CHRIS SMITH, the deputy chief executive of MF Global, the newly floated brokerage arm of Man Group, was warned of the failings of one of the firm’s hedge-fund clients several months before its collapse, according to documents just filed.

It is claimed that Smith was told that Paul Eustace, the fund manager of Philadelphia Alternative Asset Management (PAAM), had failed to deliver $15m (£7.3m) to cover his losses. It is also claimed that Smith admits this should have been “a very big red flag” warning of the dangers.

Rather than closing the fund in line with the broker’s internal guidelines, Eustace was allowed to continue trading to try to generate returns to cover the call.

The documents have been filed by the receiver acting for PAAM investors, which are claiming $600m compensation from Man Group for failing to prevent the collapse. They aim to prove to a judge that the evidence is so compelling that there is no need for a trial, which is set for November. MF Global denies all the allegations.

The disclosures come as MF Global struggles with its disappointing $2.9 billion flotation two weeks ago. The stock stumbled on its New York Stock Exchange debut.

The receivers claim that a couple of weeks after the first warning there was a second margin call for an additional $23m. Smith and his deputy had a conference call with Eustace and Thomas Gilmartin, the prime broker at Man’s brokerage arm, to rein in and monitor their trading. But the receivers claim that despite the warnings not enough action was taken.

Within weeks, in June 2005, the US Commodity Futures Trading Commission stepped in and froze Eustace’s accounts at Man’s brokerage arm, prompting the collapse of the hedge fund.

Large parts of the evidence centre on the relationship between Eustace and Gilmartin, who was the fund’s prime broker at Man. They were at college together. Gilmartin was also an investor in PAAM, although this was not disclosed until after the fund’s collapse. The documents allegedly provide details of an account the pair used to hide PAAM’s losses.

A spokesman for MF Global said: “We strongly contest all the claims made in this case and we will vigorously defend what we believe to be false allegations.

“MF Global has a hands-on approach to risk management. It is not uncommon for senior executives to be told of margin calls.”

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