The world is flat. This adage rings true within the hedge fund industry, as hedge fund managers face a difficult capital raising environment and are seeking access to a wider global investor base. With these challenges in mind, an increasing number of managers are taking stock of how they fit in with the global expectations of their investors. This article will provide a road map to such managers, examining the various fund structuring, product options and distribution methods available to U.S. fund managers seeking greater access to the global market.

Product Options

U.S. fund managers looking to attract European investors, who represent a significant amount of investor assets, should understand that these investors typically prefer to invest in European regulated products. The preference for European regulated products is partly based on the perception that the addition of a custodian/depository coupled with the increased regulatory oversight may decrease the risk of a substantial fraud or even negate the effects should one arise.

Of course, being able to provide these benefits to investors preferring a European product means that managers will be exposed to new challenges such as increased compliance, monitoring and reporting, which add to costs in an age where management fees are being challenged and cost management is a priority focus. Admittedly, potential increased reporting to a second or third regulator coupled with increased costs can be off-putting when considering global distribution.

But the current global landscape and expectations indicate that managers looking to grow their assets under management need to transverse a number of regulators and consider different products to attract a global investor’s base. If done well, costs can be managed and profits realized.

UCITS

The Undertaking for Collective Investments in Transferable Securities (UCITS) offers distributable product across the E.U. Initially, the UCITS structure was developed and envisaged as a mutual fund directive; however it has been adopted by hedge fund managers because it provides investors a recognizable mark of quality that the market needed post 2008. The success of the product is illustrated by many statistics, including the fact that 70% of funds publically distributed in Asia are UCITS and the growth of combined UCITS assets under management (AUM).

So what’s the potential downside? First, many hedge fund managers have found that their strategy does not fit within the UCITS framework or needs significant alternation to meet the portfolio guidelines, liquidity terms and significant upfront costs to name a few. Where a strategy does fit, the UCITS brand is worth considering due to recognized brand/quality market perception.

AIFMDs

Where a strategy does not fit, hedge fund managers may now be able to fully replicate their strategies in a dedicated hedge fund product under the Alternative Investment Fund Manager Directive (AIFMD). AIFMD was developed as the hedge fund equivalent of the UCITS and provides a strong alternative where a UCITS does not meet the objectives and needs.

QIFs and SIFs

These alternative funds are overseen by the same regulatory framework as UCITS. The Qualifying Investor Fund (QIF) is regulated by the Irish Financial Regulator and the Specialised Investor Fund (SIF) by the CSSF in Luxembourg. Increasingly, the majority of hedge fund managers are launching alternative funds under the QIF and SIF brands than under UCITS. We expect this trend to continue since funds established under the European directive meet the requirements of and are overseen by local regulators while giving managers a lower cost option that restricts their strategy less.

Distribution Options

By allying a European fund with the existing Cayman Master Feeder structure, a manager can create a suite of products that attract U.S. onshore, U.S. tax exempt, European, Asian, Latin American and Australian investors.

While structures can evolve in any number of ways, here are two basic options:

The first model assumes that most U.S.-based managers have U.S. limited partnerships which are utilized due to their tax advantages for U.S. taxable investors.

For a significant percentage of alternative managers in the U.S., the addition of a Cayman fund facilitated access for U.S. tax exempt investors, institutional investors as well as European High Net Worth Individuals (HNWI’s).

As such, managers who can replicate (marginally amended or otherwise) their strategy in a UCITS fund will help gain access to European pension plans, institutions and Asian investors that may otherwise be inaccessible.

For the alternative managers that are unable to access the European, Asian and Latin American investors yet whose strategies do not fit into a UCITS, the implementation of AIFMD creates a great alternate through the QIF or SIF, which are being referred to as the ‘Alternative UCITS’.

When AIFMD is fully implemented, non European managers will be prohibited from marketing their offshore product to European investors.

While the world is flat, capital raising doesn’t have to be limited to one jurisdiction as a result of not having the right structure or products. In light of the pending restrictions on non-European based investment managers under AIFMD, it’s important to be aware of European products, capital raising opportunities and limitations with European and other international investors.

