From the January 01, 2012 issue of Futures Magazine • Subscribe!

Former CFTC head offers MF Global solution


The full facts remain elusive but, according to the MF Global bankruptcy trustee, some $1.2 billion may be missing from MF Global’s segregated customer account. For generations, the U.S. Commodity Exchange Act has required a strict separation of a broker’s customer funds from its own operating resources. Under no circumstances may customer funds be used to pay the broker’s own bills. Violations are crimes. And, for generations, that creed was honored. If it is concluded that this is the exception, especially considering the size of the shortfall, there will be calls for corrective measures. The challenge, in that case, will be to find a remedy that does more good than harm.

The “good” is to reassure market users that this is one-of-a-kind event and has been addressed effectively. The harm would be devising a response that chases traders out of the market because of cost. This article identifies the dangers (and opportunities) that two solutions under active consideration could yield.

Insurance. One proposal would seek to emulate a program that has been in place for many years in the securities industry, namely, an insurance system administered by the Securities Investor Protection Corporation (SIPC) that (within limits) compensates securities customers if they suffer losses from their broker’s bankruptcy. Such a plan for the futures community was considered once but rejected because the customer funds segregation regime (until now?) worked remarkably well.

But SIPC has a fundamental difference from what is now being proposed for futures, namely, in almost all cases the deficiency in securities accounts occurred lawfully because stockbrokers are not subject to the same “seg” restrictions as the futures world. Within limits, a securities broker may use customer funds for other purposes, so shortfalls at bankruptcy typically are the result of lawful broker conduct. An insurance program, as a result, restores the customers within the existing legal framework, not as a result of broker criminality.

But the losses to futures customers from a broker bankruptcy can occur only if a violation of law has occurred. Otherwise, all customer funds would be safe and sound, readily transferable in full by the trustee to other brokerage firms. It is less common to insure against criminal behavior. Thus, a futures insurance plan would be based on different facts and circumstances and, presumably, a different risk profile.

Policymakers also need to consider the “moral hazard” feature of an insurance plan that pays for the criminal actions of others. Might such a program encourage the ethically challenged to follow their instincts more quickly than if they would face crippling personal liability by proceeding?

Then there is cost. The Commodity Futures Trading Commission (CFTC) would need to dictate an insurance program by rulemaking. It already is being sued over other rules for allegedly failing to give proper attention to the costs inflicted on regulated entities by its directives. If the cost of an insurance program were to prove substantial, it may be attacked as well.

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