By Barbara Cohen
Chief Information Officer
On Friday the 13th of July 2012, the Commodity Futures Trading Commission (CFTC) finally approved financial rules submitted by the National Futures Association (NFA) to ensure the safety of customer funds held by Futures Commission Merchants (FCMs).
What finally pushed the CFTC to file new protections?
FCM firm, Peregrine Financial Group Inc. (PFGBest) declared bankruptcy after losing $215 million of customer segregated funds. Once again, the CFTC failed to protect futures traders.
Look at what's happened over the last 9 months. Nine months ago, MF Global used approximately $700 million in customer segregated funds to meet its liquidity issues. In total, $1.2 billion went missing. The $700 million was supposed to be "segregated."
When a futures trading account is opened by a customer, a check is written or funds wired to a registered FCM regulated by the CFTC. The funds are deposited in a customer segregated account at a major bank, such as Harris Bank in Chicago. Segregated accounts ensure that, even if the FCM were to run into liquidity issues, that would have no impact on the customer's individual account. By law, FCMs may not commingle their business funds with the funds of their customers. The only case in which funds may be removed from customer accounts is when the money is being taken to cover the customer's own liabilities. It is the CFTC's responsibility to monitor FCMs, ensuring that FCM business funds are never commingled with segregated customer funds.
MF Global did run into liquidity issues. They made high risk investments in European Sovereign debt that were not profitable, accelerating their liquidity shortfall, ultimately resulting in their own bankruptcy. In an attempt to handle their shortfall, customer funds were, in fact, commingled, and lost. But here's the real problem. The CFTC is expected to conduct regular audits, ensuring FCMs comply with rules and regulations regarding commingling. How then did MF Global manage to commingle $700 million of customer funds if the CFTC was doing its job?
Fast forward 9 months. FCM Peregrine Financial Group Inc., PFGBest, commingles and loses $215 million of customer segregated funds. Regulators actually revealed this week that PFGBest had been "deceiving" the CFTC for more than 2 years. How was the loss discovered? The CFTC finally verified customer assets electronically instead of relying on paper statements. Unbelievably. . . the CFTC never ensured PFGBest segregated funds for 2 years. That's right, count them. . . 2 years. What makes this even worse is that PFGBest had already been the subject of enforcement actions many times, including February of this year.
In an article published in ZeroHedge, Tyler Durden revealed that PFBBest, on a level of 100 to 0, was ranked just 41, 4th from the bottom of all FCMs. The most obvious problem noted was that other futures brokerages similar to PFGBest had one or two CFTC/NFA Disciplinary Actions. PFGBest had 76 - 76 disciplinary actions and the CFTC relied on years of paper statements instead of verifying segregated accounts electronically. Now take a look at the "new rulings" from the CFTC. Remember. . . these are "New Rulings."
"FCMs must hold sufficient funds in secured accounts to meet their total obligations to customers trading on foreign markets computed under the net liquidating equity method representing the total account balance owed to customers."
"FCMs must maintain written policies and procedures governing the maintenance of excess (i.e., proprietary or residual) funds in customer segregated accounts."
"Any withdrawals that are in excess of 25 percent of the excess segregated secured funds that are not for the benefit of customers must be pre-approved in writing by senior management and FCMs must file notice with NFA of any withdrawal of 25 percent or more of the excess segregated funds that are not for the benefit of customers."
"FCMs must file on a daily basis with the NFA segregation. FCMs must file with the NFA detailed information regarding the depositories holding customer funds and the investments made with customer funds as of the 15th and last business day of each month; and FCMs must file with the NFA additional monthly net capital and leverage information."
It took a billion dollar loss for the CFTC to finally "enact rules" requiring FCM's to report. But looking at the "new rules", are they really new? The CFTC requires written policies and procedures. Shouldn't those have already be in place for years? The CRTC requires pre-approval of segregated fund withdrawals. Shouldn't this also be an existing rule? So what actual changes did the CFTC make on Friday the 13th that weren't already in place? What did they rule on that will ensure that 9 months from now another futures brokerage won't be commingling their funds and stealing customers segregated accounts?
So often, FCMs will testify in front of Congress that they need less banking regulation. They don't want the Dodd/Frank bill implemented and lobby heavily, stopping the CFTC from activating the laws that were passed. Imagine what trading would be like in a completely unregulated world, driven by Wall Street greed. Talk about buyer beware. Markets in America have a reputation of having oversight, ensuring a level playing field for all. MF Global, PFGBest, and the CFTC's lack of monitoring give a whole new meaning to "level playing field."