PFGBest in Liquidation Mode

[FCM-Reform 10]

Last Thursday the CFTC held a public hearing to determine what steps should be taken to repair the damage done by the bankruptcies of PFG and MF Global. I’d like to share with everyone some of the highlights of the hearing:

 

Better Accounting Standards: There was much discussion of auditing standards for both Regulators of FCM’s and the CPA’s who audit FCM’s. There was general agreement these standards need to be raised. FXCM believes FCM’s should be required to use a top accounting firm to avoid the kind of accounting issues that plagued PFG.

 

Additional Disclosure Requirements: An extensive discussion on FCM transparency was held and it is clear that FCM’s are going to have to make more disclosures of their books to regulators and to the public. The question is how much is to be disclosed? On the one hand there was testimony from FCM’s like Vision who publish their balance sheet on their website and on the other hand were those who were concerned that too much disclosure could lead to possible “bank runs” by investors. FXCM believes investors should be able to see a company’s audited financial statement once a quarter. Too many investors are forced to fly blind when they choose a Futures Commission Merchant or Forex Dealer. No trader should be subjected to this kind of risk post-PFG.

 

Insurance: Commissioner Bart Chilton released his proposal for a futures insurance fund on the same day of the hearing. Towards the end of the Roundtable the topic turned to insurance and John Roe of the Commodity Customer Coalition once again made a forceful case for a fully insured fund for the futures industry. As of now, Commissioner Chilton’s proposal does not include retail forex, but there is no reason that it shouldn’t. FXCM supports insurance for the futures/forex industry.

 

The CFTC will now deliberate into October before announcing their proposals. We encourage everyone to comment using the link below:

 

http://comments.cftc.gov/PublicComments/CommentForm.aspx?id=1250

[bakrob99 11]

Perhaps everyone should read this before commenting

 

Guest Post: The Sentinel Case - Another Nail In The Coffin Of 'Market Confidence' | ZeroHedge

 

This is clearly absurd when funds can be stolen and then used as collateral with a bankthat can then claim they "acted in good faith". Give me a break.

[bakrob99 11]

This just keeps getting better and better. Corzine of MF Global won't be having any charges laid against him. Unbelievable.

 

No Criminal Case Is Likely in Loss at MF Global - NYTimes.com

[FCM-Reform 10]

Just read a very interesting comment letter to the CFTC by James Gellert of Rapid Ratings:

 

http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=58346&SearchText=

 

Mr. Gellert makes the following comment about the benefits of FCM’s being required to disclose their audited financials:

 

Would Mr. Wasendorf have been as ready to invent financials if his customers had demanded full, audited balance sheets and income statements all along? Would Mr. Wasendorf have been able to compose such reports with sufficient skill as to withstand rigorous third-party examination over twenty years? Rapid Ratings recalls that, by applying large numbers of interrelated calculations to the published reports of Enron, our firm was able to detect vivid inefficiencies entirely inconsistent with the investment grade ratings that Enron enjoyed from the larger rating agencies – inefficiencies that later turned out to have been the result of commingling accurate and fabricated reporting lines.

 

Mr. Gellert’s point about the difficulty of forging financial documents using the kind of standards that publicly traded companies use is well taken. Had PFG been forced to use such standards Wasendorf’s scam would have likely been caught long before July of 2012. Furthermore, ratings agencies like Rapid could break down the data in a manner that average investors could more easily understand. Although, we disagree that only ratings agencies be allowed to see such data. We believe any trader who opens an account with a FCM or Forex Dealer should be able to judge for themselves a firm’s financial health.

 

You can make your feelings known to CFTC by posting comments here:

http://comments.cftc.gov/PublicComments/CommentForm.aspx?id=1250

[bakrob99 11]

I appreciate your comments and welcome more. But I think the main point should be that Individual Investors should not be put into the position of having to judge their FCM's credit worthiness. Rather - the industry should protect investors funds as sacrosanct... and the only way to manage this is with a credible insurance against loss.

 

Without an insurance program, and relying strictly on balance sheet judgments, the natural tendency will be for larger FCM's to dominate the industry which will reduce competition and limit technical development as the smaller firms will be unlikely to attract traders.

