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Regulation 1.25: The Undoing of MF Global?

The headline says it all: “Purgatory For MF Global Customers.” The story, appearing Nov. 16 in the Wall Street Journal, highlights the aftermath of MF Global’s bankruptcy filing and the consequences now facing MF Global clients.

MF Global filed for Chapter 11 bankruptcy on Oct. 31. More than two weeks later, some 33,000 customers are unable to access their money – “stuck in a sort of purgatory.” And it’s possible that customers may never get all of their money back.

“My entire business has come to a halt,” said Andrew Gochberg in the Wall Street Journal article. “I’m angry and I no longer have any confidence in our system.”

Gochberg had more than more than $1 million with MF Global – in what he and thousands of other investors thought were safe, protected accounts and accounts kept separate from MF Global’s own money.

But that apparently didn’t happen. After MF Global filed for bankruptcy protection, regulators discovered more than $600 million missing in customer money.

How did it happen? That’s the $64,000 – or, in MF Global’s case, the $600 million-dollar – question. It may have something to do with a little known finance rule called Regulation 1.25. Before 2000, the rule allowed futures brokers to take money from their customers’ accounts and invest that money in approved, relatively safe securities with high liquidity.

But, as reported in a Nov. 16 story by Bloomberg, things changed in December 2000 when the Commodities Futures Trading Commission amended Regulation 1.25. Now investments were permitted in “general obligations issued by any enterprise sponsored by the United States, bank certificates of deposit, commercial paper, corporate notes, general obligations of a sovereign nation, and interests in money market mutual funds.” In short, riskier investments were now allowed under Regulation 1.25.

More changes came in February 2004 and May 2005, with Regulation 1.25 amended even further so that firms like MF Global could do “internal repos” of customers’ deposits – i.e. take money from customer accounts and invest that money in the short term in a variety of high-risk securities.

And that, of course, ultimately led to the undoing of MF Global and the beginning of a financial nightmare for its clients.

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