Gary Gensler, chairman of the Commodity Futures Trading Commission (CFTC), has a lot of explaining to do. Segregating customer money—protecting client accounts from being raided by an unscrupulous broker—is even more important in the futures industry than it is in other markets.

Associated PressGary Gensler

In the world of stocks and bonds regulated by the Securities and Exchange Commission, it’s terrible when client funds go missing, but at least the average investor has a backstop in the Securities Investor Protection Corp., which provides insurance up to $500,000. There is nothing like it in the futures industry, so if they do nothing else CFTC regulators have to make sure that nobody is digging into the customer cookie jar.

It’s still not clear in this case whose hands dipped into customer funds or why, but it’s hard to imagine a financial firm raising more red flags than MF Global did under former Chairman and CEO Jon Corzine. A former New Jersey Senator and Governor, he took the top job at MF Global in March of 2010, four months before enactment of the Dodd-Frank financial reform law. The former Goldman Sachs chief had been out of the Wall Street game for a decade while he pursued his political ambitions, but MF Global shares rallied on the news of his hiring.

In a research note, Sandler O’Neill Partners wrote of Mr. Corzine: “We suspect that his contacts in Washington could prove useful as MF Global navigates a shifting regulatory environment.” Those “contacts” included Mr. Gensler, a onetime colleague of Mr. Corzine at Goldman. In previous Beltway stints, the duo had helped to write the 2002 Sarbanes-Oxley law that was also supposed to protect investors.

While Mr. Gensler’s CFTC was MF Global’s primary regulator, the company also wanted to do business with the Federal Reserve Bank of New York, run by another Goldman alum, William Dudley. A year before Mr. Corzine’s arrival, the New York Fed had considered designating MF Global as one of its prestigious primary dealers, but it decided not to.

Did MF Global benefit from Mr. Corzine’s contacts? Let’s review the record. In May 2010, on his first conference call with analysts, Mr. Corzine made clear he wanted to take big risks. “As he seeks to realign the brokerage, Corzine said MF Global will begin taking principal risk across most of its product lines,” reported Dow Jones. In other words, MF would increasingly bet its own capital, instead of simply servicing clients.

MF Global created a new proprietary trading desk and hired a onetime employee of George Soros’s hedge fund to run it. And Mr. Corzine began making the bets on European sovereign debt that would total $6.3 billion and eventually wreck the business.

MF Global’s new trading frenzy might have attracted even more attention if Mr. Corzine hadn’t hidden his biggest bets. His purchases of European government bonds added up to several times MF Global’s entire market cap. But by using a “repo-to-maturity” technique, he was able to consider them “sold” for accounting purposes and therefore they disappeared from MF Global’s balance sheet.

Except they hadn’t really been sold. They were used as collateral to borrow money, and if the value of the bonds declined, MF Global would have to post additional collateral. How much more? Markets eventually decided that it was enough to destroy the company, and MF Global’s funding dried up.

Keep in mind that both Dodd-Frank and Sarbanes-Oxley, written by Mr. Gensler and others, were supposed to protect investors from such shoddy disclosure. In any event, even the numbers Mr. Corzine was disclosing were terrible. In November 2010, MF Global announced its sixth loss in its last seven quarters. In February 2011 the company reported more losses.

Yet just before the announcement of another bad quarter came news in February 2011 that the New York Fed had changed its mind and bestowed upon MF Global the coveted title of primary dealer. The New York Fed doesn’t publicly discuss such decisions, but a source with knowledge of the process says that it sometimes takes several years for a firm to gain acceptance. We hope Congress investigates both the decision and its curious timing.

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MF Global customers are still waiting to be made whole, but the larger importance of this story relates to the effectiveness of the Dodd-Frank, Sarbanes-Oxley regulatory model. Americans have been told that, in response to the 2008 financial crisis that regulators failed to predict or prevent, regulators needed to have vast new powers to prevent the next crisis. But in MF Global the regulators failed the law’s first serious test.

MF Global also shows how this new era of regulatory power puts a premium on political connections. Mr. Corzine was named CEO of the company in part—maybe in substantial part—because he had close ties to regulators and could help MF Global navigate the many new rules. This is the new financial crony capitalism, and it also failed its first test. The mistake is to believe in regulator prescience, as opposed to simpler, straightforward rules on, say, leverage or capital.

Mr. Gensler, for his part, has a response to the cronyism charge. Since the firm went bankrupt he has announced that he will recuse himself from issues affecting MF Global. Now?

Congressman Randy Neugebauer sent a letter to Mr. Gensler this week, and Wednesday night Senator Richard Shelby contacted the CFTC’s inspector general seeking an answer to the question of how and when Mr. Gensler decided that recusal was appropriate. This is another answer Mr. Gensler should bring to today’s hearing.