[FCM-Reform 10]

I appreciate your comments and welcome more. But I think the main point should be that Individual Investors should not be put into the position of having to judge their FCM's credit worthiness. Rather - the industry should protect investors funds as sacrosanct... and the only way to manage this is with a credible insurance against loss.

 

Without an insurance program, and relying strictly on balance sheet judgments, the natural tendency will be for larger FCM's to dominate the industry which will reduce competition and limit technical development as the smaller firms will be unlikely to attract traders.

 

No question insurance is a key component of reform. We support it. In terms of disclosure, larger firms are not guaranteed an automatic advantage in the market. Many large firms have huge debt while smaller firms may not have any major liabilities at all. We believe that FXCM could have competed many years ago with a public disclosure requirement when we were smaller since we did not take on any major debt and grew organically. At the end of the day it is the quality of the firm that will win out. Public disclosure of financials merely helps to reveal what kind of firm a trader is dealing with. Is it a firm that is healthy and growing with strong financials or are they leveraged to the hilt and struggling to make ends meet? Traders should be aware of this before they put funds on deposit.

[FCM-Reform 10]

Two new developments in the last few days indicate that regulators are trying to get out in front of the safety of funds crisis that has gripped the futures/forex industry. However, these reforms may not extend to the retail forex market.

 

On Friday the National Futures Association approved a new rule requiring all Futures Commission Merchants to grant real-time, online access to FCM bank accounts. This rule is in response to Russ Wasendorf’s bank statement forgeries which had fooled regulators for 20 years. The language specifically references FCM’s and we are currently checking to see if Retail Foreign Exchange Dealers (RFEDs) will have to comply with the rule as well. FXCM’s position is that RFEDs need to be more transparent, which is why we also support a rule requiring all FCMs/RFEDs to fully disclosure their financials to the trading public.

 

The second development came last Thursday at a meeting in Chicago, as reported by the WSJ, in which the CME was reportedly “softening” its opposition to an insurance fund for futures traders. Again, however, no mention of extending such protections to retail forex traders was made.

 

http://online.wsj.com/article/SB100008723963904445085045775934240 33950042.html?mod=googlenews_wsj

 

While both of these development are positive, the negative aspect to them is that retail forex may very well be over looked. This is why we are strongly encouraging the trading public to contact the CFTC and leave comments about the need to further protect retail forex traders. Traders can leave comments using the link below:

 

http://comments.cftc.gov/PublicComments/CommentForm.aspx?id=1250

[FCM-Reform 10]

Reading through the comments at the CFTC a number of good points have been brought up regarding the need for additional protections.

 

Alex Winters made the following comment to the CFTC: http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=58421&SearchText=

 

Forex traders should be considered in these rulings. PFG and MF Global hurt both Forex and Futures traders during their collapse. I submit that any protections offered to futures traders also be extended to forex also. While insurance would be the best protection the emerging forex industry shares the same (and more) insecurities. For this industry to survive and prosper we must be able to trust that brokers that hold our funds are solvent especially since past CFTC rulings (50:1 leverage) require that we deposit even more of our money with brokers when we have no way auditing their financial health.

 

 

The CFTC's requirement a few years ago that traders put up more margin to trade retail forex leads to the logical conclusion that regulators put in additional protections (disclosure of company financials, better accounting standards, insurance) since retail forex traders now have more capital at risk. This is a pretty powerful argument and I would encourage traders who leave comments with the CFTC to make it.

[FCM-Reform 10]

The CFTC has recently closed the comment period that was associated with the Public Roundtable on PFG:

 

http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1250

 

This could mean that CFTC is nearing a decision and is about to announce their planned reforms. Comments and suggestions can still be sent to the CFTC however by emailing secretary@cftc.gov.

 

FXCM is recommending that all FCM’s and forex dealers publicly publish their financials once a quarter and employ a top ten accounting firm. We encourage retail forex traders to share these and other suggestions with regulators by emailing them directly. Thousands of PFG customers traded retail forex with PFG and their voices should be included in any discussion designed to increase customer protections for NFA regulated firms. Furthermore, providing insurance to futures traders and not forex traders would be a further insult to injury for those currency traders at PFG and any future forex traders caught up in an insolvency. Make your voice heard today.

[Scat 10]

My fx account with them seems lost. Nice that it isn't a big sum.

