. Change that incentive and maybe they'll keep their money at MFG, helping it weather its liquidity crunch.
The argument against this is that you really want to avoid unwinding regular-way trading market activity, and protect the sanctity of words like "segregated account." If the term "segregated account" means "account that is in your name at a bank, and can't be shared with MF Global or other customers, until there's a problem, at which point screw it we're all in this together" then it doesn't really mean much does it? Of course, MF Global's segregated account holders have every reason to be pissed anyway, since it seems that those who didn't get out may have to "share" their money unless and until Bart Chilton gets some (non-chemical) satisfaction. Clawing back customers who already got out, though, creates even bigger problems for the next futures broker who wants to tell clients "no, really, this is your money and isn't going to be shared or eaten up in our bankruptcy." And if everyone's dumped into this bankruptcy together, customers will increasingly be driven to do business with only the biggest and unfailiest of the too-big-to-fail banks.
There's no single right answer: the bankruptcy code is usually in favor of tossing everyone who got out in the last 90 days in with the creditors left holding the bag, but makes lots of exceptions for trading liabilities and secured debt and child support payments (really). I suspect that MF Global's segregated accounts are well on the child-support side of the line, and people who got out early won't have to "share" with the rest. Which is probably how it should be.
Insight: Clients who fled MF Global face clawback risk [Reuters]
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