Derek Delaney is Managing Director of DMS Offshore Investment Services (Europe) Limited and Global Head of Business Development for dms Fund Governance Ltd. He can be reached at ddelaney@dmsoffshore.com.

Speaking to Reuters Insider, Rep. Barney Frank (D-Mass.) critiques the pace of Wall Street reforms and regulatory rulemaking two years after his namesake legislation took effect. (more…)

If you have been following the blog, or know anything about Attain, then you know that last week, the industry was rocked by the revelation that Russ Wassendorf, Sr., CEO of FCM PFGBest, attempted to commit suicide, leaving behind a note that indicated he had been falsifying bank statements showing how much customer funds PFG had on deposit.  The most important parts of his confession are below (emphasis ours).

I have committed fraud. For this I feel constant and intense guilt. I am very remorseful that my greatest transgressions have been to my fellow man. Through a scheme of using false bank statements I have been able to embezzle millions of dollars from customer accounts at Peregrine Financial Group, Inc.The forgeries started nearly twenty years ago and have gone undetected until now. I was able to conceal my crime of forgery by being the sole individual with access to the US Bank accounts held by PFG. No one else in the company ever saw an actual US Bank statement. The Bank statements were always delivered directly to me when they arrived in the mail. I made counterfeit statements within a few hours of receiving the actual statements and gave the forgeries to the accounting department.

… I had no access to additional capital and I was forced into a difficult decision: Should I go out of business or cheat? I guess my ego was too big to admit failure. So I cheated, I falsified the very core of the financial documents of PFG, the Bank Statements. At first I had to make forgeries of both the Firstar Bank Statements and the Harris Bank Statements. When I choose [sic] to close the Harris Account, I only had to falsify the Firstar statements [elsewhere in signed statement Wasendorf noted that Firstar "eventually became US Bank"]. I also made forgeries of official letters and correspondence from the bank, as well as transaction confirmation statements.

Using a combination of Photo Shop, Excel, scanners, and both laser and ink jet printers I was able to make very convincing forgeries of nearing every document that came from the Bank. I could create forgeries very quickly so no one suspected that my forgeries were not the real thing that had just arrived in the mail.

With careful concealment and blunt authority I was able to hide my fraud from others at PFG. PFG grew out of a one man shop, a business I started in the basement of my home. As I added people to the company everyone knew I was the guy in charge. If anyone questioned my authority I would simply point out that I was the sole shareholder. I established rules and procedures as each new situation arose. I ordered that US Bank statement were to be delivered directly to me unopened, to make sure no one was able to examine an actual US Bank Statement. I was also the only person with online access to PFG’s account using US Bank’s online portal. On US Bank side, I told representatives at the Bank that I was the only person they should interface with at PFG.

When it became a common practice for Certified Auditors and the Field Auditors of the Regulators to mail Balance Confirmation Forms to Banks and other entities holding customer funds I opened a post office box. the box was originally in the name of Firstar Bank but was eventually changed to US Bank. I put the address “PO Box 706, Cedar Falls, IA 50613-0030″  Confirmation Forms to the Bank’s false address, I would intercept the Form, type in the amount I needed to show, forge a Bank Officer’s signature and mail it back to the Regulator or Certified Auditor.

When online Banking became prevalent I learned how to falsify online Bank Statements and theRegulators accepted them without question.

Twenty years. Photoshop.  An Iowa P.O. Box. Let that sink in.

This never should have happened. It doesn’t take someone familiar with the details to know that.  Every customer of PFGBest relied on the NFA to perform their duty and sufficiently audit the financials of PFG for each of the past 20 years, and they were let down in epic fashion. We have spent the past week speaking with clients, other victims, industry participants and members of the media, and the response has been the same across the board: outrage and disgust. Our own anger was palpable enough, but the more stories, laments and outbursts we heard, the more clear it became. It was time to fight.

There are two battles on the horizon: One, the return of PFGBest customer funds, and, two, an overhaul of both the regulations which govern us and the regulators themselves.

