Get your Comments in (CTA/CPO Capital Requirements)

In late January 2014, the National Futures Association (“NFA”) announced to its membership they were considering requiring Commodity Pool Operators (CPO’s) and Commodity Trading Advisors (CTA’s) to have minimum net capital requirements similar to what the clearing firms (FCM’s) and Introducing Brokers (IB’s) have:

“…reviewing the current regulatory structure applicable to Commodity Pool Operator (“CPO”) and Commodity Trading Advisor (“CTA”) operations. In particular, NFA is looking at ways to strengthen the regulatory structure governing CPO operations to provide greater protection for customer funds… [and] exploring ways to ensure that CPOs and CTAs have sufficient assets to operate as a going concern.” 

The review of the CTA/CPO regulatory structure also includes possible measures such as the verification of CPO fund balances similar to what is done now for FCM’s, and the possibility of requiring all CPO’s to use third party administrators, or at least have a third party approve all movement of money out of funds.

These are wide ranging possible changes, and every CTA/CPO should consider how these changes might affect their business, especially how their costs might increase, and whether that increase in cost would actually do anything to strengthen customer protections. The deadline for submitting comments is fast approaching, and we urge any and all CPO’s and CTA’s out there to get their comments in before tax day, April 15th. Email the comments to CPOandCTAfeedback@nfa.futures.org with the specific answers and commentary they are looking for here:

We won’t bore you with our full response, which is likely a little too much ‘inside baseball’ for most. But here’s some questions to ponder before writing up your comments (and please do, CPO’s/CTA’s).

1.  Should CTA’s and CPO’s be lumped together in this?  CTA’s do not hold customer funds.

2.  Did capital requirements help at all in the case of Griffin Trading, Refco, Sentinel, MF Global, and PFG?

3. What will it cost you to have a third party administrator for your fund?  Are your investors willing to bear that cost? Do they feel the need for greater protections?

4.  What sort of certification would an admin need to be qualified to perform this role if mandated by NFA? What sort of slippery slope are we headed down if this new requirement create the need for admins to register, a new class of NFA member, new fees, new dues, etc.?

5. How would the NFA verify hard to value assets held by CPO’s which do only nominal futures trading but are required to be registered as a CPO?

6. Is this even a problem?  Are customers of your CTA/CPO asking you about protections, are they worried that your insolvency can cause them problems?

 

 

 

Managed Futures Linkfest

Managed Futures and Manager Mentions:

Industry News/Regulation affecting Managed Futures:

  • Extreme Makeover: Gary DeWaal Says FCM Landscape has to Change – (John Lothian News)
  • Banking Under Dodd-Frank Takes Shape With Volcker-Rule Approval – (Bloomberg)
  • NIBA Reports on Meeting With CME Group – (Dan Collins Report)
  • CME data fee increase more onerous than originally thought – (Futures Magazine)

Market moves, stories, and other items of note to Managed Futures:

  • Speculators Hold Smallest Bullish Gold Positions Ever In One CFTC Report – (Forbes)

PFGBest Update: Speeding Up

As many have already heard, there have been some new developments in the PFGBest bankruptcy proceedings. Here’s what’s relevant:

  • Vision Financial filed the winning bid for reception of PFGBest accounts by way of bulk transfer, and will provide $325,000 to the Trustee. To read the full legal order, click here. Vision is one of the larger FCMs in the industry, primarily dealing with retail accounts. Information for former PFGBest brokers may be found here, while general reporting on the transfer may be viewed here. The target date for the move is October 19th, but as we’ve learned throughout this process, these sorts of targets are frequently moving. The amount to be moved will remain 30% of 4d (Segregated) balances and 40% of 30.7 (secured) balances.
  • At this point, we’re simply happy that the distribution is moving ahead, and are hopeful Vision acts in an honorable manner to provide the necessary assistance for these victims as they decide whether to send money home, transfer to a broker of their choice, or stay at Vision. Attain has a pre-established relationship with Vision, and will be working with their staff to help our clients through this process.
  • As a part of this agreement, the concept of a “first” or “second” wave of distributions is a thing of the past. The initial distribution to PFGBest clients will happen all at once, with the remaining funds distributed via a claims process, or, potentially, another bulk distribution.
  • There were, however, roughly 350 accounts which could not be initially verified, and will not be included in the initial distribution. Items that might have put an account into this category included accounts with a round number with no activity, accounts with no activity for 90 days prior to the bankruptcy, accounts where the SSN or corporate tax ID number could not be verified with the IRS. The list of these accounts has not yet been made public, and as of now, we’re unsure as to how the accounts will be handled. Our best guess? They’ll go straight to the claims process.
  • PFGBest victims will need to file a claim form by no later than November 16th. Attain is filling out all necessary paperwork on behalf of their clients, but for others, the information can be found here.

