Published July 17, 2012
The U.S. futures regulator acknowledged on Tuesday the regulatory system had failed to protect the customers of Peregrine Financial Group, which collapsed last week as its founder admitted to a $100 million fraud spanning two decades.
In testimony before the Senate Agriculture Committee, Commodity Futures Trading Commission Chairman Gary Gensler was also expected to outline his agency's plans to contain the fallout from the Peregrine case, including a look at the role of self-regulatory organizations (SRO) that police much of the market.
"Although we do not know the full facts of what happened in this matter, the system failed to protect the customers of Peregrine," Gensler said in prepared testimony. "Just like the local police cannot prevent all bank robberies, however, market regulators cannot prevent all financial fraud.
"Nevertheless, we all must do better."
The stunning downfall of Peregrine, or PFGBest, and its founder, Russell Wasendorf Sr., dealt a new blow to confidence in the futures industry, just months after MF Global Holdings Ltd's bankruptcy, which left customers with a $1.6 billion shortfall and which is still being investigated.
Some of the fiercest criticism has been leveled at the National Futures Association (NFA), the first-line regulator that oversees dozens of smaller brokers, including PFGBest.
"The recent events at Peregrine highlight the necessity of looking at the decades-old system of SROs as first-line regulators and the commission's role in overseeing SROs," Gensler said.
AFTER A CENTURY OF SEG FUNDS, TWO VIOLATIONS
The MF Global and PFGBest scandals have raised questions about the strength of federal commodities regulations designed to segregate and protect customer funds.
Wasendorf was arrested on July 13 and charged with lying to government regulators. The CFTC charged him with misappropriating customer money in a civil case. His firm filed for bankruptcy.
The NFA eventually uncovered the fraud after it sought to confirm PFGBest's bank balance electronically. Prior to that, the NFA had conducted such checks through the mail. Wasendorf used a post office box to intercept the bank confirmation requests and forge the documents to conceal the missing customer money, according to an FBI's complaint.
"I find that mind-boggling that no one at NFA could discern this," said Senator Tom Harkin, an Iowa Democrat.
Gensler said on Tuesday that the NFA had just completed an audit of the brokerage in May 2011 and was in the process of conducting another one over the past few weeks when the fraud was uncovered.
Senator Pat Roberts, the committee's ranking Republican member, slammed Gensler for failing to provide market players a clear plan for a raft of derivatives reforms mandated by the 2010 Dodd-Frank law.
"And as if this weren't bad enough, the CFTC isn't doing a good job of what it was created to do -- police the financial streets," Roberts added. He said Gensler was "too busy working on his inter-galactic plan" -- a nod to the heavy slate of Dodd-Frank reforms -- rather than implement reforms after MF Global.
NEW RULES TO SAFEGUARD FUNDS
On the same day as Wasendorf's arrest, the CFTC moved to approve new customer protection rules requested by the NFA.
One such rule, named for MF Global's former CEO, Jon Corzine, would require top executives at futures brokers to sign off on major withdrawals from customer accounts.
But Gensler said on Tuesday that more steps need to be taken.
"I believe it is critical that we bring the regulators' view of customer accounts into the 21st century," he said. "We must give the SROs and the CFTC direct electronic access to the FCM's (futures commission merchants) bank and custodial accounts for customer funds, without asking the FCM's permission."
He also noted that letters confirming bank balances "must come directly to regulators from banks and custodians."
Gensler hopes to incorporate the new NFA regulations approved last week into the commission's own rules, so it can "directly enforce" the reforms.
Moreover, he called for giving customers more transparency into their holdings, as well as greater oversight for how SROs such as the NFA conduct examinations.
He said he has asked for a public roundtable to discuss what other customer protections are needed.