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MF Global had objected to stricter government regulations

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Long before broker MF Global landed in bankruptcy with an unexplained shortfall in customer accounts, federal regulators had identified the handling of client funds as a point of risk in the industry.

But when the government proposed tightening restrictions on the handling of those funds, MF Global strenuously objected.

In a letter to rulemakers last year, MF Global protested that the government was trying to “fix something that is not broken.”

When MF Global this week filed one of the largest bankruptcy cases in the nation’s history, brought on by risky bets on European bonds, the rules change proposed a year ago remained on the drawing board.

It is unclear why an estimated $633 million of customer funds is missing at MF Global, or whether the proposed restrictions would have made a difference in this instance.

But Nancy Watzman, a consultant to the Sunlight Foundation, said MF Global’s protest offers a window into the firm’s mind-set.

“I think it shows some hubris, like, ‘Hands off this, we know what we’re doing, this isn’t risky,’ ” Watzman said.

The Sunlight Foundation, which works to bring government records to light, called attention Thursday to MF Global’s December 2010 letter to the Commodity Futures Trading Commission (CFTC), one of the firm’s regulators.

The implosion at MF Global has raised questions about how much safer the financial system has become since 2008, when businesses such as Bear Stearns, Lehman Brothers and AIG foundered.

The revelation that hundreds of millions of dollars were missing was all the more shocking because MF Global is headed by Jon S. Corzine, former governor of New Jersey, U.S. senator and chairman of Goldman Sachs.

An alphabet soup of federal and industry authorities is now focused on MF Global, including the CFTC, the Securities and Exchange Commission, FINRA, the Chicago Mercantile Exchange (CME), the Securities Investor Protection Corp. (SIPC), and the FBI — showing how complex the oversight of financial firms can be.

In a statement Wednesday, CME Group, which is a marketplace for derivatives and an industry self-regulator, said it appears that MF Global transferred customer funds “in a manner that may have been designed to avoid detection.” The firm should have been holding about $5.4 billion on behalf of clients, but as of the close of business Tuesday, there was an 11.6 percent shortfall, the CME Group has estimated, according to a government document.

MF Global had run afoul of regulators earlier this year. FINRA concluded that the company was holding too little capital in connection with investments involving European government bonds, according to a company disclosure. The company appealed to the SEC, which backed up FINRA, said a person familiar with the matter, speaking on the condition of anonymity.

In effect, MF Global had kept certain items off of its balance sheet but was not entitled to do so, the person said.

MF Global spokeswoman Diana DeSocio declined to comment.

Firms such as MF Global are supposed to keep clients’ funds separate from the money that the firms wager for their own gain or loss. The client funds can be held in the form of cash or other investments considered safe and liquid, such as U.S. Treasury bonds.

The firms are also allowed to essentially borrow cash from the customer accounts in so-called repurchase or “repo” transactions. When they do that, they are supposed to transfer assets of their own to the customers’ side of the ledger.

Last year, the CFTC proposed tightening restrictions on the type of investments in which brokers can park their clients’ money.

For example, the agency proposed banning the internal transactions. It also proposed prohibiting brokers from holding the money in bonds issued by foreign governments.

The agency said it was trying to safeguard customer funds. The financial crisis, it said, “has highlighted the fact that certain countries’ debt can exceed an acceptable level of risk.”

MF Global argued against those changes. The existing rules “have not, to our knowledge, resulted in any” firm’s “inability to provide customers their segregated funds upon request or to continue as a solvent entity,” the firm wrote in a letter co-signed by another brokerage firm.

“We believe the proposed amendments could decrease significantly the income” firms “derive (and could potentially derive) from prudently investing in customer segregated funds,” MF Global wrote.

MF Global clients are now waiting to find out what happened to their money and how much they will recover.

When stocks end up missing from customer accounts at failed brokerage firms, the SIPC covers losses up to $500,000 per customer. But regulators have said the deficiency identified at MF Global involves accounts used to invest in futures — for example, bets on the future price of commodities.

The SIPC does not insure assets missing from futures accounts, and there is no comparable backstop for those accounts.

CME Group spokeswoman Anita Liskey said the main source of protection for the holders of those accounts is the mandatory practice of segregating client funds — the very requirement MF Global is accused of violating.

MF Global makes a similar point in a section of its Web site on “How MF Global protects client assets.”

Under the rules, the company says, “the cardinal safeguard” is probably that those funds must be “segregated” from the funds of the brokerage firm and “may not be used to meet any obligations” of the firm.

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