Eight months before Russell R. Wasendorf Sr. tried to kill himself by running a hose from his exhaust pipe into the passenger compartment of his car, he took delivery of a cache of silver coins from the New Zealand mint. They were licensed by Nickelodeon and shaped like the cartoon character SpongeBob SquarePants. They were legal currency on the South Pacific Island of Niue, had “In Sponge Bob We Trust” emblazoned across the top and had a face value of $2.

As novelty items, however, they were priced at 30 times that amount. This ratio was not much higher than the one Wasendorf achieved with Photoshop when he faked bank statements showing more than $200 million in customer segregated funds even though he’d skimmed more than 95% of those off to subsidize losing ventures around the world and to build the glittering headquarters of PFGBest, also known as Peregrine Financial Group (PFG), in Cedar Falls, Iowa.  It was in the parking lot of that impressive, empty compound that he attempted to take his own life. 

The ratio of cash to stated balance at PFGBest was almost as ridiculous as the image of Wasendorf sitting alone in his darkened office, a shaft of light across his sweaty brow, as he doctored those documents week after week, month after month, year after year — first in his cramped quarters in the Chicago Mercantile Exchange building, then in his roomier digs on LaSalle Street across from the Chicago Board of Trade (CBOT) and finally in his massive $18 million compound in Cedar Falls (see “PFG rap sheet").

“The offices never made sense,” says Paul Ehrhardt, who for 20 years ran WWW Investments, which was one of PFG’s first introducing brokers (IB). 

They make sense now, because they were funded by raiding the more than $200 million in customer funds that were kept in segregated accounts at US Bank. The only thing that customers can hope to get back in the short-term is their share of the margin money that was on deposit with exchanges, and trustee Ira Bodenstein says there’s just $181 million of that “on hand.” On September 6, he asked the court for permission to begin sending $123 back in waves, with $58 million held back until he could be sure customer accounts themselves weren’t part of the scam. While the move was long overdue for the liking of PFG customers, the Commodity Futures Trading Commission (CFTC) says the books are still too much of a mess for a dispersal.

Even if approved, the 30¢ to 40¢ on the dollar distribution will not be enough to save scores of IBs and thousands of clients. More than half of PFG’s 400 IBs were guaranteed, meaning they were financially backed and supervised by PFG but also locked into exclusive clearing arrangements with them. Several commodity trading advisors (CTAs), some still smarting from the MF Global debacle, were forced to close shop. 

A hearing on the dispersal is set for Sept 21, but Judge Carol Doyle already has given Bodenstein the green-light to let competing FCMs bid for the PFG accounts. If a suitable FCM emerges, the funds will be transferred to the new FCM, and customers who wish to keep trading simply can do so, while those who want to take their money and run can do so as well.

“It’s very important how that’s done,” says Howard Marella, president of Index Futures Group, an independent IB that uses several FCMs, including PFG. “Opening new accounts takes time, especially if trusts are involved, so it would be best for customers and IBs alike if the accounts are transferred to a new FCM.”

Even if an FCM steps up to the plate, it’s not at all clear how many of those customers will elect to stay or how smaller IBs will manage the transition. 

William Gallwas, president of independent IB Striker Securities, says, “About half our customers were impacted by MF Global, but 90% of them stayed. About 30% of our customers used PFG, and I don’t know how many of them will [stay].”

The implosion of PFG was a central theme at this year’s Burgenstock Meeting in Interlaken, Switzerland, which had been structured around the fallout from MF Global. Swiss Futures and Options Association Chairman Otto E. Nägeli chaired a session titled “MF Global — can similar surprises now be prevented?”

“Well, we know the answer to that,” said Nägeli. “That’s the nature of surprises.”

For customers and investigators, however, PFG is proving to be much uglier than MF Global ever was — largely because MF Global was the result of one impulsive action by a megalomaniac CEO, while PFG was a calculated 20-year fraud.

The double-whammy of MF Global and then PFG has shaken confidence in the industry, and many place blame squarely on the regulators. “Over the last few years, the biggest losses for clients haven’t come from the markets,” says Marella. “They’ve come from the FCMs, and regulators bear that burden.”

The National Futures Association (NFA) has hired Berkeley Research Group and the law firm of Jenner & Block to conduct a forensic review of its auditing practices and has implemented the electronic reporting system offered by Confirmation.com — the one that drove Wasendorf over the brink — and has asked the CFTC for permission to access segregated funds accounts on a view-only basis at will. 

While the NFA has come under fire — as the designated self-regulatory organization (DSRO) for PFG — for moving too late on the electronic front, Confirmation.com says that only 15% of audit confirmations anywhere are done electronically, up from 1% three years ago, and that no other regulators have real-time access to customer balances.

Everyone we spoke to welcomes that move, and also called for a change in the way positions are liquidated.

