Freeh: MF Global Trustee Sues Corzine Breach of Fiduciary Duty

7:23 p.m. | Updated

A bankruptcy trustee has sued Jon S. Corzine and other former MF Global executives, claiming they were “grossly negligent” in the lead-up to the brokerage firm’s collapse.

The action by the trustee, Louis J. Freeh, comes just weeks after he agreed to postpone the lawsuit and enter mediation with Mr. Corzine. By filing litigation that appeared to catch the MF Global executives off-guard, Mr. Freeh may have jeopardized those talks.

“We question why the trustee chose to file this lawsuit, which is filled with seriously flawed allegations, while he is participating in court-ordered mediation of these very claims,” said a spokesman for Mr. Corzine, Steven Goldberg.

Mr. Freeh, who represents hedge funds and other creditors of MF Global, said on Tuesday that “the mediation process is ongoing,” and that it was “in the best interests of the Chapter 11 estates to file the complaint.”

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•  Documents: Reports on MF Global's Bankruptcy

The lawsuit, filed in United States Bankruptcy Court for the Southern District of New York late on Monday, echoes a report Mr. Freeh issued this month that blamed MF Global executives for engineering a “risky business strategy” and ignoring “glaring deficiencies” in internal controls. The report and the lawsuit accuse the executives of allowing more than $1 billion in customer money to disappear from the firm.

In the new complaint, Mr. Freeh took aim at Mr. Corzine, a former Democratic senator and New Jersey governor who became MF Global’s chief executive in 2010. Mr. Freeh, a former director of the F.B.I., also sued two of Mr. Corzine’s top deputies: Bradley I. Abelow, the chief operating officer, and Henri J. Steenkamp, the chief financial officer. Mr. Freeh labeled the men as “Corzine’s handpicked deputies.”

“Defendants, in their capacities as officers, breached their fiduciary duties of care, loyalty, and oversight over the company, and failed to act in good faith,” Mr. Freeh wrote.

The action against Mr. Abelow and Mr. Steenkamp is unusual in that both executives remained at MF Global for more than a year after the firm’s collapse, working under Mr. Freeh. They stayed to help sort through the bankruptcy process.

Gary P. Naftalis, a lawyer for Mr. Abelow, noted that Mr. Freeh had himself described that work as “invaluable.” Mr. Naftalis criticized Mr. Freeh for “now making allegations that lack any factual or legal basis.”

Mr. Goldberg, the spokesman for Mr. Corzine, also said the assertions in the suit were unsubstantiated. “There is no basis for the claim that Mr. Corzine breached his fiduciary duties or was negligent,” he said. “We look forward to proving the actual facts in court.”

The suit, which could help Mr. Freeh recover money for MF Global’s creditors, blamed Mr. Corzine for ramping up a risky bet on European debt. While the bonds were not by themselves to blame for the collapse of MF Global, the wager unnerved its investors and ratings agencies, further undermining the firm.

“Corzine engaged in risky trading strategies that strained the company’s liquidity and could not be properly monitored by the company’s inadequate controls and procedures,” Mr. Freeh said.

Mr. Goldberg in turn called the complaint “a clear case of Monday morning quarterbacking.” Mr. Corzine, he said, inherited a firm in 2010 that had lost money in each of the previous three years.

It is unclear whether the lawsuit will alter the mediation talks. While Mr. Freeh said the discussions were continuing, the lawsuit could derail or delay the mediation process.

The litigation might also complicate an effort to return money to customers. Mr. Freeh pursued his own case against Mr. Corzine, rather than join an earlier lawsuit filed by a second MF Global trustee, James W. Giddens, and some of the firm’s customers. Mr. Giddens, who has the task of recovering money for the customers, has already returned about 89 percent of the shortfall to MF Global’s clients in the United States. Some people close to the case say Mr. Giddens has identified a path to potentially making customers whole.

The lawsuit, coming on the heels of a bankruptcy judge approving Mr. Freeh’s plan to liquidate MF Global, could empower him to recover additional money for creditors. But the case might not sit well with customers.

In a statement, Mr. Giddens said he had joined the customers’ class-action lawsuit “because it was the most efficient way to get money to customers and creditors.”

Federal authorities, including the Commodity Futures Trading Commission, also continue to investigate the misuse of customer money. Mr. Corzine has not been accused of any wrongdoing by the agency, and internal e-mails suggest he was not aware that at least some of the customer money was improperly sent to the firm’s banks.

“Anyone who violates the law, and particularly anyone at MF Global who used a billion bucks of customer cash that should have been protected, should be punished appropriately,” said Bart Chilton, a member of the trading commission.