[FCM-Reform 10]

We've been told by the NFA that the instant "view only" bank account access that FCM's must now grant to the NFA is not applicable to Forex Dealers. In short, NFA is not requiring forex dealers provide the same instant bank account access that Futures Commission Merchants provide. This is the clearest sign yet that regulators are not planning to extend any additional customer funds protections to the retail forex community.

 

The stated reason is that since retail forex funds are not legally required to be "segregated" they are not in the same category as the seg funds that FCM's hold on deposit. This has long been an issue involving the Commodity Exchange Act which grants seg funds to on-exchange contracts but does not have a word to say about retail foreign exchange because nobody was trading forex online in the 1970's when these laws were passed.

 

This logic will likely be used for additional proposals such as insurance where we can now expect retail forex to be excluded as well. This is why financial disclosure for retail forex firms becomes even more important. With retail forex dealers not being included in the safety of funds discussion currency traders are now solely left to their own due diligence when it comes to picking a broker.

 

We still encourage you to email secretary@cftc.gov to let regulators know that retail forex should not be excluded. If no one speaks up then regulators can assume that retail forex need not be a priority.

[FCM-Reform 10]

I've been asked why retail forex does not have seg funds protection and so I wanted to pass along this brief regulatory history of the retail foreign exchange market:

 

In 2001 retail online currency trading was regulated for the first time with the passage of the Commodities Futures Modernization Act of 2000 (“CFMA”). This law provided that any non-bank firm making a market in retail FX transactions could be registered and licensed by the Commodities Futures Trading Commission (“CFTC”). This law was a step in the right direction but it did not in any way grant customers trading FX with these firms any funds protection in the event of bankruptcy as is common in exchange traded markets such as equities and futures.

 

In particular, the CFMA did not make any adjustments to the CFTC’s “segregation rule.” The segregation rule stipulates that all client funds deposited for trading domestic, on exchange futures or options on futuresbe kept segregated from all company funds and that in the event of bankruptcy the customer’s funds are legally segregated from creditors and must be returned to the clients.

 

In May 2008, Congress amended the Commodity Exchange Act (“CEA”) and created an entirely new registration category, the Retail Foreign Exchange Dealer (“RFED”), for forex dealers operating in the U.S. Neither at that time nor two years later when Congress enacted sweeping financial sector reform legislation with the Dodd-Frank Reform and Consumer Protection Act of 2010 were provisions included that could have provided for RFEDs to segregate funds for the protection of retail FX customers

 

The CFTC explained the reason for not including segregation of funds for retail FX as follows:

 

http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-21729a.pdf

 

 

“… Several commenters maintained that the Commission should require segregation of customer funds by counterparties in order to provide some protection in the event of a counterparty insolvency. The Commission’s segregation requirements with regard to futures flow from Section 4d of the Act which, generally speaking, requires that customer property for trading commodity contracts be kept apart, or segregated, from the FCM’s own funds. However, as noted in the Commission’s proposing release, a segregated funds regime cannot be replicated in the context of off-exchange retail forex trading. Unlike segregation of customer funds deposited for futures trading, under the relevant provisions of the Bankruptcy Code, such amounts held in connection with retail forex trading would not receive any preferential treatment to unsecured creditors in bankruptcy.”

 

This hiccup with the bankruptcy code is what is currently holding up everything from seg funds protection to insurance. More in my next post.

[FCM-Reform 10]

Next Wednesday morning the CFTC will be holding a meeting where they are expected to announce additional post-PFG customer protections. As I discussed in my previous post the absence of any language pertaining to off-exchange, retail forex transactions in the bankruptcy code is the given reason cited by regulators as to why no additional protections for retail forex traders can be put in place. It will likely also be the reason that retail forex will be excluded from any insurance scheme. We shall see on Wednesday.

