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

Dan Roth: Working on rebuilding confidence

Q & A

FM: Can you design a compliance strategy that gives end users confidence that customer segregated funds are appropriately protected so that such a fund is unnecessary?

DR: We are talking about public confidence here. One question is: Will an insurance fund bolster public confidence? We are assuming you are talking about a fund modeled after other programs where there are caps on recovery. When you are talking about an institutional marketplace like we have, those caps would need to be sufficiently low that for a large portion of the marketplace that insurance program would do little to bolster their confidence. That is why this has to be studied to figure out where you could draw limits that would impact public confidence. The other part of this [is] what can you do from a regulatory point of view to bolster confidence, with or without insurance. The answer that we have been trying to develop is this concept of daily confirmation of segregated balances so that we are confirming on a daily basis from outside sources that the funds that the FCM claims it is holding, it is actually holding. That doesn’t address all the risk involved in customer segregated funds — there is always fellow customer risk — but regarding potential misuse of customer segregated funds by an FCM, daily confirmation of seg balances should go a long way to providing customers with assurances along with greater transparency about FCM data.

FM: Besides the specific measures to monitor movement of customer funds, have you looked at your general approach to self-regulation?

DR: We have the Berkeley Research Group conducting an examination of the NFA’s audit practices regarding Peregrine, and we look forward to any recommendations they have for how the audit process can be strengthened. We are hoping to get that in November. Another thing that we are doing is that we always have had a number of our staff go through a certified fraud examiners certification process. We have a class of 30 of our staff that are starting that program in the next week or two, and we will continue to send staff to the program on an ongoing basis.

FM: Did complacency play a role in these failures? Did the fact that there had not been breeches in customer seg funds provide a false sense of security? If so, how do you avoid this once things begin to calm down?

DR: I wouldn’t use the word “complacency.” I don’t think anyone in the industry has even been complacent about customer segregated funds; it has always been a core principle. But regulators tend to focus their attention on known weaknesses in the system and that is where you tend to allocate your resources, that is where you tend to spend your time. The failure of those two firms has certainly heightened awareness of those weaknesses but I don’t think we were ever complacent about customer segregated funds.

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