Investors everywhere were shocked to see that MF Global seems to have lost over a billion dollars of their customers capital. In most cases, this capital was cash customers thought was sequestered as collateral for their trading accounts. MF Global took its customers money and used that money as collateral in making risky, leveraged bets on European sovereign debt, bets that fell apart as debt prices fell and MF Global faced margin calls on its bets that it did not have the liquidity to cover.
Certainly it strikes most folks as unethical to lose the assets in your customers' brokerage accounts making bets for the house. But it turns out, it may have been entirely legal. This article is quite good, and helps explain what was going on, what this "hypothecation" thing is (basically a fancy term for leveraging up assets by using them as collateral on loans), and why it may have been legal.
In short, the article discusses two regulatory changes that seemed to be important. The first was a 2000 (ie Clinton era, for those who still think these regulatory screwups are attributable to a single Party) relaxation in how brokerages could invest customers' collateral in their trading accounts. The second was a loophole where brokerages created subsidiaries in countries with no controls on how client money was re-used (in this case mostly the UK) and used those subsidiaries to reinvest money even in US brokerage accounts.
The increase in leverage was staggering. Already, cash in most commodities trading accounts is leveraged - customers might have only 30% of the value of their trading positions as collateral on their margin account. Then the brokerage houses took this collateral and used it as collateral on new loans. Those receiving the collateral on the other end often did the same.
MF Global would be bad if it were fraud. But it is even worse if MF Global is doing legally what every other brokerage house is still doing.
Here is the minimum one should do: Diversify brokerage accounts. We diversify between bonds and stocks and other investments, but many people have everything in one account with one company. I am not sure anyone can be trusted any more. My mutual funds are now spread across three firms and, if I grow my brokerage account for individual stocks and investments (right now it is tiny) I will split that as well.