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MF Global Proves Enron-Era Accounting Lives On

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The off-balance-sheet accounting methods that Enron and Lehman Brothers made famous in their epic failures years ago have a modern-day poster child: MF Global.

Like its predecessors, the bankrupt brokerage formerly run by Jon Corzine took advantage of an accounting maneuver to keep certain financial obligations off its books, making the firm look less indebted and thus less a risk than it really was.

On Thursday, Mary Schapiro, chairman of the Securities and Exchange Commission, told a committee of Congress the SEC was investigating the accounting treatment that helped mask MF Global's exposure to risky foreign sovereign debt.

The fact that MF Global was able to use the technique highlights how off-balance-sheet moves are evolving as quickly as new accounting rules intended to stop them. Earlier this year, the Financial Accounting Standards Board changed its rules to bar an off-balance-sheet loophole that had helped Lehman Brothers get into trouble in 2008.

The fixes of FASB often are too specific to keep firms from trying new tacks, said several analysts, academics and former regulators. "They keep trying to put a Band-Aid on this thing, but you've got this problem that is huge and requires major surgery," said Penn State University accounting professor Ed Ketz.

Within The Rules
MF Global's version complies with current accounting rules. Other Wall Street firms use it too, though generally for ultra-safe U.S. Treasuries, which the government promises to repurchase at face value.

In MF Global's case, the off-balance-sheet accounting itself didn't cause the firm's downfall, but it allowed MF Global to use borrowed money to make billions of dollars in ultimately catastrophic bets on European sovereign debt - and obscured the risk those bets posed to the company.

Nothing was done to force MF Global to respond until the U.S. Financial Industry Regulatory Authority demanded that MF Global's broker dealer business put aside more cash and liquid assets to absorb any losses in its European bets. Moody's downgraded the firm, setting off a rapid drop in confidence that ended with the firm's Oct. 31 bankruptcy.

Moody's senior analyst Al Bush told the Wall Street Journal last month his firm was surprised to learn that MF Global's large off-balance-sheet position was not being held for clients, but was the firm's own bet.

Law-enforcement officials, regulators and the bankruptcy trustee are still searching for as much as $1.2 billion in missing investor money believed to have been unlawfully mingled with the firm's own funds. The firm has said it is cooperating fully with the investigation. Corzine has been quiet on the matter since his Nov. 4 resignation, though at that time he pledged to help the firm respond to inquiries.

MF Global's off-balance-sheet maneuver involved what's called a repo, or repurchase agreement. In repo deals, a firm borrows money, but puts up assets as collateral, assets it agrees to repurchase later. Repo deals are common, and typically don't move assets off the balance sheet.

Lehman got in trouble for doing deals in late 2007 and in 2008 using a slightly different move, what it called the "Repo 105,", which used to get assets off its balance sheet, often just days prior to its reporting deadlines.

Lehman's repo created "a materially misleading picture of the firm's financial condition," according to a 2010 report by Anton R. Valukas, the now-defunct firm's Bankruptcy Court examiner and chairman of Jenner & Block law firm.. It has been closed by a new FASB rule being implemented this quarter.

MF Global used a version of the off-balance-sheet move called "repo-to-maturity." The firm offered billions of dollars in sovereign debt as collateral on a series of loans designed to expire at the same time as the collateral itself. With the collateral and the loans coming due simultaneously, MF Global might never take possession of that debt again. That entitled the firm to count those as sales, and moved $16.5 billion off its balance sheet, most of it debt from Italy, Spain, Belgium, Portugal and Ireland.

It did disclose a $6.3 billion exposure to European debt, a figure that eventually became a concern for regulators and others doing business with the firm.

To top it all off, the accounting for these deals added $124 million in financing payments to the firm's revenue over the last four quarters, according to SEC filings, firm documents and people close to the firm.

Hard To Track
It's hard to track the intricacies of repo-to-maturity deals. A few other financial firms including Oppenheimer, Nomura Holdings and Merrill Lynch have disclosed that they use the structure. Much like MF Global, Nomura used the deals to help build a bet on European debt that was as high as $3.6 billion at the end of September, but which has now been cut by the Japanese firm to $884 million. A New York spokesman for Nomura could not immediately be reached for comment.

Accounting and financial experts are starting to call for a re-examination of the repo structure that MF Global used. "We are talking to FASB about whether that is a policy that ought to be changed," Schapiro said on Thursday, referring to the Financial Accounting Standards Board. In response, a FASB spokesman declined immediate comment.

Last month, Leslie Seidman, FASB chairman, told Reuters in an interview that the U.S. accounting rule maker relies on regular contact with regulators, investors, accounting experts, companies and accounting firms to know what accounting concerns are out there and no one had raised questions about repo-to-maturity transactions.

Accounting rules since Enron have forced many deals onto the balance sheet and disclosure of important details on other deals. Hundreds of billions of dollars of investments in credit card debt, for example, moved onto balance sheets after accounting changes in 2010, though similar bets on real estate loans remain largely off bank balance sheets. Hundreds of billions of dollars in obligations of all types sit off balance sheets.


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