CFTC Completes Client-Funds Rule After MF Global Collapse

U.S. derivatives regulators approved restrictions on how brokers can invest customer funds, acting on a delayed rule after as much as $1.2 billion went missing before MF Global Holdings Ltd. sought bankruptcy protection.

The Commodity Futures Trading Commission voted 5-0 today to limit how brokers invest clients’ margin in money market funds, and ban investments in foreign sovereign debt and in-house transactions such as repurchase agreements.

CFTC Commissioner Bart Chilton, one of three Democrats on the five-member panel, pushed for completion of the measure, which he dubbed the “MF rule.” CFTC Chairman Gary Gensler said the regulation is “critical for the safeguarding of customer money” by preventing in-house repurchase transactions.

“I believe there is an inherent conflict of interest between parts of a firm doing these transactions,” Gensler said at the CFTC meeting in Washington.

The rule approved today will overturn a policy, instituted in 2005, that let brokers invest client funds in in-house transactions. It will ban such trades by brokers, who earn interest income by investing funds from segregated accounts, while allowing third-party deals, according to a CFTC summary.

Brokers will also be permitted to invest client funds in U.S. Treasuries, municipal debt, money-market funds and debt of Fannie Mae (FNMA) and Freddie Mac (FMCC) as long as the two housing finance companies are under the conservatorship of the Federal Housing Finance Agency, according to the summary.

180 Days

The rule will take effect 60 days after its publication in the Federal Register. Brokers will then be required to comply within 180 days.

“This rule is necessary to restore confidence,” said Mark Wetjen, a Democrat participating in his first rulemaking meeting as a CFTC commissioner.

Gensler delayed the rule in July after being lobbied by brokers and their executives including Jon S. Corzine, the former New Jersey Governor then serving as MF Global’s chairman and chief executive officer. The rule would govern brokers including Newedge USA LLC and the futures brokerage subsidiaries of banks such as Morgan Stanley. (MS)

MF Global, the first Wall Street firm to fail since the Dodd-Frank Act was signed into law last year, filed for bankruptcy protection on Oct. 31 after making wrong-way bets on European sovereign debt. Corzine resigned on Nov. 4.

Missing Funds

James W. Giddens, the trustee overseeing the bankruptcy of MF Global’s brokerage subsidiary, estimated a $1.2 billion- shortfall in client funds. It isn’t known whether the missing funds are related to practices prohibited by the rule.

The CFTC, Securities and Exchange Commission and U.S. Justice Department are investigating the missing client funds.

The House Agriculture Committee voted last week to issue a subpoena to compel Corzine to testify at a Dec. 8 hearing.

“The events that have unfolded since Oct. 31 are unprecedented and have resulted in the loss of property of many of our constituents and a loss of confidence in the futures markets,” Representative Frank D. Lucas, the Oklahoma Republican who leads the Agriculture Committee, said last week.

The Senate Agriculture Committee and House Financial Services Oversight and Investigations subcommittee separately announced plans to consider subpoenas this week for Corzine, a Democrat who served in the Senate before running for governor.

In a separate vote today, the CFTC moved unanimously to complete rules governing foreign boards of trade. The measure would set up a registration system for the trading venues when they provide direct access to U.S.-based traders.

Commissioners also voted 4-1 to seek public comment on a proposal for how exchanges and so-called swap execution facilities decide to make swaps available for trade. Under the proposal, the trading platforms must consider a series of factors, including volume, the number and type of market participants and whether there are ready and willing buyers and sellers. The platforms then must submit their determination to the CFTC for approval or other self-certification procedures.

To contact the reporter on this story: Silla Brush in Washington at sbrush@bloomberg.net

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net

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