Analysis: For brokers like Peregrine, from bad times to worse

Mon Jul 23, 2012 5:29am EDT
 
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By Ann Saphir and Jeanine Prezioso

CHICAGO/NEW YORK (Reuters) - Long before Peregrine Financial Group's dramatic collapse last week, months before MF Global's meltdown triggered an industry-wide crisis of confidence, the world of the independently owned futures broker was not a happy one.

Even as trading volumes handled by these relatively small futures commission merchants (FCM) boomed over the past decade, profits were dwindling: electronic trading, the rise of the hedge fund and rapid-fire algorithmic trader, and the slump in interest rates had upended their century-old business model.

Some turned to speculating with their own money, trade finance or market research to bolster earnings; others have been sold, further depleting the ranks of an industry which saw market share halved in 10 years. Two, MF Global and Peregrine, allegedly looted their customers' money to try to stay afloat.

"The root cause of issues at both firms was the lack of profitability," says Gary DeWaal, general counsel of broker Newedge, which is owned by two French banks and is one of the world's largest futures brokerages.

"That caused the principals to do things that, in the end, were probably not such a good idea," he deadpanned.

The worst may not be over. Every new proposal to restore traders' trust in the futures markets threatens to further erode already wafer-thin margins. And an obscure new swaps rule imposed as part of the Dodd-Frank financial overhaul is amping up the risk brokers must take to hold their clients' cash.

Within that context, it becomes somewhat easier to see why Peregrine's founder and chief Russell Wasendorf Sr., who cast himself as a leading figure in the futures world until last week, said in his confession he "hated" the industry. Beneath the trappings of success, including a private jet and an $18 million headquarters, was a two-decade fraud in which he used over $200 million of customer funds to stave off collapse.

Jerry Markham, a law professor at Florida International University in Miami who has written extensively about regulations and collateral, summed up the challenge ahead:   Continued...

 
The building housing the PFGBest headquarters is seen in Chicago July 11, 2012. REUTERS/John Gress