 

However, this would not preclude regulators from requiring FCM's/RFED's from disclosing their financials on a quarterly basis or requiring tougher accounting standards. In fact, absent insurance protection or seg funds these may be the only protections that can be offered to the retail forex community. Since customers cannot rely on clear legal language to protect them in the event of bankruptcy it becomes even more imperative that customers be able to see for themselves just how sturdy the retail forex broker they are doing business with is. Comments can still be submitted to CFTC by emailing secretary@cftc.gov

[FCM-Reform 10]

As regulators continue to investigate PFG news is coming out showing that the futures firm had been losing money for years:

 

http://www.valuewalk.com/2012/09/pfgbest-in-more-trouble-as-liabilities-outweigh-assets/

 

 

QUOTE:

 

"Its financial statement submitted to the court, indicated that the business has been going down since 2010. The company suffered $2.7 million in gross income losses in 2010, $1.2 million in losses in 2011, and $259,000 losses during the six month period of the current fiscal year."

 

PFG had recorded three straight years of losses. And yet they had just moved into an $18 million glass and steel office complex in Iowa boasting some of the most luxurious office amenities imaginable. But because PFG never had to disclose their losses they were able to give customers the impression that the firm was healthy and growing, when in fact it was sick and contracting. Customers should be aware of this before they open an account. Particularly since there is no insurance for futures or forex.

 

The CFTC postponed their vote on additional customer protections this week giving traders a little more time to comment.

[FCM-Reform 10]

The National Futures Association has added some additional public financial information on their BASIC search function effective September 1:

 

NFA's BASIC System - Public Display of FCM Financial Information

 

 

At its August meeting, NFA's Board of Directors determined that certain FCM financial data should be made publicly available on NFA's website to assist customers in their due diligence review of an FCM.

 

The Board determined that the best way to display this information is on an FCM-by-FCM basis through NFA's BASIC system. Therefore, NFA is adding new sections to each FCM's BASIC page to disclose certain financial related information. Specifically, from each FCM's BASIC page, the public will be able to access three separate FCM Reports - FCM Capital Report; FCM Customer Segregated Funds Report; and FCM Customer Secured Funds Report.

 

 

These actions are a step in the right direction. Clearly, regulators believe that public disclosure of FCM financial accounts are beneficial to customers as they conduct their due diligence. It therefore follows that additional financial disclosures (complete disclosure of a FCM's balance sheet for example) would empower traders to an even greater degree.

[FCM-Reform 10]

The federal bankruptcy judge in the PFG case authorized a series of initial customer distributions today. PFG Customers to Get Money Back | Fox Business

 

The first wave of payouts will happen by October 8 and a second wave will occur before October 29, Fishman said.

 

The Commodity Futures Trading Commission initially raised concerns about the trustee's plan because of uncertainty about the integrity of Peregrine's books. The commission warned that some people could get money they were not entitled to without proper vetting of records.

 

The fate of PFG's retail forex customers remains in doubt. The CFTC has yet to announce their proposed reforms. Retail forex needs to be a part of these reforms. We're still encouraging traders to contact CFTC at secretary@cftc.gov to voice their concern.

[FCM-Reform 10]

Reuters has just published an exhaustive two part special report on the fraud perpetrated by Russ Wassendorf. Wassendorf spent tens of millions of dollars on luxury items and in failed business ventures with money stolen from client accounts.

 

Part One: Special Report: Iowa broker built empire on a lie concealed in a postal box | Reuters

 

Part Two: Special Report: As Peregrine teetered, founder went on shopping binge | Reuters

 

One of the most distressing aspects of the fraud is that Wassendorf was nearly caught last year in a routine audit but managed to head off the NFA with a last second fax that allowed him to keep the fraud going for another year. The episode highlights the need for greater auditing and accounting standards, not to mention the need for more financial disclosures for brokers so as to prevent lone wolf CEO's like Wassendorf from hiding the true state of their firm's finances.

[FCM-Reform 10]

The CFTC has released a transcript from the public roundtable that was held in August.

http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/transcript080912.pdf

 

While retail forex is absent from the discussion the issues pertaining to FCM’s is of importance to retail forex customers since FCM’s like PFG routinely offer retail forex as part of their suite of products.

 

One of the arguments against additional financial disclosures for FCM’s is that these disclosures may weaken the fragile, financial health of less profitable FCM’s. Warren Davis of Sutherland, Asbill & Brennan made the following point in response:

 

 

"In the case of a FCM, the money that the customer gives the FCM is not for the use of the FCM. It's solely to protect the customer, so it seems to me that the run on the bank analogy is not altogether appropriate here. But what is appropriate is to ensure that customer money is, in fact, used for the only purpose for which it's given which is to secure the customer's obligations to the FCM and the clearinghouse. And therefore, if information is released which causes a customer to move its account from one FCM to another, that shouldn't be viewed as a bad thing. That's sort of the way the futures world is supposed to work."