Fight One: Return of Customer Funds

Here is the current status of client funds held by PFGBest, based on the facts that are currently available. Of the $400 million in customer assets that were reportedly held by PFG, the NFA predicted in their member action a $220 million shortfall. All assets have been frozen since Monday, and all positions held by customers have been liquidated (although not all have been reconciled on statements yet). Chapter 7 bankruptcy proceedings are underway. In their filings, PFGBest listed between $500 million and $1 billion in assets, and $100 million to $500 million in liabilities. Both a receiver and trustee have been appointed, and the Commodity Client Coalition (CCC) has already been in court in order to provide PFGBest clients with a voice in the proceedings.

There are a few positives to note in this situation. First, the bankruptcy was filed under Chapter 7, and not Chapter 11, which means that the firm is only liquidating assets, and not attempting to restructure as a profitable company. The perspectives that have been offered to us indicate that this, in theory, should free up more assets, more quickly to be put towards client fund distribution.

Further, the bankruptcy proceedings are, from all reports, not under the purview of SIPC as MF Global was, and instead will have the CFTC heavily involved. CFTC regulation 190.08(b) states:

Allocation of property between customer classes. No portion of the customer estate may be allocated to pay non-public customer claims until all public customer claims have been satisfied in full. Any property segregated on behalf of non-public customers must be treated initially as part of the public customer estate and allocated under paragraph (c)(2) of this section.

This would indicate that clients have top priority over any other creditors when it comes time to divvy up the company assets . It’s important to note here that, per our understanding,  the amounts in customer segregated accounts do not even become part of the pool of assets for the general creditors – they are customer funds only.

With all of this being said, we are of the opinion that we cannot wait for the bankruptcy proceedings to play out. These investors cannot put their investments on hold while the lawyers finish their squabbling.  As one client put it, “My managed futures hedge against stock market crisis periods has now become a bankruptcy claim that can’t provide that non-correlation.”

To begin with, we’d like to see an emergency motion filed for the release of the $125 million of futures customer segregated funds confirmed available by  Jefferies on July 11^th(story). This is not another MFGlobal, with their desire to be a mini-Goldman Sachs creating an intense web of bank accounts making it impossible to ascertain available funds. The court must prioritize this action in order to provide the struggling clients with, at a minimum, the money that has not been spirited away so they can at least re-establish a portion of their investments. We urge the various groups partaking in the proceedings, including the CCC, to move swiftly here. If these parties are truly interested in getting clients back on their feet, now is the time to make that happen.

However, this action alone, in our minds, is inadequate, because it still leaves the clients waiting on at least half of their funds. They trusted the system. So did we, and that shored up their faith in it. This is a shared pain, but we cannot allow our clients to wallow in it. We owe them better than that.

We have called upon the CME to step up and make clients whole. In our public letter, pushing them to act, we stated:

News came out yesterday that you will be making the Farmers Insurance Fund available to qualifying victims of the PFGBest scandal. This is definitely a step in the right direction, but its impact may be limited. After all, the reimbursement is for only $25k per account, and is only available to a small group of market participants. Those who are likely more active in the markets – and thus the bulk of your profit base – won’t be able to benefit from the move, and even if they did, the reimbursement would be a drop in the bucket compared to their account balances.

Here’s the thing- $220 million is missing. With MFGlobal, the loss was at $1.6 billion. There was no way you could be expected to cover that, of course, but it didn’t stop the media and industry from demanding it, and criticizing you for not doing so. You have an opportunity here to make clients whole, without anywhere near the cost of the MFGlobal scandal. In doing so, you become champions of the industry, and send a message to futures investors that, even with reforms necessary at the regulatory bodies, the industry as a whole has their back. It’s not a giveaway, either. You don’t need to take a hyper optimistic view of the liabilities and assets of PFGBest to see that you’d most likely be able to recoup the money in the bankruptcy proceedings. In the meantime, you take the industry off pause, and show investors – your clients – that you’re in their corner.

This isn’t just about a potential slow down in volume and market participation in the short term – it’s about long-term confidence in the markets and the safety of the funds we put in it. We’ve got a long road ahead of us, but you can help the journey along. We hope you’ll do the right thing.

Given that the latest reports from the CME show a 38% decrease in trading volume in June compared to last year, an 11% year over year decrease in trading volume, and a projected $29 million in losses as a result of the MFGlobal scandal, we’re hoping somebody over there realizes that being a leader on this front and creating a fund (get everyone to chip in) which can make customers whole will benefit their bottom line in the long run. The bottom line is that we want clients made 100% whole- not just for those clients we talk with on a daily basis and care deeply about, but also for the industry as a whole to remain a viable one.

