Brokers - the good, the bad, and the ugly

[arco]

T took only seven hours early on Wednesday for a trader at MF Global to make bad bets on the direction of wheat prices that cascaded into $US141.5 million ($149 million) in losses at the brokerage firm and exposed another breakdown in Wall Street's risk management. The announcement of the ill-fated trades was an embarrassment for the Bermuda-based futures and derivatives firm, which suffered a 28 per cent drop in its share price. It was the steepest decline since MF Global was spun off last year from hedge fund giant Man Group, and the blow-up raised questions about how one of the largest customers on several futures exchanges could have left itself so exposed to a single trader's bets.
MF Global identified the trader as Evan Dooley, who worked in the firm's Memphis office until he was fired for having "substantially exceeded his authorised trading limit".
In an interview, the 40-year-old Mr Dooley, who goes by his middle name, Brent, blamed the trading loss on the computer systems he was using. That system "failed on a lot of things", he said, including problems in "setting limits". He declined to be more specific.
MF Global insisted that the breakdowns resulting in the steep loss were isolated and have been fixed. But Kevin Davis, the brokerage's chief executive, acknowledged that existing internal controls could have stopped Mr Dooley's trades from being processed - but were turned off in certain cases to allow for speedier transactions by brokers at the firm who traded for themselves.
"This is an absolutely awful event but we believe it was an aberration in our risk controls and we have fixed it," Mr Davis said.
Mr Dooley, who has spent more than 15 years in the rough-and-tumble business of commodities trading, was betting that wheat prices would fall from their record levels, according to a person familiar with the situation. Wheat and other commodities have surged in recent weeks because of strong demand, tight supply and a cash infusion from investors.
MF Global's risk management procedures include "buying power controls" that are supposed to flag big or risky trades that might expose the firm to potential losses. But those internal controls had been turned off at the Memphis office and possibly other locations in order to speed up trades. The surge in commodities trading volume has created pressure on brokerage firms to keep up.
The Chicago Board of Trade handled Mr Dooley's orders. By Wednesday morning, though, wheat prices were moving sharply higher, meaning that Mr Dooley was suffering losses that far exceeded the balance in his own trading account. Since his account was depleted, MF Global was forced to step in and fund the trader's losing position. "It happened very quickly," Mr Davis said. Mr Dooley did not have the capital "to support even a fraction of his positions".
Traders in Chicago said MF Global's buying binge pushed wheat prices higher and fuelled heavy trading on Wednesday. It took several hours to undo Mr Dooley's trades.
The MF Global mess was "certainly the main thing" that caused the market to gyrate on Wednesday, said Vic Lespinasse, an analyst at Illinois Grain and a veteran CBOT floor trader. The most actively traded May wheat contract surged to the CBOT-imposed limit of $US1.35 a bushel.
Covering Mr Dooley's short positions cost MF Global $US141.5 million in cash, or about $US80 million on an after-tax basis. That is equal to 6 per cent of the brokerage firm's capital - and exceeds the company's net income in the fiscal third quarter.
Some of the loss may be recovered from insurers, but Mr Dooley is unlikely to make much of a contribution. The trader "does not appear to be terribly long of assets", Mr Davis said.



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