What Is “Commingling,” Alex?

Azam Ahmed and Ben Protess, Clients Raise Questions About MF Global Checks, New York Times DealBook (Apr. 1, 2012);

Building a criminal case has proved difficult for federal prosecutors. It is unclear whether anyone at MF Global knowingly tapped customer money to cover the overdraft at JPMorgan. MF Global, like other firms dealing in futures, kept a buffer of its own money in customer accounts to facilitate day-to-day operations, and may have dipped into the customer money without knowing it.

Wait, what? Everyone knows that putting client money in your own account is problematic. That’s commingling. It makes accurate accounting much harder, and misappropriation much easier. But putting your own money in a client account is also problematic, because it’s also commingling. There’s a reason that professional responsibility laws prohibit lawyers from commingling funds in either direction. With a rigid separation between a client account and the lawyer’s own account, there is never a justification for a transfer in or out of the client account except in connection with a client’s business. Break that separation, and there go your audit trails, there go your internal controls.

In other words, the general anti-commingling principle is designed to prohibit precisely what MF Global did, because of precisely the risk that what would later happen would happen. In the best case, MF Global was negligent; negligent in a way that wouldn’t have led to ruin without commingling. In the worst case, MF Global was criminal; criminal in a way that would have been far easier to prove without commingling.

How on earth did Wall Street come to treat this as normal, acceptable practice? How on earth did regulators decide that it’s permissible? Can anyone cite me any justification for putting non-client funds in a client account?

I believe the justification is that you want to put in some house money so that if you trade on margin and you have a margin call you don’t have to unwind the entire position (at a significant loss).

Maybe your point is that you should never leverage client money, but that seems like a much larger fight.

I presume that lawyers have it simpler because no one expects their retainer to be earning significant interest.

Couldn’t (indeed shouldn’t) the trades on margin be done with a pair of associated accounts, rather than with a single one? The account containing client money is subject to the strict rules about client funds. The associated account containing house money is subject to less stringent rules, since it’s not subject to the same overriding principles — segregating clients’ funds from the risks associated with other clients or with the brokerage’s own positions. (There would still be some constraints related to the margin, but these would be less ironclad.)

Happy to be talked out of this view; I’m just not yet seeing how margin requires commingling.

To be clear, I’m not arguing that this ought to be allowed. I was more trying to explain how it could happen and no single step would be egregious.

I bet it began because systems were set up to back margin trades with a single account, not several.