Louis Freeh Report Blasts MF Global Head

                                                        IS YOUR GOLD ACCOUNT SAFE?

Louis Freeh's MF Global trustee report says John Corzine knew or should have known the firm was headed for a bust.

Former MF Global CEO Jon Corzine

FORTUNE -- On Thursday, Louis Freeh, one of the two bankruptcy trustees for MF Global and a former head of the FBI, released a report that for the first time squarely places the blame of the demise of the commodities trading firm on one person.

Back in March 2010, MF Global's board of directors created the position of global head of capital and liquidity risk, a response to an earlier trading blunder that had cost the firm more than $100 million. The position was created the same month CEO Jon Corzine, the former Senator and head of Goldman Sachs (GS), was hired to run the firm. So basically Corzine's first assignment from the board was to hire this person.

The job of the global head of capital and liquidity was to be the ultimate guard of MF's cash, alerting the board if there was any chance the firm would run out. Basically, the buck was supposed to stop there on whether MF had enough bucks. As anyone familiar with the MF Global story will tell you, this person clearly failed, horribly.

EARLIER: The last days of MF Global

According to Freeh's report, over the next year and a half, Corzine embarked on a trading strategy that systematically drained the company of its cash, created phony one-time earnings gains, and regularly violated the firm's risk controls, which Corzine and the rest of management knew were horribly flawed anyway.

And not once did MF's global head of capital and liquidity risk speak up. The person never wrote a single report to the board or even called a meeting.

The logical response at this point should probably be, "Bring me this guy (or gal)." We need to question this person or put him in jail or haul him in front of Congress or whatever it is we do to financiers who have screwed up this bad. And that would be a good thing to do, except for the fact that the person the company's board mandated to be put in place to keep MF Global in check was never actually hired. Corzine didn't fill the position.

Freeh's report places more blame on Corzine for MF Global's undoing than any of the numerous other reports and investigations that have been produced since the firm collapsed in late 2011. The 124-page report was filed in bankruptcy court on Thursday, ahead of hearing on the firm's liquidation on Friday. But that's probably not the end of MF's legal saga. Freeh's report seems to be setting things up for a possible suit against Corzine.

MORE: JPMorgan agrees to settlement in MF Global dispute

But he doesn't accuse Corzine in a direct way. Freeh doesn't claim that Corzine gave permission to use customer money to fund his bet on European debt. He doesn't even say Corzine knew customer funds were missing, a key issue in the wake of the firm's collapse. (Much of the money has since been found.)

Instead, Freeh says MF Global's accounting systems were so bad executives probably were unaware that they had illegally tapped customer accounts to fund the company's prop trade. Nor do they know how close they were to running put of money. But Freeh does say that Corzine knew or should have known how weak the firm's risk controls were. He and other executives were instructed to fix the problem, for instance making the key hire the board had mandated, but never did.

Why didn't they? Freeh's report paints the picture that Corzine preyed on those weak risk controls to build up his $6.3 billion bet on European debt, which eventually led to cash shortfalls of as much as $2.1 billion, bankrupting the company.

Corzine structured his bet on Europe using "repos-to-maturity," a way that would generate upfront one-time profits. The only way to keep that profit machine going was to make the trades bigger and bigger. Throughout 2010 and the first half of 2011, Corzine repeatedly asked the board to up the size of his trade, and then he blew through his limits anyway. That can still work if the trades go your way or if you have a Goldman or TBTF-sized balance sheet. But that's not the league Corzine was playing in anymore.

Instead, as the situation on Europe gpt worse, all those trades required MF Global to put up more and more in its margin account. Eventually MF Global had no more to give.

Any individual, or system, tasked with evaluating the risk of those trades should have been able to see the ultimate folly in Corzine's position. The Freeh report leaves you with the feeling that Corzine understood the benefit, at least short-term, of not having someone look over his shoulder.

MORE: Congressional report blames Corzine

Here's how Freeh's report put it: "As these events unfolded, Corzine and his management team failed to strengthen the company's weak control environment, making it almost impossible to properly monitor the liquidity drains on the Company caused by Corzine's proprietary trading strategy."

But what's also curious is why the board didn't do more. Why didn't they ever ask why the position they mandated never got filled? Board members that Freeh questioned said they relied on the assessment of the company's CFO, who was clearly willing to stretch the truth. On Monday, October 24th, the beginning of the week that MF collapsed, Henri Steenkamp wrote an e-mail to S&P saying that MF Global's "capital and liquidity positions have never been stronger." If it's so easy to duck corporate boards and lie to ratings agencies, what are those checks and balances for exactly?