PFGBest bankruptcy fuels calls for stronger protection of customer funds

The collapse of Peregrine Financial Group, which comes just nine months after the bankruptcy of MF Global, has raised the pressure on US regulators to boost protection of customer funds held by futures commission merchants.

The sudden implosion of Peregrine Financial Group, commonly known by its brand name PFGBest, has rattled the commodities trading industry and reignited the debate over whether greater protection is needed for segregated customer funds held by futures commission merchants (FCMs).

On July 9, the industry’s self-regulator, the National Futures Association (NFA), took an emergency enforcement action against PFGBest, revealing that it had discovered a shortfall of $220 million in a bank account that was supposed to hold segregated funds belonging to PFGBest customers. On the same day, PFGBest founder and chief executive Russell Wasendorf attempted to commit suicide outside the company’s headquarters in Cedar Rapids, Iowa, according to local police. On July 10, the Commodity Futures Trading Commission (CFTC) filed a complaint against the company and Wasendorf, accusing them of misappropriating customer funds and making false statements about PFGBest’s accounts as far back as 2010. Shortly afterwards, the company filed for bankruptcy.

The PFGBest debacle has shaken confidence in FCMs – especially since it follows last year’s failure of MF Global, the futures brokerage that declared bankruptcy after making ill-timed bets on European sovereign debt. “It is another hit to a market segment that is already reeling due to bad economics,” says Craig Pirrong, a finance professor at the University of Houston’s Bauer College of Business. “It has further knock-on effects to the exchanges, particularly the smaller hedgers and retail traders, who will become only more leery about the risk to their funds held by brokers and will trade less or stay out of the markets altogether as a result.”

In December, in the immediate aftermath of the MF Global bankruptcy, in which $1.6 billion in customer funds went missing, the CFTC approved the so-called ‘MF Rule,’ which tightened the restrictions on what FCMs can do with customer money. Now, the failure of PFGBest has given ammunition to those who think regulators should go even further in policing the industry and protecting customers.

“This latest development tells us that more should be done,” CFTC commissioner Bart Chilton told Energy Risk in emailed comments. “For example, I’ve called for an insurance fund to cover customer losses if something like this happens. That’s similar to what the securities and banking worlds already have.”

One possibility that some have floated is to extend the guarantees provided by the Securities Investor Protection Corporation (SIPC) – the government-mandated, member-funded entity that protects stock and bond investors in the event of a broker-dealer bankruptcy – to investors in commodity futures. “In our minds, there is zero reason why investors in traditional asset classes should be afforded such protection while investors in the alternative space are not,” said Attain Capital, a managed futures brokerage firm based in Chicago, in a blog post on July 10. Regulators should also set up a framework for handling future FCM bankruptcies in an orderly fashion, Attain Capital added.

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