Restoring confidence in the post-MF Global world

In the wake of the MF Global and Peregrine Financial Group (PFG) bankruptcies, customer confidence in the sanctity of segregated funds was decimated. In one case, the funds were misused, in the other they appear to have been stolen outright. In both instances, it became clear the industry needed to make significant changes to convince investors the bulwark was secure.

Industry leaders recognized the need for improvement. “The blame for what happened at MF Global and PFG is broad. Improvements were needed at all levels of the industry, and we recognized some that could be made within our own firms,” says Walt Lukken, president of the Futures Industry Association (FIA). “There’s been a collective soul-searching throughout the industry on all levels as to how to improve and protect customer funds.”

Each bankruptcy revealed weaknesses in the regulatory structure. MF Global trustees still are working to identify what happened, but weak internal controls, disorganized recordkeeping and a margin call on the firm’s proprietary positions are suspect.

At PFG, former CEO Russell Wasendorf Sr. pleaded guilty to falsifying audit paperwork and lying to regulators with the expressed intention of defrauding customer funds to keep the firm afloat.

Over the last year industry leaders and regulators have worked to implement changes to reporting requirements at futures commission merchants (FCMs), internal compliance and auditing practices (see “Big changes a coming”). Further, CME Group unveiled a pseudo-insurance fund to protect some members it recognized as being particularly vulnerable.

The majority of new rules to come out of these crises have centered on ensuring the safety of customer funds. “Customers in the futures market need to know that their funds are safe,” says Karen Wuertz, senior vice president of strategic planning and development at the National Futures Association (NFA).

The NFA has worked closely with the Commodity Futures Trading Commission (CFTC) and the FIA to identify areas of improvement. “We’ve developed a number of new processes and regulatory tools to provide that level of assurance. One of the trends has been a focus on using technology better to perform this surveillance function,” she says. In fact this is what ultimately revealed the PFG fraud. 

Following MF Global’s collapse, the FIA assembled a task force of industry leaders to offer specific recommendations. The majority of those recommendations have been enacted by regulators.

Gerald Corcoran, chief executive officer at R.J. O’Brien, serves on the boards of both the NFA and the FIA and saw firsthand how the industry has worked with regulators throughout the process. “The industry and the regulators have worked together to create the new framework that we’re working in today. There’s been a lot of good give and take,” he says. “A crisis brings people together, and this was an absolute crisis of confidence by the users of the marketplace.”

In the aftermath of MF Global, CFTC Commissioner Scott O’Malia hosted a roundtable to discuss ways technology could be used better to monitor firms. At that meeting, the NFA was introduced to, an electronic, secure clearinghouse for audit confirmations. “Once we became aware of it, [we] thought it made sense to start implementing it,” Wuertz says.

According to Brian Fox, founder of, his company provides “an electronic confirmation service that validates the parties who are participating in the confirmation process.”

Whereas the paper process for audit confirmations could take four to six weeks to complete, his company allows auditors to verify balances more securely and much more quickly, sometimes in just hours. 

This change largely resulted in the uncovering of the fraud at PFG. “Wasendorf had been manipulating the paper process for more than 20 years. Within 24 hours of using our service, the fraud had been uncovered. That’s the big benefit,” Fox says.

Although some have faulted the NFA for failing to catch the fraud sooner, Fox says instead the NFA should be lauded for taking the necessary steps to uncover the deception. “If a police officer makes a big drug bust, we don’t tell him, ‘You should have caught him before,’” he says.

The NFA conducted e-confirmations for all segregated bank accounts maintained by FCMs for which it is the designated self-regulatory organization as of June 29, 2012 and noted no other violations of segregation requirements.

Farmers’ & ranchers’ fund

In February, CME Group announced the Family Farmer and Rancher Protection Fund as a first step to restore customer confidence in the futures markets after MF Global’s bankruptcy. It is a $100 million fund intended to provide farmers and ranchers “up to $25,000 per account in the case of losses resulting from the future insolvency of a clearing member or other market participant.”

According to Bryan Durkin, chief operating officer at CME Group, the fund is explicitly for farmers and ranchers because of their role in feeding the country and their use of futures markets to manage risk. “Those are the folks most impacted in terms of releasing collateral to get themselves back in operation,” he says.

The fund had to be drawn upon just five months later when PFG went under. As of press time, CME Group was in the process of reviewing applications from farmers and ranchers who had been PFG customers, and Durkin expects benefits to be paid out by the fourth quarter.

Although the industry has responded with a broad range of changes to improve customer safeguards, some individuals see room for continued improvement. 

One area that has received considerable attention is the idea of an insurance fund similar to what the Securities Investor Protection Corporation (SIPC) offers. “Everyone in the industry is open to it,” Corcoran says. “We see the value of it, but we don’t know what it may look like or what it may cost. People look at SIPC for the securities industry, but the securities industry is just so much larger than the futures industry in terms of transactions.”

Lukken says the FIA is committed to studying the issue of insurance. “The largest thing is we are shoring up the segregated model to improve it, and we hope to make more improvements over time. If we layer on an insurance product, then what are the benefits and costs to the customer of doing that?” he asks.

According to Corcoran, the FIA has received eight responses from different segments of the consulting world for a study on an insurance fund and is hopeful the findings will be ready by 2013.

Another area that may require attention is the bankruptcy code. “What happened after the bankruptcies was we didn’t have the authority to release the collateral along with the positions, so that created disruptions in the marketplace,” Durkin says. “We are proposing that Congress amend the bankruptcy code to allow clearinghouses that hold sufficient collateral that support the positions of failed firms to be able to move promptly with the transfer of those positions.”

Next year is a reauthorization year for the Commodity Exchange Act, and Lukken says that may be a time to propose changes. 

Corcoran has suggested that FCM chief financial officers (CFOs) meet industry criteria for their position. “There should be a registration specific for CFOs so that the industry can be assured that they have a minimum level of knowledge of the rules. There is in the securities world,” he says. 

A year ago the futures industry regulatory approach stood as a model for the rest of the financial world, but MF Global and PFG undercut the bedrock of trust in segregated funds. The industry has responded with changes, but more may be needed. “We’re open to any additional suggestions to enhance the confidence,” Durkin says.

About the Author

Web Editor/Assistant Editor Michael McFarlin joined Futures in 2010, after graduating summa cum laude from Trinity International University, where he majored in English/Communication.