The Commodity Futures Trading Commission, the
federal agency that regulates the commodity markets, has embarked on an
aggressive effort to hold individuals and banks accountable for assisting in the misuse of segregated customer funds by futures commission merchants. The CFTC’s actions come in
response to the stunning failure of two of the nation’s largest FCMs, MF
Global and Peregrine Financial Group.
Both firms engaged in conduct which, their customers
discovered too late, had caused the loss of hundreds of millions of dollars the
investors believed were safely deposited in customer segregated fund
accounts. In less than a one-year
period, both MF Global and Peregrine sought bankruptcy protection, leaving
their anxious clients scrambling to understand what happened to their funds and who was responsible.
MF Global
The 2011 collapse of MF Global occurred under the leadership
of Jon Corzine, the former CEO of Goldman Sachs who also served a term as a United States Senator as well as Governor of New Jersey before he was hired to lead the firm. According to
published reports, MF Global was a powerful force on the Chicago Mercantile
Exchange. Its customers constituted 28
percent of the trading volume on the CME, with 3 million futures and options
positions with a notional value in excess of $100 billion.
Upon accepting the CEO position at MF Global in 2010,
Corzine pursued a strategy designed to convert the firm’s business from a
futures broker to an investment bank by causing it to purchase European bonds
at a time that Europe was in financial turmoil, and then borrowing larges sums
of money using the bonds as collateral through a series of complex repurchase agreements.
As the countries whose bonds MF Global owned continued to suffer
ever-weakening economies, MF Global’s regulators required the firm to raise
additional capital in the event of margin calls. Additional disclosures about the size of its
positions caused ratings agencies to downgrade the company, which in turn
caused its creditors to demand even more collateral for the loans. As a result of the growing concern over MF
Global’s stability, clients abandoned the firm, creating additional liquidity pressures on the firm.
The combination of increasing margin calls in the face of a
liquidity crisis meant that MF Global was unable meet its debt obligations without falling below its net capital requirements. Ultimately, the firm reported a serious shortfall of hundreds of millions of dollars in its customer segregated fund account, and on October 31, 2011, it filed for bankruptcy protection. The bankruptcy trustee investigated the segregated account shortfall, and learned that MF Global had used those purportedly
protected funds to meet its increasingly unmanageable debt obligations. According to a subsequent congressional
investigation, the shortfall in the segregated funds account “was without
precedent in the history of the futures industry.” As a result, the losses to investors who deposited money with MF Global for safekeeping have been estimated to be as high as $1.6 billion.
Peregrine
Financial Group
Peregrine’s collapse also centered around the misuse of its
customer segregated fund, not as a result of mismanagement but instead because
of the outright fraud of the firm’s owner, Russell Wasendorf, Sr. At the time of its July 2012 bankruptcy,
Peregrine was the second largest non-bank, non-clearing FCM in the nation. As an FCM, Peregrine maintained customer
segregated fund accounts with U.S. Bank and the J.P. Morgan.
Beginning in 1992, Wasendorf used the customer segregated
fund account maintained at U.S. Bank (and its predecessor bank) for his own
personal and business purposes.
Wasendorf rented a post office box in town of Peregrine’s headquarters,
Cedar Falls, Iowa, for the purpose of intercepting mail intended for U.S. Bank
by one of the Peregrine’s regulators, the National Futures Association.
For two decades, Wasendorf misappropriated more than $200
million from the segregated fund account and avoided detection by falsifying
bank account statements to misrepresent to NFA auditors the amount of money in
the U.S. Bank customer segregated fund account.
At the time of Peregrine’s bankruptcy, only $7 million remained in the
U.S. Bank customer segregated fund account.
After his fraud was exposed, Wasendorf unsuccessfully attempted suicide,
and has now pled guilty to fraud and is currently serving a 50-year prison
sentence.
CFTC Enforcement
Actions
As the federal regulator of FCMs, the CFTC has now adopted
an aggressive enforcement strategy for the massive losses suffered in the
customer segregated fund accounts for MF Global and for Peregrine which had not
been discovered by regulators prior to the firms’ respective bankruptcy
filings.
On June 25, 2013, the CFTC announced its intention to file
suit against Corzine for his role in causing the losses in MF Global’s customer
segregated fund accounts. Quoting law
enforcement officials, the New York Times reported that the agency will blame
Corzine for failing to sufficiently supervise the firm and prevent the bad acts
of lower-level employees. According to
the Times, the CFTC advised Corzine’s lawyers that it intended to file the case
without first giving him the opportunity to settle, setting the stage for a
protracted and public legal fight.
The CFTC’s expected action against Corzine comes shortly
after it filed a lawsuit against U.S. Bank for its participation in Wafendorf’s theft
of Peregrine customer funds. On June 5,
2013, the CFTC filed a complaint against the bank alleging that U.S. Bank knew
that Wasendorf was using customer funds in the segregated account for improper
personal and business purposes.
Additionally, the CFTC alleges that U.S. Bank improperly used the
segregated customer account as collateral for a $6.4 million construction loan
to one of Wasendorf’s affiliate companies and a $3 million personal loan to
Wasendorf. While U.S. Bank is not
regulated by the CFTC, the agency asserts that the bank’s actions are governed
by the Commodity Exchange Act, which makes is unlawful for a bank that has
received customer funds to hold or use such funds for the benefit of anyone
other than the FCM’s customers. The CFTC,
authorized to enforce the CEA and its implementing regulations, alleges that
U.S. Bank violated the statute’s requirements.
Conclusion
While neither CFTC action will directly protect investors
from future episodes of FCMs plundering customer segregated funds, they serve
as an important message that the federal government will pursue individuals and
institutions that assist misconduct that results in the loss of investor monies. Even though the CFTC does not contend that
either Corzine or U.S. Bank actually misappropriated the missing funds, the
agency nonetheless considers them responsible for allowing the losses to
occur. While more needs to be done to
prevent the misappropriation of customer funds, the CFTC’s actions appear intended to give some assurance to commodities investors that all wrongdoers
responsible for their losses will be pursued.