 

 

Unfortunately, that is not currently the way the futures world works. Because FCM’s are able to keep their financials hidden from the public there is no way of truly knowing if the firm traders are doing business with is healthy or unhealthy. The net result is that traders are left to play a guessing game about whether their funds are safe or not.

 

CFTC has yet to announce when they will unveil their reform proposals.

[FCM-Reform 10]

The PFG bankruptcy proceedings are turning into a tragedy for PFG's retail forex customers who may now be forced to stand by and watch their funds be used to reimburse customers who traded on-exchange futures with PFG. In response, a group of traders have started a website to try and rally support amongst PFG's forex customers: PFG Forex Metals Legal Account - Home

 

The Traders who have setup "Forex Metals Account LLC" have also sent out an email to PFG's forex customers updating them on the bankruptcy proceedings: Forums - PFG - What happens if you have accounts with them??

 

 

Our Forex and Metals monies are currently intact at JPMorgan Chase Bank and Royal Bank of Scotland as confirmed by the Trustee. You may think that because our accounts are listed in the Trustee’s documents that our accounts are safe. Initially we believed this as well. In fact, if you carefully read thru all the Motions, schedules and documents submitted to the bankruptcy court, nothing could be farther from the truth. Our accounts are at risk of being completely emptied in the current legal proceedings - effectively stealing our money in the next few weeks - and converted to pay Futures account holders and the Trustee’s law firm. We view what may be about to take place as equivalent to criminal theft/larceny. We never in our wildest dreams thought that one man or a group of lawyers could put 100 percent of our accounts at risk, do it openly, publicly, and legally get away with it. The Trustee’s Motions are designed to distribute $123 million to Futures account holders – which was approved in court on 9/20/12 – and will deplete the funds available to Forex and Metals account holders. We need to immediately protect our accounts. If we let the Trustee and the dozens of lawyers representing non-Forex and non-Metals clients take our money without doing anything about it, then we don’t have anyone else to blame but ourselves. We cannot sit idly by and watch our hard earned money be divided between creditors and other customers.

 

 

FXCM has been lobbying Congress since 2005 to include retail forex in any bankrupcy prodeeding but we have not had much success due to the hesitancy of Washington to re-open the bankruptcy code on behalf of retail forex customers. In the meantime, the PFG bankruptcy should give retail forex traders pause in regards to opening a retail forex account with a Futures Commission Merchant instead of a Retail Forex Exchange Dealer due to the disparity in treatment the two class of customers are getting in this bankruptcy.

 

We are also still encouraging traders to contact CFTC at secretary@cftc.gov to urge greater protections for retail forex traders.

[FCM-Reform 10]

The Wall Street Journal is reporting that PFG's trustee is now going to address the status of PFG's retail forex customers:

 

http://online.wsj.com/article/SB1000...googlenews_wsj

 

Ira Bodenstein, the trustee liquidating Peregrine, in a notice Wednesday told holders of currency and precious metals accounts with the firm that addressing their claims was his "next agenda item," though no decisions have been made on how these will be handled or how much money these customers may get back.

 

"If the Bankruptcy Court concludes that payment in full to forex and metals customers is appropriate, there are sufficient funds to accomplish that outcome," Mr. Bodenstein wrote. "If the Bankruptcy Court reaches a different conclusion, there are sufficient funds to address whatever treatment of these claims that the Bankruptcy Court orders."

 

Of further interest to traders in the article is the NFA's support for additional legal protections, although nothing was specified.

[FCM-Reform 10]

The lawyers for PFG's Forex/Metals customers have just filed a motion designed to prevent creditors from laying claim to the funds of forex traders. The hearing for this motion is set for Thursday morning.