We’ll continue to follow the situation closely, but all in all, there’s really only one thing to say: it’s about time. The money of former PFG customers has been locked up too long.

PFGBest Update: How far did the apple fall from the tree?

Since the PFGBest scandal broke, investors have been calling for heads on a platter. They have wanted Wasendorf Sr. arrested (done), the NFA disbanded/sued/held liable (not yet), and pray for US Bank and their deep pockets to have some liability so they pay out investors (fingers crossed). Underneath all of that, however, has been the question of just how much others at PFGBest (and especially Wasendorf’s son – Russ Wasendorf Jr.) knew about the fraud.

Well, we may have a chance to find out.  Via the Chicago Tribune:

An Iowa grand jury is expected to hear testimony from Peregrine Financial Group’s president [Jr.] next week as it begins considering alleged wrongdoing at the failed futures brokerage. […] Wasendorf Jr., through his lawyer, has denied that he knew about wrongdoing at the company. Other top Peregrine executives, including the chief financial officer, also are expected to testify before the grand jury in Iowa, where the brokerage had its headquarters, lawyers have said.

Now, Wasendorf Jr. has steadfastly claimed he had no knowledge of the fraud, and his testimony, alongside the testimony of other executives, is not meant to be indicative of suspected guilt – just a part of prosecuting Wasendorf Sr. Indeed, Wasendorf Sr. has claimed from the start that he alone knew of the fraud. But as more and more details come out, we may have reason to pay close attention to the testimony and evidence in this trial. In fact, we’ve talked with more than a few PFGBest former employees who have serious doubts about the elder Wasendorf’s ability to operate a computer to the level needed to carry out the fraud. If what the NFA said about the deluge of forged documents is correct, it’s not that big of a leap to assume Wasendorf Sr. probably had help along the way.

However, Wasendorf Jr., in particular, has a bright light shining on him now. He was, after all, in charge of operations, and, by all accounts, the one actually running the firm the last few years; so the idea that he had no clue that nearly half of customer funds had been funneled away from the firm strikes most as ludicris. Add to this transfers of lucrative property from Wasendorf Sr. to Jr. back and last week’s report that Wasendorf Jr. was actually planning on leaving the firm… well, we wouldn’t be surprised to hear a lot of 5th amendment invocations during the testimony.

Of course, the prosecutors had Wasendorf Sr. handed to them on a silver platter via the confession in his suicide note – building the case against him wasn’t exactly a tough job. What comes next – ascertaining guilt outside of Wasendorf Sr. – could be a horse of a different color.

PFGBest Update: A Lack of Understanding

Yesterday’s bombshell news out of the PFGBest case related to the Wasendorf admission that he had misappropriated funds to pay for regulatory fees, which, as we detailed, gives us hope of a clawback. But that’s not all that hit the wires yesterday.

First up, the NFA announced that they had retained the law firm Jenner and Block to conduct a review of their audit procedures. We’ve already had a couple of people reach out to ask us if we believed this was adequate, or felt that the Congressional investigation we’ve been calling for is still necessary. No doubt about it – we still want the investigation. There are a couple of things to consider here. First off, in a strange twist of fate/coincidence/<insert vague and sarcastic language here>, Jenner and Block was also the firm that worked as legal counsel for the Sentinel case years back. Though the public outrage over the failure of regulators to detect the fraud was just as palpable then, Jenner and Block never suggested any action against them.

The second curious component of this NFA announcement is that it’s technically a review of audit practices. As we have detailed, the PFGBest scandal and its implications for the NFA are far wider in scope, with serious questions being raised about red flags that were missed and how Russ Wassendorf, Sr.’s role on the FCM committee may have impacted how they were treated by regulators. For instance, it’s fairly common practice for NFA members to be required to respond to NFA directives by end of business on the day of notification, or, in generous cases, by the end of a work week. Yet, PFGBest was able to delay authorization of electronic account balance verification for months. Issues like this, the NFA’s hiring practices, and more would appear to fall outside the scope of this Jenner and Black review. That’s where we need Congress and the CFTC to step up.

But the CFTC was making headlines of their own yesterday, as Gensler testified before Congress regarding the development of swaps regulation. Of course, there was no way the subject of PFGBest would be avoided, but it was how the Chairman responded to those questions that didn’t get enough attention or scrutiny, in our opinion.

“Just like the local police cannot prevent all bank robberies, however, market regulators cannot prevent all financial fraud.”

Here’s the problem. If you want a relevant use of this metaphor, then the police officers saw a man dressed in black, with a ski mask on, carrying bags of money, and asked him if the money was his. When he said, yes, they let him go. On several occasions. Despite reports of a bank robbery coming in over the radio. This comment, paired with NFA non-executive Chairman Chris Hehmeyer’s attempt to claim the NFA was responsible for exposing PFGBest fraud and should be applauded (because reading a suicide note after the fact takes such intensive work), was borderline laughable.

