The Con Man’s Lament: Equity vs Commodity Firms

There may be no honor among thieves, but there has always been some small measure of dignity — even respectability — amongst the con men of the equity markets.

Apparently, there is no such corresponding code of honor amongst commodity trading firms.

I refer of course to the debacle that is MF Global. How on earth could $633 million in customer accounts simply disappear?

As it turns out, quite legally.

The regulations governing these customer accounts are 25 plus years old, according to a few insiders I spoke with. They gave the firms an ability to hypothecate (lend) client money, so long as it was only used to legally purchase investment grade sovereign debt.

So that was what MF Global did.

As originally conceived, client monies were only supposed to purchase US Treasuries. However, so as to not offend trading partners (and other reasons), the regs were written so as to include any “investment grade sovereign” in the rules. Hence, AA rated European sovereign debt, despite the obvious fact that in 2011 they are obviously not the equivalent of US Treasuries, technically qualify. Whether this violates the obvious spirit and intent of the law will be for a judge to decide.

Of course, this raises another question: If the corrupt and compromised rating agencies had actually done their jobs — downgrade European junk to what it really was — would MF Global been able to empty client accounts? I suspect not.

Regardless, consider the Con Man’s Lament: The past half century of boiler rooms, accounting scandals, pump & dumps, backdated options, corrupted analysts, IPO spinning, derivative debacles, etc., have all come about for this simple reason: Brokerage firms cannot simply reach into client accounts and take the money for firm use.

This wasn’t a face-in-hand moment — Hey, why didn’t we think of that? — amongst equity criminals. Rather, it was a well understood rule that was enforced without question. “Borrow” money from a client account without their knowledge, go to jail for grand theft.

Consider:

• If the weasels at Stratton Oakmont or any other ’90s boiler room thought they could merely empty client accounts, they would have. Instead, they had to concoct enormous Pump & Dump schemes to dupe willing rubes out of the money.

• If Merrill Lynch could have merely grabbed billions from Orange County, rather than create an elaborate derivatives scheme that ultimately bankrupted the county, don’t you think they would have done that?

• Instead of the IPO spinning to capture assets and revenues that most of the major bulge bracket firms did int he boom times of the late 90s, wouldn’t it have been easier to merely leverage up client accounts?  Heads we win, tails you lose?

• Would any of the major accounting firms had to do such absurd audits of firms like WorldCom or Tyco? They worked hand in hand with Wall Street to help capture money. (But steal? Never!)

• Consider the side pockets developed by Enron with the help of McKinsey & Co. If there was a way to simply take client money, why would anyone bother going through all that trouble?

• Even the convoluted Lehman’s Repo 105 was a way to hide $50 billion per quarter from investigators and regulators. Had they been able to tap client monies, who knows how their saga might have ended.

Now, that may not sound like much, but it is worth considering. Neccessity being the mother of invention forced the very worst enterprises on the equity side to engage in all manner of deception and duplicity by morally compromised, ethically challenged bad actors. They had to do this, because they could not merely grab monies from client accounts.

It was a point of pride amongst equity con men that they did not merely steal. They cajoled, wheedled, scammed, and cheated, but they never stole.

Hey, what kind of people do you think we are?