 

Hearing for Motion scheduled for Thursday, October 11, 2012 at 10:00a.m. - PFG Forex Metals Legal Account

 

Given the current broad inclusion of retail forex within the scope of the CEA, CFTC Regulations and NFA Rules, as well as the CFTC‘s core mandate to protect the investing public, it defies logic to deny retail customers who trade such contracts the same statutory protections now afforded all other market participants, including institutional dealers in cleared currency swaps and options. It would be equally unjust and irrational, given the wide ranging regulatory controls to which retail forex is now subject, to attempt to exclude this most vulnerable class of customers from the single provision most directly protective of their economic interest.

 

It is a noble sentiment and one that FXCM wholeheartedly supports. We have been hammering away in Washington on this issue for seven years now. Here’s hoping the judge surprises on Thursday with a ruling supportive of retail forex traders everywhere. But clearly, the status quo cannot be tolerated. You can let the CFTC know by emailing secretary@cftc.gov and by contacting your local Congressional Representatives and passing along your concerns. In the meantime, we will continue to advocate for Segregation of Funds, Customer Insurance, and Public Disclosure of Financials for all FCM’s and RFED’s.

[FCM-Reform 10]

In yesterday's hearing on Drohan Lee LLP's motion on behalf of PFG's retail forex customers Judge Carol Doyle advised the plaintiffs to file an "adversary" suit against the Trustee to force him to return the funds of PFG's forex customers.

 

Peregrine Forex, Metals Clients To Sue Over Funds, Atty Says - Law360

 

That is exactly what they are about to do. Futures Magazine has a good article regarding the new motion:

 

PFG forex, metals customers want justice

 

In total, there are 7,000 clients with forex and metals accounts at PFG, but Medley says the impact of the case could be much broader. “We feel like this is a precedent-setting case with respect to the rights of forex and metals account holders, and how it relates to the CFTC regulations.”

 

A victory for Drohan Lee would indeed be a huge precedent for all retail forex traders in the United States, and a welcome one at that. However, the precedent may not be to the liking of many in the futures industry. This quote from John Roe of the Commodity Customer Coalition is very telling:

 

Roe says the CCC has not made a decision on how to argue this but says, “The important thing once this is all said and done is that we don’t have a precedent at PFG that once someone steals something out of segregation, it doesn’t matter. That would mean segregation protection is completely meaningless,” he says. “The NFA said in its brief in the MF Global case that the intent of Congress was not to have to trace funds when the music stopped. If they aren’t there and there is a hole, you have to replace those with substitute assets. In this case, the substitute asset is FX customers’ money.”

 

If FX customer assets are no more than a backstop for futures customers in the event of bankruptcy then retail forex traders need to think long and hard before opening an account with a FCM whose primary business is futures. That is what is at stake in the adversary suit that is about to be filed.

Edited October 12, 2012 by FCM-Reform

[FCM-Reform 10]

The CFTC has just announced they will be holding an open meeting to consider additional customer protections for the futures industry next Thursday.

 

CFTC to Hold Open Meeting to Consider a Notice of Proposed Rulemaking on Enhancing Customer Protections

 

FXCM has been lobbying in Washington to extend such protections to retail forex traders as well. FXCM supports tougher accounting standards, customer insurance and a requirement that all FCM's disclose their fully audited financials to the public. We are encouraging traders to submit their comments to the CFTC at secretary@cftc.gov.

[FCM-Reform 10]

Chairman Gary Gensler put out a press release today announcing a series of reforms designed to afford customers greater protections in the futures industry. It does not appear retail forex has been included in these reforms but we'll learn more in the days ahead. Here are the highlights:

 

Statement by Chairman Gary Gensler of Support: Enhancements for the Protection of Customers and Customer Funds

 

 

 

This customer protection proposal incorporates these NFA rules into the Commission’s regulations so that the CFTC can directly enforce these important rules. Under this proposal, FCMs would be required to:

 

• Hold sufficient funds in Part 30 secured accounts (funds held for U.S. foreign futures and options customers trading on foreign contract markets) to meet their total obligations to customers trading on foreign markets computed under the net liquidating equity method. FCMs would no longer be allowed to use the alternative method, which had allowed them to hold a lower amount of funds representing the margin on their foreign futures;

 

• Maintain written policies and procedures governing the maintenance of excess funds in customer segregated and Part 30 secured accounts. Withdrawals of 25 percent or more would necessitate pre-approval in writing by senior management and must be reported to the designated SRO and the CFTC; and

 

• Make additional reports available to the SRO and the CFTC, including daily computations of segregated and Part 30 secured amounts.