Gensler went on to say that regulators must “do better,” and stated:

“The recent events at Peregrine highlight the necessity of looking at the decades-old system of SROs [Self-Regulatory Organizations] as first-line regulators and the commission’s role in overseeing SROs.”

Alright, point well taken. Except, he also said:

“Swap dealers, for the first time, will register and begin to come under comprehensive regulation.  This includes implementing already completed external and internal business conduct standards that will lower their risk to the economy and promote confidence in their integrity… Based upon completed registration rules and the recently completed joint rule further defining the term “swap,” we anticipate dealers will begin registering with the National Futures Association (NFA) in the early fall.”

In other words, despite the fact that the NFA, after over thirty years in the industry, failed to detect over twenty years (2/3 of their regulatory reign) of simplistic fraud, and that there have been serious questions raised regarding how they could have missed so many red flags, we are now going to be relying on them to oversee a more opaque and complex set of markets in brand new regulatory territory.

Because that sounds like a great idea, right?

This is why we’re so insistent that a full investigation of the NFA take place. We’re not calling for board resignations or immediate revocation of their charter because the one constant in this entire situation has been that we don’t have all the facts on the extent of the problems within the NFA. Clearly, the CFTC and Congress don’t have a full grasp on the situation either, or they wouldn’t be entrusting a whole new realm of oversight to them. This investigation is critical to establishing that baseline of understanding, and the development and implementation of reforms that actually address the issues moving forward.

If you haven’t signed the petition, we hope you do – click here.

PFGBest Update: NFA on hook for $870k?

If you’re going to read mainstream media coverage of the PFGBest scandal, and you’re not reading the Wall Street Journal – particularly Jacob Bunge – you’re doing it wrong. Today they report:

The note and the statement, which a person familiar with the situation said were left by Peregrine Chief Executive Russell Wasendorf Sr., blames the fraud on “mean spirited” regulators that dogged his firm, saying they were looking to put firms out of business rather than protect commodities investors. The statement also said that deceiving the regulators was “relatively simple.”

“Most of the misappropriated funds went to maintain the increasing levels of Regulatory Capital to keep [Peregrine] in business and to pay business [losses],” said the signed statement, which was reviewed by The Wall Street Journal. The statement says the misappropriated customer funds also were used to build Peregrine’s headquarters in Cedar Falls, Iowa, and to “pay Fines and Fees charged by the regulators”

At first glance, one might think this news item is a bad thing. After all, he’s saying the money was spent.  But hey- at least it’s not in some Swiss bank account we’ll never find. If much was spent on hard assets – like his private jet – that may be better for the customers as they can expect to get some sort of value from their sale, even if it is just cents on the dollar. Every penny counts.

Another silver lining? The NFA – those regulators that bungled this “relatively simple” fraud for two decades – are the ones who received the money. The problem is that it wasn’t theirs to receive; Wasendorf Sr. stole it from the client segregated funds. However, what this means is that they know exactly where it is (in their war chest).  We’re here to ask them to immediately return said funds to the courts to be included in the bankruptcy proceedings.

We can see from the NFA’s website that PFG has paid the NFA and CFTC $870,000 over the years. We are reaching out to various legal representatives to argue that those funds should be put towards making clients whole. True, this is hardly enough to make up a $200 million shortfall, but it is certainly enough to get things started in the right direction.

 Dear NFA – please send $870,000 to the customer assets pool of the bankruptcy immediately. 

PFGBest Update: One Phone Call

More news on how badly botched the verification of segregated accounts appeared to be at PFGBest in the Wall Street Journal:

Officials of the National Futures Association, an industry self-regulator, reached out to U.S. Bank in early 2011 seeking to confirm that PFGBest’s customer-account figures matched the bank’s own account, according to a person familiar with the investigation. The regulator received a response showing that the client-fund account held less than $10 million, which was far below what it was supposed to contain.

Peregrine Financial Group filed to liquidate in bankruptcy on Tuesday, after regulators sued the futures brokerage for about $215 million of client funds allegedly missing from the firm. Jerry Dicolo reports.

The NFA a few days later received a fax purporting to be from U.S. Bank that showed that the account was whole, with more than $200 million, according to this person, who added that investigators now believe the fax came from a number controlled by Mr. Wasendorf. It isn’t clear whether the NFA followed up on the original report that the account was dramatically underfunded.

If this is true, it is simply unbelievable.  How in the world is a red flag THAT big missed? Let’s take a look at the series of events. You speak with the bank, and you find out there’s a shortfall in segregated funds. Shortly thereafter, you receive a fax that negates the news you had previously received directly from the bank. You don’t call the bank back? You don’t check the number it was sent from? You don’t launch one of your legendary surprise audits? You just assume this magical fax is legit? It isn’t like the account was underfunded by a couple of bucks. This was a massive shortfall.

Forget red flag- this was a flashing neon sign that spelled fraud.