The PFGBest revelation raises serious questions about the safety of the U.S. Futures industry. One of the themes that had been struck throughout the MF Global mess is that the safety of segregated funds had been absolute up until that “one-off” event. Now, apparently customer segregation has been violated twice in nine months.
In a complaint filed this morning against PFG and Russell Wasendorf Sr. by the Commodity Futures Trading Commission (CFTC) alleging fraud, misappropriation of customer funds, violation of customer fund segregation laws and making false statements, the Commission alleges that “from at least February 2010 through the present, PFG and Wasendorf failed to maintain adequate customer funds in segregated accounts as required by the Commodity Exchange Act and CFTC Regulations.”
The complaint goes on to say, "PFG and Wasendorf have used customer funds for purposes other than those intended by its customers, and consequently, have misappropriates these funds. The whereabouts of the funds is currently unknown."
Additionally, the U.S. Federal Bureau of Investigations (FBI) is participating in the probe, according to Sandy Breault, a spokeswoman for the FBI's Omaha office. "We are currently reviewing the facts of the situation,” she said, declining to elaborate.
Jefferies, the clearing firm for PFGBest, which operated as a non-clearing Futures Commission Merchant, announced today that it began an orderly liquidation of PFG’s positions "after PFG was unable to meet a margin call that Jefferies made in response to yesterday’s National Futures Association’s (NFA) Member Responsibility Action."
This comes nine months after the MF Global debacle and six months after the CFTC along with CME Group and the NFA completed a review of 70 firms holding customer segregated funds. The CFTC reviewed the 14 largest firms and CME and NFA reviewed the remaining 56 firms.
In a Jan. 25 statement, the Commission noted, “The limited reviews of the 70 FCMs found that, as of the review date, each firm maintained assets in Section 4d segregated accounts in excess of the net liquidating equities of each of its customers as required under Section 4d of the Act and Commission regulations. The limited reviews further found that, as of the review date, each FCM maintained assets in Part 30 secured accounts in excess of the aggregate margin required.”
John Roe co-founder of the Commodity Customer Coalition said “here we go again.” In an e-mailed statement Roe says, “Yesterday’s revelations regarding PFGBest should dispel the notion that serious reforms are not merited in the wake of MF Global’s collapse. Since the year 2000, four of the 15 largest bankruptcies in U.S. history included firms who had FCM operations (Enron, Refco, Lehman, MF Global). The list would be larger had Merrill Lynch and Bear Stearns not been forcibly acquired by other firms. Something is clearly seriously wrong with this industry and the regulatory scheme that governs it.”
Roe also noted the FCM review. “When the primary regulators in charge of this industry can get it this wrong this quickly, the regulations protecting customers are a paper tiger. Heads should be rolling over this,” Roe says.
The CFTC complaint further alleges that defendants made false statements in filings required by the Commission regarding funds held in segregation for customers trading on U.S. Exchanges.
CTA Marc Levitt says, "You got to wonder how asleep at the switch the [designated self-regulatory organization] for PFG was," referring to the NFA. FCMs file customer segregation reports daily and are typically audited at least once a year. Add to this the special review performed by regulators on the top 70 FCMs after the MF Global shortfall in customer segregated funds was found and you can understand the frustration of futures traders.
Jeff Greenblatt, a futures trader and director of Lucas Wave International, says, “Why would anybody trust any broker anymore? Are they just going to allow these people to rape and pillage the industry to the bone until nothing is left? How can this industry recover from MF Global when the trend continues?”
One Futures reader echoed Greenblatt's sentiment. "I expected a domino effect [after MF Global], and now more are starting to fall," he said in an emailed note. "The futures industry is going to contract in size no matter what, but they are not getting my funds to play the fraud games for personal gains."
The crisis at PFG is increasing the call for a Securities Investment Protection Corporation (SIPC) style insurance plan for futures segregated funds. This came up following the MF Global debacle but was largely dismissed because of the high cost of such a program. This morning CFTC Commissioner Bart Chilton reiterated his support for such an insurance program in an emailed statement to the Wall Street Journal.
“The only mechanism which can mitigate the impact of fraudsters is account insurance,” Roe says. “We have proposed a liquidity facility for victims of failed commodity brokerage firms. However, there is tremendous resistance to the concept of account insurance for commodity customers from the industry. It will require substantial public pressure resulting in legislative action from Congress to make such an insurance mechanism a reality.”
Former CFTC Chairman Philip McBride Johnson rejected the notion of an insurance program, preferring the creation of a central customer funds repository. Johnson says a repository plan eliminates the risk and be cheaper. “All customer funds would move solely and directly between the trader and the repository. Each customer would maintain a trading account with the broker and a funds account with the repository,” Johnson notes, adding the broker customer relationship would not change much, “But customers would send their initial and maintenance margins directly to the repository for deposit in their separate accounts there, and all return payments would flow directly from the repository to the customer.”
CME Group initiated a scaled down version of an insurance program, CME Group Farmer & Rancher Protection Fund, covering family farmers and ranchers up to $25,000 and agricultural cooperatives up to $100,000.
Robb Ross, principal of commodity trading advisor (CTA) White Indian Trading, says the best solution may be to have all customer funds held at the exchange clearinghouse. Ross, whose CTA had customers at MF Global during it bankruptcy as well as customers at PFG, fears this could harm commodities trading. “Who is going to trade commodities,” he wonders.
Following MF Global's collapse on Oct. 31, 2011, a number of customers migrated to PFG. Ironically, Roe notes that the SIPA Trustee’s rolling distributions to customers actually may have shielded them from additional losses at PFG. "The remaining 28% of your 4d and 100% of your 30.7 property trapped in MF Global’s SIPA liquidation will be sent to you via check. Sadly in a zero interest rate environment, a bankruptcy claim may be the safest place for your money."
On Tuesday, July 10, Attain Capital addressed the PFG scandal in its managed futures blog. In "Broken Promises, Shattered Trust," Attain, which was a client of PFG, among other FMCs, detailed its front-row seat as the crisis unfolded, first with what appeared to be wild rumors, then news of Wasendorf Sr.'s attempted suicide then, finally, confirmation that more than $200 million was, indeed, provisionally missing.