“The accounts were frozen and then liquidated, and we got no word of anything, for weeks,” Ehrhardt says. “Nobody knew what their account balances were, or how they were liquidated. You add that on top of the fact that you don’t even know where your margin is, and you can understand why people were upset.”

Marella says that could be avoided if regulators and legislators could provide agreed-upon ways of liquidating positions in the event of an FCM bankruptcy.

“Jeffries was the clearing FCM, but to Jeffries, PFG was just a few omnibus accounts,” he says. “If PFG had 2,000 longs and 2,500 shorts, to Jeffries, it’s only 500 shorts, so when they were told to liquidate, they just got out of 500, which of course wasn’t a liquidation to a customer with a hedged position. So they’d take off the exposure, then create more exposure that they had to take off. It was a mess — an expensive mess that cost my customers hundreds of thousands of dollars.”

In mid-August, CME Group bosses met with representatives from FCMs and regulators as well as the Futures Industry Association (FIA) and the Customer Commodity Coalition (CCC), which was formed to protect customers in the wake of the MF Global debacle. At the meeting, the CME offered to reconsider its opposition to an insurance fund for the derivatives sector, and even to consider holding customer funds itself, but said both developments were unlikely. A fund, it has long said, will be too expensive, while holding the money itself would present too much of a liability.

IBs, however, want to see all options considered.

“You hear this talk about going straight to the exchanges and having the exchanges do the clearing,” Marella says. “That’s an option worth considering — everything should be on the table.”

Gallwas, however, says the NFA has been getting a bad rap, and warns against implementing wholesale change.

“Look at 9/11,” he says. “We prevented a repeat by locking the pilot doors, but then we went ahead and implemented all these other changes that arguably don’t make us safer but do make for good show. [Futures has] a system that has worked very well for more than a hundred years, and we need to make changes rationally, not impulsively.”

He does, however, believe that senior management at companies like PFG should be held accountable. “There was a failure to supervise on the part of upper management,” he says. “We need to make it clear that titles mean something — that a compliance officer has culpability, that a chief financial officer has culpability, that anyone responsible for internally policing the organization has culpability.”

Neither CFO Brenda Cuypers nor chief compliance officer Susan O’Meara have been targeted publicly by investigators, but O’Meara was on the receiving end of an email to both herself and the NFA that critics say should have flushed the shortfall into the open more than a year ago (see “Just the fax, ma’am” on the last page).

Even more ire has focused on in-house counsel Rebecca Wing, who proved ruthless at going after IBs that tried to take their business elsewhere but not so good at returning calls, and oblivious to the shenanigans on Wasendorf’s computer. In 2011, she earned $380,220, and in early September was given a $20,000 raise, recommended by Bodenstein, to $400,000 if she stayed on with the company.

“Ms. Wing [has] a wealth of knowledge regarding the debtor’s business and has extensive experience as a commodity/financial services attorney,” wrote Bodenstein in petitioning for the raise. 

“We find the request more than a little tone deaf,” answered John Roe, co-founder of the CCC. “It … lacks any structure to pay the increase on the basis of production, which would provide a financial incentive to find and return property that belongs to customers,” he wrote. 

Scrutiny also has fallen on Jeannie Veraja-Snelling, who did the financial auditing of PFG from her home.

“Financial auditing is different from regulatory auditing, but it does make sense to have a financial auditor who understands the business,” Roe says. 

Industry changing

Marella, Gallwas, Ehrhardt and even Roe believe the small IBs that PFG catered to may be a thing of the past, but aren’t sure what will take their place.

PFG served a purpose, Marella says. “There isn’t another place out there  that is as efficient in terms of getting the accounts opened quickly and having questions answered right away, and it took them years to get to that point.”

That raises the question of what happens to PFG’s infrastructure and trading platform, which was praised universally by users. 

Bodenstein also has drawn fire from nearly all quarters, mostly for his lack of transparency compared to MF Global trustee James W. Giddens. “With MF Global, we knew within two or three weeks where things are going, and with PFG it took two months,” Gallwas says. 

Sources close to Bodenstein, however, say he couldn’t have moved more quickly given the fear of inadvertently sending money to co-conspirators.

MF Global was different because the CFTC deferred to the Securities and Exchange Commission and the Securities Investors Protection Corporation (SIPC), which brought it under the purview of a trustee with securities experience. PFG, on the other hand, was in Chapter 7 liquidation. Industry insiders have complained about the SIPC trustee’s lack of experience with futures, yet he has managed to get funds out quicker than the PFG trustee.

As of press time, Bodenstein also appears caught in the middle of a regulatory blame game and is the man who must answer to angry customers waiting for their money. 

Just the fax, ma’am

Among the more intriguing developments in the PFG case was the revelation that on Friday, May 13, 2011, Hope Timmerman, an assistant manager at US Bank, sent an email to PFG’s compliance officer, Susan O’Meara, who was herself a former NFA auditor. Timmerman copied the message to the NFA and attached a document showing alleged confirmations of both PFG’s US Bank customer segregated and house accounts.