Just Because You Bought It...

...doesn't mean it's yours.  There's a big brouhaha in the MF Global bankruptcy.  It seems the trustee's definition of the bankruptcy estate (and hence the assets available for him to liquidate) includes gold and silver bullion that traders and investors parked, or at least thought they were parking, with the firm and received warehouse receipts for.  And they are WAY unamused they can't get their bling.

A little background.  First, warehouse receipts.  I'm Joe Farmer, and I just brought in my corn harvest.  I decide to store it at the grain elevator for a couple of weeks.  I take it to the elevator, physically deposit it there, and get a receipt for X amount of corn.  When I want it back, I turn in the receipt, pay the handling charges, and get my corn back.  Substitute any storable thing you care to name, it's the same, basic process.

Second, other people's property in a bankruptcy estate.  If you lend your friend $100, and he declares bankruptcy, chances are you'll never see old Ben Franklin again.  If you let your friend use your car, though, and he declares bankruptcy, the trustee can't just take your car.  The bankruptcy estate doesn't include things the debtor possesses but someone else owns.

And that's what the warehouse receipt people are saying.  They have receipts for specific bars of precious metals that they bought and that were supposed to be stored in the MF Global facility.

Problem the First: Unlike Joe Farmer, extremely few of these people actually lugged any gold bricks to MF Global for storage.  Some put money directly into an MF Global account for purchase and storage, and took a "warehouse receipt" in return.  Others were brokers themselves and were making purchases for customers.  Either way, they weren't really following warehousing procedures (How often do you ask the warehouse to buy the stored item for you?), so off the bat we have a question of whether these "warehouse receipts" are warehouse receipts.

Problem the Second (and here's where it gets painfully apparent that a brokerage is not a warehouse): Back in 2005 the CFTC adopted Rule 1.25, which allows certain commodities investors to invest clients' deposit accounts (as opposed to investment accounts) so long as an asset of "equal value" is substituted in (As an aside, if I as an attorney were to do this with a client account, I'd be doing the perp walk in nothing flat.  In Investment World, though, it's perfectly OK.  For the investment house, that is.).  This fact was undoubtedly disclosed somewhere in the "storage agreement," and unless I miss my bet, that condition wasn't entirely one-sided.  If MF Global could invest the deposits, it could defray some of its costs instead of passing them on to the depositors (Remember those handling charges I mentioned?  Running a grain elevator isn't free.).  I certainly wouldn't be surprised if that was how MF Global pitched it.

So instead of the gold and silver sitting in the warehouse, MF Global pulled it and replaced it with "assets," namely paper instruments with all the value of papier de la toilette, or some such.  Needless to say, a bunch of the gold and silver is nowhere to be found.  Which means a bunch of those "warehouse receipts" don't stand for anything.  Which is perfectly OK since, by the receipts' own terms, the bullion could be swapped out.  Which leaves the "warehouse receipts" looking less like warehouse receipts and more like mislabeled investment contracts.  Which is exactly how the bankruptcy trustee is treating them.  If the depositors want it any different, they'll have to take the trustee to court and force it.  Good luck with that.