July 10, 2012 / 7:00 AM / 7 years ago

MF Global redux: CFTC says Iowa broker misused over $200 million

NEW YORK/CHICAGO/WASHINGTON (Reuters) - The U.S. futures trading industry reeled on Tuesday as federal regulators accused Iowa-based broker PFGBest of misappropriating over $200 million in customer funds for more than two years in an alarming echo of MF Global’s collapse.

A trader working in the crude oil and natural gas options pits on the floor of the New York Mercantile Exchange in New York August 8, 2011. REUTERS/Shannon Stapleton

The Commodity Futures Trading Commission (CFTC), which had give a clean bill of health to dozens of brokers in January, said that the firm’s regulated Peregrine Financial Group (PFG) unit and its owner had failed to maintain sufficient capital in segregated accounts since at least February 2010.

It also said the broker lied to regulators in order to hide the shortfall, which now stands in excess of $200 million, more than half of the broker’s total client funds.

“The whereabouts of the funds is currently unknown,” the CFTC said in a complaint against the PFG and its founder and chairman, Russell R. Wasendorf Sr., whose apparent suicide attempt on Mon day morning outside the firm’s Cedar Falls, Iowa, offices appears to have triggered the crisis.

The shortfall is modest relative to the estimated $1.6 billion missing from MF Global’s accounts, but news of a second broker violating sacrosanct segregated customer funds threatens to shatter the fragile confidence in the industry which once prided itself on an unblemished record in protecting client money.

Wasendorf, a well-known and mostly well-regarded figure in the industry over a four-decade career as a journalist, trader and executive, was reported to be in a coma, the filing said.

The complaint relies on many of the details released on Monday by the National Futures Association (NFA), the broker’s first line regulator, which discovered during an audit that a U.S. bank account that PFG reported was holding $225 million in 1,845 customer accounts actually contained only $5 million.

As customers faced the prospect of millions of dollars in losses, or at a minimum a lengthy wait for the return of frozen funds, traders were quick to call for better regulation to protect their funds. While a dozen new measures had been proposed after MF Global’s bankruptcy, few have been implemented.

“It’s déjà vu all over again,” said John Roe, co-founder of the Commodity Customer Coalition (CCC), set up in the aftermath of MF Global’s collapse last October to help clients recoup their money. In its dying days, MF Global dipped into customer funds to help meet margin calls, investigators believe.

“Everyone in the industry claimed this couldn’t happen again, but if the money really is missing, then it’s like a repeat of MF Global. Anyone who thought things don’t need to change, well, have to reappraise their position,” Roe added.

The PFGBest disclosure came hours after Wasendorf Sr., a 40-year veteran of futures markets, was found in his car o n Monday morning after an apparent suicide attempt. He was in critical condition at the University of Iowa Hospitals and Clinics on Monday. A hospital spokesman said he was unable to comment on Wasendorf’s status on Tuesday due to federal privacy laws.


PFGBest, a well-known broker for U.S. foreign exchange and commodity markets for 20 years, was among a dozen or so mid-sized, independent brokers that scrambled to reassure customers of the safety of their funds after MF Global’s collapse.

In February it posted a notice that the firm “reports daily and monthly to regulators concerning customer segregated accounts.” A number of former MF Global customers also moved their accounts to PFGBest.

But unlike MF Global, which is believed to have misused customer funds in a mad scramble to meet margin calls on proprietary trades in its waning days, PFGBest’s abuse may have extended back years, according to the complaint. There is no indication yet how or why that money was used.

The CFTC case filed in the U.S. District Court for the Northern District for Illinois, Eastern Division, alleges that PFG failed to segregate customer funds, committed fraud by misappropriation and reported false data to regulators.

The CFTC complaint says that PFG records showed a balance of $207 million in the 1,845 customer segregated accounts as of February 28, 2010, although the actual bank balance was under $10 million. They said the same sum was in the account as of March 30, 2011, when PFG records showed a balance of $218 million. The same accounts showed just $5 million this week, it said.

The NFA order said the accounts were held at U.S. Bank. A source familiar with the situation said that PFG’s balance had been steady at around $5 million for several years.

Some have advocated adopting a government or industry-backed insurance program that would protect futures traders, similar to a scheme that has long existed for securities investors.

But Iowa Senator Chuck Grassley, a senior Republican and member of the Agriculture Committee, said it was premature to start talking about an indemnity fund or changes to the law.

“Right now, I’d like to concentrate on whether the regulators are doing their job,” he told reporters.

Much of the early criticism is already falling to the CFTC, which said it found no “material breaches of customer funds protection requirements” during a joint review of the 70 largest FCMs with the NFA in January.

