Less than nine months after MF Global's collapse sent shock waves through U.S. futures brokerages, news that more than one-half of customer funds at Iowa-based PFGBest are missing threatens to shatter the fragile confidence in the industry.
PFGBest, a 20-year old broker of foreign exchange and commodity futures, on Monday told customers their accounts had been frozen after an apparent suicide attempt by its chairman. A few hours later, an industry body said about $220 million in customer funds were not in the brokerage's bank accounts.
While PFGBest is less than one-tenth the size of MF Global, the fallout may be larger. If the National Futures Association's (NFA) report on the missing funds proves accurate, questions about the safety of the brokerage model and whether regulators have again been found wanting are inevitable.
"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 had been accused of dipping into customer funds to help meet margin calls.
"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 owner Russell R. Wasendorf Sr., a 40-year veteran of futures markets, was found in his car near the company's Iowa headquarters, having apparently attempted suicide. 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.
It is not clear what has happened to the missing funds. PFGBest officials were not immediately available to comment beyond a notice sent to customers, saying 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.
"We had personal assurances from Wasendorf senior 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 well-regarded 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 the Wasendorfs at PFGBest for about two-and-a-half years as a managed futures broker.
"I know them personally, I watched them operate. I'm reserving judgment until the officials come out with definitive confirmed information."
Others expressed less shock.
One former employee of the firm said he had grown concerned that Wasendorf didn't 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.
Wasendorf's son, Russ Wasendorf Jr., briefed employees on Monday. One employee said he sounded "extremely depressed, confused, stunned."
"I would say he probably didn't have any idea this was going on," he said.
Many PFGBest employees contacted by Reuters said they expected the firm to fold. One said PFGBest is "doomed."
PFGBest was among the firms that scrambled to reassure customers of the safety of their funds last November, just after MF Global's collapse, posting 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 trading accounts to PFGBest.
Unlike MF Global, which is believed to have misused customer funds in a mad scramble to meet margin calls on proprietary trades, PFGBest was not believed to have placed trades with its own funds and doesn't seem to have suffered an exodus of customers.
Also unlike MF Global, PFGBest's shortfall may extend back years, raising even larger questions about regulators. The NFA said on Monday that previous customer account balances from February 2010 and March 2011 reported by the firm may have been inflated by as much as $190 million, with PFGBest only holding $10 million of a claimed $200 million.
In the letter, it said PFGBest's clearing unit, Peregrine Financial Group (PFG), had told the NFA just two weeks ago that it held $400 million in customer segregated funds, of which over $225 million was on deposit at the firm's bank.
But on Monday, after receiving information that PFG's founder and owner may have falsified bank records, the NFA said that only $5 million was on account at the bank days earlier.
Unlike the securities markets, customers of futures brokers do not enjoy any government or industry-backed insurance program in the event funds are stolen or go missing.
"Such a fund is critically important. Futures customers should be protected like banking and securit(ies) customers are protected," Bart Chilton, one of five Commodity Futures Trading Commission (CFTC) commissioners, said late Monday.
In the wake of the MF Global collapse last year, exchange operator CME Group Inc 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.
While regulators have taken some small measures to toughen up rules protecting customer accounts, investors have said they may not be sufficient to fully restore faith in the industry.
A joint review of the 70 largest Futures Commission Merchants (FCMs) by the CFTC and NFA in January found no "material breaches of customer funds protection requirements during the spot check," leading traders to question the thoroughness of the review.
"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."
FROM BASEMENT TO COMPOUND
PFGBest is far smaller than the big broker-dealers that dominate the futures trading business, but was among a dozen or so well-known independent firms that tended to cater to local traders, farmers, wealthy individuals or smaller retail players.
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 home town, describing the new building as a "compound" but also acknowledged 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, while electronic trading threatens their role as middlemen.
"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.
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