Nobody likes to lose money — least of all when it occurs in a system long considered safe. Regulators, exchanges, futures firms, and individual brokers have all taken pride and advertised that futures customer funds are segregated from any monies or positions of the clearing member holding customer funds. As CME Clearing’s Financial Safeguards document states: “The (segregation) regulations are designed to protect customers in the event of insolvency or financial instability of the clearing member through which they conduct business. CME Group’s Audit Department routinely inspects the books and records of the clearing members to ensure among other things, their compliance with segregation requirements.” Prior failures of Futures Commission Merchant firms posed little to no disruption to the firm’s futures customers — the entire book of accounts, positions and funds were typically transferred intact to another firm or firms that seamlessly integrated that business. “Business as usual” had been the mantra in the past; customers were literally segregated from the financial losses of the firm that had held their account(s).
Then came October 31. The collapse of MF Global and the discovery that something in excess of $1 billion of customer segregated funds were unaccounted for in the final days before the MF Global bankruptcy filing shook the futures industry to its core. MF Global’s demise wasn’t just about one firm’s failure; this exposed systemic weaknesses in these regulations and laws governing the protection of customer funds held in all futures and options accounts at all firms. Customers and brokers alike discovered that the “letter of the law” and the perceived customer protections were quite different. Some accounts found their positions transferred to other firms by Nov. 4, while other accounts remained at MF Global which was no longer able to handle transactions. But much of the customer segregated funds, including Treasury Bills, remained either missing or seemingly in ‘limbo.’
MF Global became mired in both an S.I.P.A. liquidation and the eighth largest bankruptcy in the U.S. (bigger than Chrysler). The actions are governed under separate laws and regulations, and encompass 38,000 futures customers (and 400 securities accounts) from London to Los Angeles. The SIPA Securities & Investors Protection Act liquidation is overseen by Trustee James Giddens, with the Chapter 11 reorganization of MF Global Holdings overseen by Trustee Louis Freeh. The end result has been a legal tug of war, crossing continents and jurisdictions with customers caught in the crossfire at times. It wasn’t until mid-December, and after three transfers of cash, that customers had a reasonably complete record of movement of their funds to date. Approximately 72% of customers’ account balances have been returned with the remainder showing as an unrecovered asset and a claim against MF Global. Even by mid-January, the remaining dollars have not officially been located, let alone recovered.
Bankruptcies aren’t resolved quickly, and there’s reason to hope more customer dollars will be recovered, or that other resources may assist in covering customer losses. But the core issue remains: How could this happen and what’s being done to ensure it doesn’t happen again?
The weakness in the system is that the protections are sufficient, but only if an FCM does not remove customer segregated funds for any purpose other than those allowed for under law. For instance, FCMs may hold and invest Seg Funds in certain instruments authorized under CFTC regulations, with the interest earnings accruing to the FCM. If an FCM fails but all Seg Funds are held as required, regulators can quickly “sell” and move the accounts and funds to other firm(s). But it came to light there is no insurance coverage nor other protections against outright shortfalls in customer Seg Fund balances.