How investment firms make money should matter to investors

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Updated: January 12, 2012 8:33AM

Former New Jersey Gov. and U.S. Sen. John Corzine testified in front of the House Agricultural Committee on Thursday regarding his role as CEO of the now defunct MF Global.

MF Global is an investment firm that provided futures trading accounts and brokerage services to a variety of customer types including individual investors. The firm had provided these services under different brands for decades.  

On Oct. 31, MF Global declared bankruptcy due to a liquidity crunch that largely stemmed from the firm’s exposure to European sovereign debt.

As the bankruptcy unfolded it was ultimately determined the firm had improperly and illegally co-mingled cash held in customer accounts with the firm’s own funds to shore up the firm’s risky margin trades that required additional capital. At the time of Corzine’s testimony it appears about $1.2 billion of customer funds was unaccounted for. 

Whether these funds will be recouped for customers is anybody’s guess.

This is an American tragedy, as many of the affected customers were farmers and ranchers simply using their MF Global accounts to manage the pricing they would receive for crops. Others were individual investors simply using these accounts for diversification in their personal investment strategies.

So what can we as investors learn from this mess?   

First and foremost we can learn that who holds or provides custody to our money matters. Under Corzine, MF Global had gone from being a straight-forward futures trading firm that primarily provided execution services to customers to a firm that was very much focused on taking risky trading bets on its own behalf in an effort to grow its own profits quickly and aggressively.

I would wager the great majority of customers of MF Global didn’t really care how much money the firm made trading its own accounts. Their relationship with the firm was intended to be simple and clear cut: Provide me with brokerage advice, a place to store money and execution services for my trades. But somewhere along the way, MF Global changed into something else, and sadly in retrospect, their customers should have been paying attention.   

So now is a good time to ask, how do the firms that hold your money actually make their money? And shouldn’t the answer be that it makes its money by providing the services that you need from it?

Second, we can learn that Securities Investor Protection Corp. insurance matters. The SIPC was created in 1970 by an Act of Congress and serves the role of covering the delivery of customer cash and investments in the event a brokerage firm fails. It is important to note that while the SIPC does not cover general investment losses, it does however help investors recoup funds or securities that may have been stolen by a broker or have been put at risk by the failure of a brokerage firm.

If your account is covered by the SIPC it will say so on the bottom of your statement and it will be displayed prominently in your financial adviser’s office.