While former MF Global clients anticipate the return of missing funds, few realise the impact of a case pending in Britain’s Supreme Court on whether and how quickly these funds will be returned.
Clients on both sides of the Atlantic are eagerly awaiting a decision, due in March, of an appeal concerning the status and distribution of client funds by US investment bank Lehman Brothers.
At issue is the status of client money which did not make it into Lehman’s segregated accounts at the time the firm went bankrupt on 15 September, 2008.
In the UK, client funds are required by law to be segregated, but Lehman operated an approved “alternative approach” for the receipt of client funds, where monies received were paid into the firm’s house accounts and then segregated into client accounts according to a reconciliation of funds conducted the previous day. Under this arrangement, funds were not paid directly into client accounts and some client funds remained in the house accounts when Lehman’s went into administration.
Should this money be considered segregated and therefore able to be pooled by administrators? While the UK’s Court of Appeals said it should, we are yet to find out what the Supreme Court will say. In the meantime, MF Global customers are caught in the crossfire.
“The timing of the two events is remarkable,” said James Oldnall, legal director in the finance and banking group at London and New York-based law firm Mishcon de Reya. “The two bankruptcies have both called into question how safe is client money under the current rules for client segregation.”
In early February, KPMG, the special administrator for MF Global’s UK holdings, began returning client money, with first payments of 26% in the dollar to clients with “agreed claims” who had positions frozen or money lost that was supposed to be in segregated accounts. But no more funds can currently be provided to UK clients until the Supreme Court ascertains which customers can claim protection.
MF Global’s US bankruptcy trustee, James Giddens, is also fighting KPMG, asserting around US$740 million of the UK funds should be repatriated for American customers. The court’s ruling will also affect what is left for American MF Global clients.
“The key thing about a trust is you have to be able to identify the funds. If they are co-mingled, then they may lose their identity,” said David Barwise, a partner at law firm White & Case, explaining that including money in house funds within the definition of what is deemed segregated will have complex implications.
Barwise said although MF Global customers could benefit from the Court of Appeal’s decision if it is upheld by the UK Supreme Court, it will nonetheless further delay the return of those funds which did not make it into segregated accounts.
“Some former MF Global customers will be wanting the Supreme Court to uphold the Court of Appeal’s decision that client monies which were in the house account are subject to the statutory trust,” said Barwise. “This would ensure they are returned at least some pence on the pound or cents on the dollar. It is hoped the Supreme Court comes up with a logical way to deal with mixed accounts.”
The flipside of this is that those MF Global customers who know their money to have been in segregated accounts would likely experience even further delays if the Lehman’s decision required money in the house account to also be considered segregated.
“Where do you draw the line? If money in the house accounts doesn’t have to be pooled for recovery, then the return of segregated funds will be a lot faster,” said Mishcon’s Oldnall. “Any decision from the Supreme Court will be a double-edged sword, depending on where whether or not your money was in a segregated account.”
In 2008, the bankruptcy of Lehman Brothers pushed counterparty risk back to the top of the buy-side agenda, with many transactions frozen and many commission payments to third-parties unpaid.
Last year, MF Global filed for bankruptcy in New York on 31 October after counterparties reacted adversely to the disclosure of a US$6.3 billion bet on European debt. It has also been reported widely that regulators have determined that days before the 31 October bankruptcy filing, MF Global may have moved more than US$100 million in client money to its own brokerage accounts.
Some US$1.6 billion in client monies are still believed to be missing.