U.S. futures regulators, scrutinized for missing warning signs before the collapse of Peregrine Financial Group Inc., defended their oversight to congressional lawmakers today and called for new rules.
The Commodity Futures Trading Commission, the nation’s derivatives overseer, identified lapses in financial controls in at least three reviews of Peregrine since 2000, Gary Gensler, the agency’s chairman, told a House Agriculture Committee hearing today. Gensler called for new reviews of self-regulatory organizations, including the National Futures Association, the company’s primary overseer.
“The question remains: Who is minding the store?” Representative Frank D. Lucas, an Oklahoma Republican and chairman of the panel, said at the hearing. “New regulations mean nothing when regulators are not enforcing the existing rules on the books. What we need is regulators doing their job.”
About $220 million in segregated client money is unaccounted for at Cedar Falls, Iowa-based Peregrine, which does business as PFG Best. Founder and Chief Executive Officer Russell Wasendorf Sr. was ordered held in custody July 13 following a suicide attempt and a signed confession that he had defrauded customers for 20 years.
Wasendorf forged the company’s statements from Firstar Bank, US Bank and Harris Bank, he said in the signed statement. He also made forgeries of official letters and correspondence from the banks, along with trade confirmation statements. He used photo-editing and spreadsheet software, as well as scanners and printers, to produce “convincing forgeries” of almost every bank document.
The commission sued Peregrine over the shortfall on July 10, less than a year after being scolded for poor oversight following the collapse of MF Global Holdings Ltd., which left an estimated $1.6 billion gap in customer funds. The CFTC, Securities and Exchange Commission and Justice Department are probing the MF Global collapse.
Representative Jean Schmidt, an Ohio Republican, said the ultimate responsibility for oversight failures at Peregrine resides at the CFTC.
“I believe the buck stops with you,” Schmidt told Gensler. “We can continue to put out more regulations but if you’re not being the watchdog, the citizens will continue to be hurt.”
Gensler said the futures-regulatory system “clearly failed” to protect Peregrine customers. “I think that we have to take a close look at all that CFTC did to oversee the NFA and also the markets such as Peregrine,” Gensler said.
The commission reached a settlement with Peregrine in 2000 to resolve allegations that the firm violated capital rules. Peregrine was ordered to improve its financial controls and retain an independent accountant to review accounts.
The CFTC relies primarily on NFA and other self-regulatory organizations as front-line monitors of futures market participants. In turn, the CFTC oversees NFA and conducts periodic reviews to ensure the self-regulator is properly overseeing the industry. The agency also performs limited-scope reviews of futures brokers. Two such reviews of Peregrine conducted by the agency in 2007 and 2008 didn’t detect fraudulent activity.
The commission staff in those years reviewed “classification and reporting of customer-owned securities and the investment of customer funds,” Gensler said in the testimony. “The limited reviews identified improperly titled segregation bank accounts, which were corrected during the examination.”
The agency is strengthening oversight of self-regulatory organizations, Gensler said. “I have directed the CFTC’s staff to do a full review of how the agency conducts oversight of the SROs” and limited-reviews of futures brokers, he said. “I believe we need to carefully consider additional rules.”
The NFA has begun a review of internal audit procedures and how they were used to oversee Peregrine, Roth said. “The simple fact is that Wasendorf’s forgeries fooled us, and fooled us for longer than any of us would like,” he said.
The association’s board will consider new rules at an August meeting that would require futures brokers provide online access to bank balances for customer funds to their self-regulators, Roth said.
Terrence Duffy, executive chairman of CME Group Inc., the world’s largest futures exchange, said a proposal by the company to house all customer funds at clearinghouses or other depositories “will be controversial and perhaps have disruptive consequences,” according to written testimony.
Futures investors have lost money held by the futures brokers at MF Global and Peregrine rather than by clearinghouses or clearing member banks. Brokerages often hold excess collateral in customer accounts, which by law must be kept segregated from the firm’s own money, and which can be used by the brokerages to earn interest income.
CME Group said July 23 when it introduced the idea of housing all customer money away from brokerages that any interest earned would be returned to the futures brokerages to maintain a key feature of how the firms earn revenue.
“While it will be controversial and perhaps have disruptive consequences, we should explore whether customer property not required as collateral at clearinghouses should, nonetheless be held by clearinghouses or other custodians,” Duffy said in testimony prepared for the hearing. He also said limits on the ability of brokerages to transfer customer property other than to authorized parties may be needed.
Duffy also said the U.S. bankruptcy code should be changed to allow for the timely transfer of customer money away from a failed brokerage.
“We propose that Congress amend the bankruptcy code to permit clearinghouses that hold sufficient collateral to support customer positions of a failed clearing member promptly to transfer all customer positions with supporting collateral, except defaulting customer positions, to another stable clearing member,” he said.