“We should now move to approving the National Futures Association proposal for greater controls for segregation of customer funds,” CFTC Chairman Gary Gensler told a hearing on Tuesday. “We also should take up staff recommendations to further enhance segregation of customer funds.”

He said agency staff were working on measures that could improve internal controls and transparency.

In the wake of the MF Global collapse last year, exchange operator CME Group set up an insurance fund that covers farmers and ranchers for up to $25,000 and cooperatives for as much as $100,000 when a clearing member fails.

CME Group could not immediately respond to a question about whether the fund would kick in for PFGBest.

“You would think that the government would be watching these accounts and doing something,” one PFGBest employee said.

“The NFA can’t regulate this industry.”


On Tuesday, the firm’s clearing broker Jefferies Group Inc, which was responsible for clearing trades through exchanges like those run by CME Group, said it had begun unloading positions held on behalf of PFG’s clients after it failed to meet a margin call. It said a “substantial portion” had already been closed and it did not expect to incur losses.

As a “non-clearing” futures commission merchant (FCM), PFGBest acted as a middleman for mostly small-scale or retail traders, passing those trades to Jefferies to clear.

Because it was not a clearing member of the CME, a not-uncommon arrangement for smaller brokers that do not want or are unable to keep enough capital of their own, the regulatory burden falls to the industry NFA and the CFTC, letting the CME Group — which suffered harsh criticism as the front-line regulator of MF Global — off the hook.

PFGBest officials have said nothing beyond a notice to clients on Monday confirming an investigation into “account irregularities” following the suicide attempt and advising customers that they could liquidate open trading positions but would not be able to withdraw cash or initiate any new trades.

Local law enforcement officials said the investigation would likely pass to the U.S. Attorney’s Office shortly.

The Omaha, Nebraska, office of the Federal Bureau of Investigation (FBI) said it was investigating the case.

“We had personal assurances from Wasendorf Sr. as recently as two weeks ago that they were not like MF Global,” said Lauren Nelson, director of communications for Attain Capital, an introducing broker specializing in managed futures in Chicago.

“We’ve been speaking to other FCMs (Future Commission Merchants) in the hope we can eventually transfer our accounts over. But the fear is the funds are gone, the regulators have really dropped the ball.”


The shock was twofold for many in the tight-knit trading industry, who struggled to reconcile the apparent suicide attempt with the industry veteran known for his hometown philanthropy and passion for peregrine falcons.

“I always thought they were straight shooters,” said Mark Melin, an author and futures-industry consultant, who worked for PFGBest for about 2-1/2 years.

Others expressed less shock.

One former employee of the firm said he had grown concerned that Wasendorf did not do more to distance the company from a massive $194 million forex-trading Ponzi scheme run by Trevor Cook in Minnesota, who admitted defrauding more than 700 investors. Cook is serving 25 years in prison.

In February, PFGBest, which had acted as Cook’s broker, was fined $700,000 by the NFA for failing to notice the scheme. The company was subsequently sued for $48 million by the receiver rounding up the assets from Cook’s scheme.

“They never admitted they were aware of what was going on, but they didn’t deny it either,” said the former employee.

Many PFGBest employees contacted by Reuters said they expected the firm to fold. One said PFGBest is “doomed.”


Wasendorf Sr., who started as a commodities trader in the basement of his Cedar Falls home in 1972, used a windfall profit from the “Black Monday” stock market meltdown in 1987 to expand, formally launching the predecessor of PFGBest in 1992.

The firm grew significantly over the past decade, opening offices in Canada and Shanghai and buying smaller rivals.

In 2009, Wasendorf moved the firm’s headquarters from Chicago back to a facility in his hometown of Cedar Falls — a 50,000 square-foot, three-story glass headquarters that cost $18 million and was celebrated for its eco-friendly construction, geothermal climate control and four-star employee cafeteria.

The former employee said there was a “messianic” quality to Wasendorf’s desire to shift operations to his hometown, describing the new building as a “compound” but also acknowledging a practical aspect to the move.

The industry has come under enormous strain lately as ultra-low interest rates sap revenue from holding customer funds and electronic trading threatens the role of middleman.

“A large part of trying to move everything to Iowa was about slashing costs. It’s obviously a lot cheaper to hire someone in Iowa than it is in Chicago,” he said. (Reporting by David Sheppard and Jonathan Leff in New York, Tom Polansek and PJ Huffstutter in Chicago, Chuck Abbott and Alexandra Alper in Washington; editing by Ryan Woo and Jeffrey Benkoe; editing by Jim Marshall)

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