But, again, that’s just the first battle.

Fight Two: Regulatory Body Overhaul

This is where things get tricky. See, we could just focus on getting our clients their money, and letting it go. But the problem is, how, then, do we look them in the eye, and tell them that they’re safe depositing money at a new clearing firm? To be able to do that, we need to see reforms enacted immediately.

Last year, as the world reeled from the MFGlobal scandal, we put forth a series of proposals for regulatory reform. Two newly elected NF Aboard members also put forth a variety of reforms on their own, which the NFA did approve but apparently didn’t find urgent enough to get through the CFTC in a timely manner. But let’s be real – the PFGBest scandal has changed the narrative a bit from questioning not just whether we have the right rules and laws in place (most agree there are better ways to do what is supposed to be being done), to whether we have the right PEOPLE in place to insure the rules are being followed.

A cursory glance at the news coverage that emerged from this disaster reveals a myriad of disconcerting questions relating to the competence and integrity of the NFA. Here is a summation of what has been reported, with the important caveat that we are only passing on the news here, and have do not have direct access to these reports ourselves:

• Reports have surfaced that there were emails raising concerns about PFGBest segregated account protections in front of both the CFTC and NFA as early as 2004.
• The NFA failed to verify the mailing address of the financial institutions with whom they were attempting to ascertain account balances – despite the fact that one phone call would have revealed the scheme.
• The NFA was, in our opinion and based on the information we’ve seen, slow in response to the reticence of PFGBest regarding authorizing electronic confirmation of account balances.
• The NFA, according to recent reports, was made aware of a discrepancy in account balances prior to this week’s revelation after contacting U.S. Bank directly at one point, but accepted a fax that purported to rectify the account shortfall without substantiating the source of the fax as adequate contradictory proof.
• The NFA failed to dig deeper and reveal the fraud during what was represented to market participants and the public as thorough spot checks following MFGlobal.
• The NFA maintained Russ Wassendorf Sr.’s position on their FCM committee, even after assessing them with a substantial fine for failure to supervise earlier this year.
• Additional reports have surfaced from current and prior NFA members regarding other areas of concern related to competency and consistency, including admitted poor understanding of the industry by auditors and abysmal responsiveness to member concerns.

The NFA is supposed to be protecting the investing public. Their website states the following on a page titled “How the NFA Fights Fraud and Abuse” (emphasis ours)

Over the years, NFA has adopted stringent rules covering a wide variety of areas such as advertising, telephone solicitations, risk disclosure, discretionary trading, disclosure of fees, minimum capital requirements, reporting and proficiency testing. Just as importantly, we perform audits and examinations of our Members to monitor compliance with those rules. We also conduct financial surveillance to enforce compliance with NFA’s financial requirements.

What “financial surveillance” was performed on PFG during the past 20 years to enforce compliance with NFA’s financial requirements? Consider that under rule 2-29(f), NFA members are required to maintain supporting information for any promotional material used. With statements like the one highlighted above promoting the NFA’s ability to fight fraud, you’ve got to wonder if the NFA holds itself to the same standard, and will be able to provide supporting information for their claim that they conduct “financial surveillance”.  We for one, believe we were misled by this promotion of their abilities, relying on their ability to actually verify bank accounts with a little more sophistication than a P.O. Box and a Fax. We’ve sent a formal request to the NFA for supporting material related to the financial surveillance conducted on PFGBest and will report what we find out, but holding your breath on that one is likely ill-advised.

This is just the most glaring public display of incompetence at the NFA. Any NFA member can spend time telling you about all the day to day issues they encounter such as previously approved disclosure documents and promotional material suddenly found to have issues when reviewed by another person.

And before you shrug all this off as only important to NFA members – you, the investor, are paying for this ineptitude. The NFA charges $.02 for every single contract traded in the U.S. futures industry, in addition to collecting membership fees from everyone under their jurisdiction – all for the supposed security of having someone watching out for the integrity of the futures markets. We don’t know about you, but given their recent track record, we’d like our money back.

