Following the PFG collapse last July, the NFA hired Berkeley Research Group (BRG) to analyze what had gone wrong. Last night, that report was set live on the NFA website. The review was exhaustive, and was meant to look into what had and hadn’t been done during the NFA audits that had taken place at PFG prior to the discovery of the fraud. BRG described the work in their executive summary, stating:

[...] the BRG Investigative Team reviewed over 190,000 NFA  documents containing over 3 million pages, including over 166,000 emails and related attachments sent  and received by current and former NFA employees.  The BRG Investigative Team also conducted  interviews of 32 individuals with knowledge of the facts or circumstances surrounding NFA’s audits of  PFG, including 25 current or former NFA employees, 5 former PFG officials (including former PFG CEO Wasendorf), the Receiver appointed by the United States District Court for the Northern District of  Illinois, and the founder of Confirmation.com, the electronic confirmation service that NFA auditors used in 2012 which resulted in the discovery of the fraud.

That’s a lot of work. What information did the efforts yield? In a letter, NFA CEO Dan Roth and Chairman Chris Hehmeyer described the findings as such:

BRG’s review found that, overall, “NFA audits were conducted in a competent fashion and the auditors dutifully implemented the appropriate modules that were required in the annual audits” following the standards set by the Joint Audit Committee.

The review also found that, unlike in the Madoff Ponzi scheme, there were no complaints from customers and no whistleblowers stepped forward to call attention to Wasendorf’s fraud. BRG specifically concluded that Wasendorf “was able to conceal his fraud meticulously by providing numerous convincingly forged documents to NFA and others.”

The letter went on to say that BRG had made a series of suggestions on how the audit process might be improved, and that the Board had voted to implement the reforms. Good news, right? It would be… except this letter skips over much of the important parts of BRGs findings. The report also found that:

• Auditors “did not always exhibit sufficient professional skepticism in assessing and evaluating fraud risk.” One individual interviewed described audits as “essentially a paper exercise.” The report found that, “without significant support, they would struggle in being able to follow up on potential indicators of fraud.”
• Many of the audit teams were inexperienced, possessing little experience or knowledge of the futures industry. In fact, 18 of the 23 NFA staff members who audited PFG between 1995 and 2012 were fresh out of college. Supervisors frequently had less than two years of experience.
•  NFA training was not always updated after relevant events (i.e. MF Global).
• Auditors testified that the work environment did not encourage junior auditors to ask questions.
• Auditors didn’t realize that Wasendorf was the only man seeing bank account statements.
• Auditors did not interact with or review the work of the outside auditors.
• Auditors were intimidated by PFG Compliance Director O’Meara, but issues were never reported to the appropriate supervisors.
• The field supervisor in the May 2011 audit that yielded the $7mm confirmation from Hope Timmerman at U.S. Bank didn’t even compare the balance on the bank confirmation to the documents provided by PFG. The staff auditor who put the paperwork together on the $7mm confirmation never escalated the issue, instead accepting corrected copy without question and assuming their supervisor would handle it.
• Despite the fact that PFG accumulated losses of over $12mm between 2000 and 2011, and Wasendorf Sr. personally contributing over $69mm to the firm in the same time period, and highly suspect interest accrual documentation, no red flags were raised by auditors and escalated to directors at NFA.
• While forged documents may not always be easy to spot, the report found managers, field supervisors and directors had spotted them in the past at other firms. 

As if that weren’t bad enough, remember the NFA’s official line about PFG when the news first hit? Let us refresh your memory.

Dan Roth, in Congressional testimony, said:

Shortly after the demise of MF Global, we formed an SRO Committee with the CME and representatives of other exchanges, including ICE, the Kansas City Board of Trade and the Minneapolis Grain Exchange. As discussed below, the SRO Committee developed a number of rule proposals that have already been approved by our Board. Early on in its deliberations, the committee recognized that we need to make better use of technology to monitor firms for compliance with segregation requirements.

In July, the Huffington Post reported on Chris Hehmeyer’s similar perspective:

Chris Hehmeyer, the NFA’s non-executive chairman, defended the organization in an interview with Reuters on Friday, saying the NFA’s insistence on requiring Wasendorf to sign an authorization to check bank balances stopped the fraud in its tracks.

“They are the ones that uncovered this whole thing,” Hehmeyer said of NFA auditors. “If they hadn’t caught him, it could have gotten a lot bigger.”

But the BRG report tells us that it was never NFA’s idea to start electronic confirmations:

According to an NFA director, after 2008,  Bank of America, one of the larger banks, sent a letter out saying that they would no longer accept paper confirmation[.]

We’re not as ready to give the NFA credit for catching the fraud in 2012, when the method needed to catch it was forced upon the organization in 2008 by outside forces.

Now, to be fair, Roth and Hehmeyer’s letter did indicate that the Board had voted to take up the recommendations of BRG, which can be found here. Much of the recommendations make a lot of sense, and we’re pleased that the Board is moving forward with implementation (even if specifics are nowhere to be found yet). That being said, while many of these changes will have a positive impact in the future, what about now? Right now, the NFA is still staffed with inexperienced and poorly informed staff auditors. Those auditors are still supervised by inexperienced auditors. And communication and record keeping (as demonstrated in the report) is still shoddy.

And what about confirming the segregated bank accounts are indeed qualified as such at the bank? What about reviewing the cash flows out of said segregated accounts? What about accountability for supervisors who don’t supervise, managers who don’t manage, and directors who don’t direct?

On the last note, it seems as though we have our answer. The Wall Street Journal reports:

The board of the National Futures Association on Thursday determined that the regulator’s senior management will stay in their jobs following an external review of the agency, prompted by last year’s collapse of Peregrine Financial Group Inc. […]

However, four top executives will forgo bonus payments for last year, NFA directors ruled Thursday after reviewing a lengthy report on the agency’s culture and oversight practices that was commissioned following the Peregrine debacle.

THAT is accountability? A handful of people get a one-time pay dock? Color us unimpressed.

Look, it’s great that we’re moving in the right direction, but there’s still a lot of work to be done. Let’s start with being honest about the contents of this report, and then address the (in)experience of the auditors we’ve charged with protecting our industry today.