U.S. Derivatives Regulator Proposes Rules for Customer Funds

U.S. derivatives regulators, faulted for poor oversight of failed brokerages MF Global Holdings Ltd. (MFGLQ) and Peregrine Financial Group Inc., proposed new rules to improve segregation and protection of customer funds.

Commodity Futures Trading Commission members voted 5-0 to approve the proposals yesterday without a public meeting, CFTC Chairman Gary Gensler said today at a Securities Industry and Financial Markets Association conference in New York.

“This proposal is about ensuring customers have confidence that the funds they post as margin or collateral are fully segregated and protected,” Gensler said of the measures, which will be open to public comment before they are completed.

The CFTC and National Futures Association, an industry self-regulator, are bolstering oversight after Peregrine, a commodities brokerage, collapsed in July with at least $200 million in client funds missing. MF Global, which filed the eighth-largest U.S. bankruptcy last Oct. 31, is returning money to customers who faced a $1.6 billion shortfall as part of the firm’s liquidation.

The CFTC, Securities and Exchange Commission and Justice Department have been investigating the collapse of MF Global, and congressional investigators are preparing a report.

“I don’t think they substantially change what’s in place,” James L. Koutoulas, chief executive officer of Typhon Capital Management LLC and president of the Commodity Customer Coalition, said of the proposals in a telephone interview. “With laws, what is most important is enforcing them.”

The coalition has urged regulators to file civil and criminal charges following MF Global’s collapse and to take steps to improve customer protection.

Electronic Access

Under the CFTC proposal, regulators would have direct electronic access to futures brokers’ bank accounts to monitor customer funds. Russell Wasendorf Sr., founder and chief executive officer of Peregrine, pleaded guilty in September to forging statements from lenders “to embezzle millions of dollars from customer accounts.” A month earlier he pleaded not guilty to 31 counts of lying to U.S. regulators about the value of customer funds held before the firm collapsed.

“If these new rules had been in place, we may not have witnessed the Peregrine or MF Global debacles,” Bart Chilton, one of three Democrats on the commission, said in an e-mail.

The proposals also would require heightened disclosure by brokers about how client collateral is held at custodial banks such as JPMorgan Chase & Co. (JPM), State Street Corp. (STT) and Bank of New York Mellon Corp. Standards for auditors of brokerages would also be increased under the rule.

Liquidity Obligation

The proposal also calls for a new liquidity obligation for brokerages in addition to existing capital requirements. The requirement is intended to better detect distressed futures brokerages that could put customer funds at risk.

“This ensures we have the ability to act in dire circumstances to protect customer money,” Chilton said.

The proposal requires brokerages to back up segregated customer accounts with funds to cover potential deficits.

Jill E. Sommers, one of two Republicans at the commission, said she is particularly interested in public comments on that aspect of the proposal.

“As always, I am sensitive to the fact that some regulation, while well-intended, may not further its stated goals or may be so burdensome that the benefits do not justify the costs,” Sommers said in a statement.

To contact the reporters on this story: Matthew Leising in New York at mleising@bloomberg.net; Silla Brush in Washington at sbrush@bloomberg.net

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net

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