 

Beyond the NFA rules, additional reforms in this proposal benefited from the CFTC’s broad outreach and consultation with the SROs and market participants, as well as substantial feedback from CFTC Commissioners. They include:

 

• First, bringing the regulators’ view of customer accounts into the 21st century by giving the SROs and the CFTC direct electronic access to FCMs’ bank and custodial accounts for customer funds, without asking the FCMs’ permission. Further, acknowledgement letters and confirmation letters must come directly to regulators from banks and custodians.

 

• Second, increasing disclosures to customers regarding the risks associated with futures trading and using FCMs to invest their funds. Futures customers, if they wish, should have access to information about how their assets are held, similar to that which is available to mutual fund and securities customers. FCMs would be required to provide current and potential customers with specific information about the FCM’s risks.

 

• Third, enhancing controls at FCMs regarding how customer accounts are handled, including policies and procedures on supervision and risk management of customer funds.

 

• Fourth, setting standards for the SROs’ examinations and the annual certified financial statement audits, including raising minimum standards for independent public accountants who audit FCMs.

 

• Fifth, requiring FCMs to ensure they back up segregated customer accounts with funds to cover potential margin deficits.

 

• Sixth, implementing a more effective early warning system for the Commission and the SROs that alerts them to certain problems, including a) when an FCM’s funds are insufficient to meet the targeted residual interest in customer accounts b) when there is a material adverse impact to the FCM’s creditworthiness and c) when there is a material change to the FCM’s clearing or financial arrangements.

 

• And seventh, instituting a liquidity requirement for FCMs, in addition to the existing capital requirement, to better detect FCMs that have become distressed and may put customer funds at risk.

 

Prior to this proposal, the Commission already made some important improvements to protections for customer funds. They include:

 

• The completed amendments to rule 1.25 regarding the investment of funds that bring customers back to protections they had prior to exemptions the Commission granted between 2000 and 2005. Importantly, this prevents use of customer funds for in-house lending through repurchase agreements;

 

• Clearinghouses will have to collect margin on a gross basis and FCMs will no longer be able to offset one customer’s collateral against another and then send only the net to the clearinghouse;

 

• The so-called “LSOC rule” (legal segregation with operational comingling) for swaps ensures customer money is protected individually all the way to the clearinghouse; and

 

• The Commission included customer protection enhancements in the final rule for designated contract markets. These provisions codify into rules staff guidance on minimum requirements for SROs regarding their financial surveillance of FCMs.

 

[FCM-Reform 10]

The CFTC is expected to formally submit their reform proposals to the federal register, which will once again give customers a chance to make comments. I’ll post a link once it is available. In the meantime, Futures Magazine has published an interesting article on conducting your due diligence:

Spotting broker red flags

 

The article partly highlights the importance of good auditing and the benefits to traders of being able to look at the many reports that publicly traded companies have to file.

 

A red flag that has come up in several cases is inadequate auditing. A large futures broker or investment firm should have, if not one of the big four, an institutional level auditor. The Sam Israel Bayou Hedge Fund, Bernie Madoff and PFG scandals all used sole proprietor or inadequate auditors. While the big guys have messed up as well, a large firm managing hundreds of millions of dollars shouldn’t be hiring someone working out of his (or her) garage. If they do, it is a blazing red flag.

 

Publicly traded companies like MF Global have numerous reports they must file with the Securities and Exchange Commission (SEC), and, as a registered FCM, MF Global had to submit monthly segregated account reports to the CFTC. These reports can reveal a lot of information, though many of them, especially SEC filings, can be dense and hard to interpret if you don’t know what to look for. Find someone who does.

 

Traders should not have to do go searching for expensive accountants to conduct due diligence. They should be able to easily review a firm’s financial statements at a public website so that they can determine how healthy a firm actually is. This is a far better way to conduct due diligence than the current system which merely relies on the public statements of individuals like Russ Wassendorf. Marketing promises are no substitute for hard data. There is still time to get the CFTC to adopt such safeguards. Email secretary@cftc.gov to make your own recommendations regarding customer insurance, these proposals, or any others.