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 fraud of more than $100-million (U.S.) that spanned two decades.
In testimony before the Senate Agriculture Committee, Commodity Futures Trading Commission Chairman Gary Gensler outlined his agency’s plans to contain the fallout from the Peregrine case, including proposed new rules that would give regulators direct access to brokers’ bank accounts and a reassessment of the role of self-regulatory organizations (SRO).
“Although we do not know the full facts of what happened in this matter, the system failed to protect the customers of Peregrine,” Mr. Gensler said. “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 levelled 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,” Mr. Gensler said.
A handful of new rules aimed at boosting protections for futures customers’ money were sent to commissioners’ offices on Monday evening, Mr. Gensler told reporters after the hearing.
In addition to improving direct access to brokers’ bank and custodial accounts, the rules would give customers more transparency into their holdings. Some brokers including independent Rosenthal Collins Group and Citigroup have moved over the past week to open a window on customer funds in an effort to restore traders’ trust in the system.
The MF Global and PFGBest scandals have raised questions about the strength of federal commodities regulations designed to segregate and protect customer funds.
Mr. 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. Mr. 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.
Mr. 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.
Republicans and Democrats on the committee used the opportunity to refresh long-standing grievances related to the CFTC and the raft of derivatives reforms it must implement under the 2010 Dodd-Frank law, from its vastly expanded oversight powers to the battle over how to fund the agency.
“If anyone is wondering why we need these rules, all you need to do is turn on the news,” said Democratic Senator Debbie Stabenow, chairwoman of the Agriculture Committee.
Senator Pat Roberts, the committee’s ranking Republican member, slammed Gensler for being “too busy working on his inter-galactic plan” – a nod to its role overseeing the vast swaps market – to keep an eye on its futures beat.
“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,” Mr. Roberts added.
On the same day as Mr. 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 Mr. 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. He said that letters confirming bank balances “must come directly to regulators from banks and custodians.”
Mr. Gensler hopes to incorporate the new NFA regulations approved last week into the commission’s own rules, so it can “directly enforce” the reforms.
He said he has asked for a public roundtable to discuss what other customer protections are needed.
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