With the hard-earned money of investors who have placed their faith in the markets now at risk for the second time in a year; with the investments made in name of our clients’ futures in jeopardy; with the families of hundreds of hard-working brokers, FCM employees and traders now fearful over their ability to continue to provide for themselves; with an overriding sense of this being a matter of right and wrong- we see no other possible conclusions.

Consider this our formal vote of no confidence in the reliability, effectiveness, and integrity of the National Futures Association as a self-regulatory body for the U.S. futures markets.

We hereby call for the CFTC and Congress to launch a thorough investigation into the practices, policies and people of the National Futures Association in order to determine the extent of their culpability in recent oversights and highlight the actions necessary to restore public faith in regulation of this sphere, including, if necessary, the  revocation of their charter.

We believe in the necessity of this action, and we know there are others that agree, but we also know that one voice alone is not enough to propel action. That being said, should the members of this community and the constituents of those charged with ensuring its continued strength demand action together, our odds of making progress increase substantially. We have the right to free speech, and we have the right as members of the NFA to question their abilities.

If you believe that the NFA does a generally ok job, and that the recent scandals are simply unfortunate, isolated incidents, do nothing at this time. If you think the PFG scandal and NFA’s role therein is representative of bigger problems within the NFA, or have experienced incompetence by NFA staff and leadership yourself, sign this petition and help us make changes.

We will leave you with words from Pulitzer Prize winner Eudora Welty- emphasis most definitely ours:

“Integrity can be neither lost nor concealed nor faked nor quenched nor artificially come by nor outlived,nor, I believe, in the long run, denied.”

Now is the time to demand integrity from our regulators.

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To read more Managed Futures research pieces, visit Attain’s Managed Futures Newsletter archive and our Managed Futures Blog.

DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts.

The mention of asset class performance is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.) , and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices: such as survivorship and self reporting biases, and instant history.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.

Copyright © 2011 Attain Capital Management, licensed Managed Futures, Trading System & Commodity Brokers. All Rights Reserved. Reprinted with permission.

This week’s newsletter was supposed to be a spotlight of one of our top ranked managers- a celebration of research, innovation, performance and risk management. Instead, we find ourselves staring at a blinking cursor on our screen with a mix of disbelief and rage.

When we originally penned our white paper, How to Save the Futures Industry, we had no idea that we would be staring down the same deficiencies less than a year later. Today we learned that PFGBest has had a customer fund shortfall amounting to approximately $220mm (perhaps dating back to 2010). As the story has unfolded, the details have been at turns nauseating and infuriating, as a web of deceit unravels before our eyes.

MF Global had us angry, but this time, it’s personal. Our clients have money with PFGBest. We have money with PFGBest. We were misled by senior leadership that we not only trusted as partners in business. We were let down by regulators. We were failed by our government.

Enough is enough. Here, we’ll break down what we know so far, the possibilities on the horizon, and the swift, decisive action necessary to keep this travesty from becoming the final nail in the coffin of a marketplace that serves as a heartbeat of our global economy. Because, to borrow a phrase from Captain John Paul Jones, we have not yet begun to fight.

The Breakdown

PFGBest is a non-clearing FCM based in Cedar Falls, Iowa. Prior to today, the firm had roughly $440 million in assets- at least, on paper. It was certainly a smaller firm compared to the MF Global’s of the world, but we had always received excellent customer service from them. We knew Russ Wasendorf Sr. and his son personally. The partners of Attain had been invited to Wasendorf Sr.’s August wedding.

After MFGlobal, Attain began enhanced due diligence on the FCMs with whom we have relationships. During this time, we had multiple conversations with both Wasendorf and other executives with PFGBest, where all questions were answered satisfactorily. The firm was in compliance with the NFA and CFTC, and had shored up our confidence with the right responses and attitude. They were a firm focused solely on futures and forex clearing, and beyond that – weren’t has tied to short term interest rates with their slightly different model of providing ‘product’ to their customers at slightly higher revenue.

However, because of the way MF Global played out, we also committed ourselves to enhancing the ongoing due diligence process for our FCM relationships. After all, due diligence is not a one-time conversation. Again and again, we were assured of the firm’s health and compliance, even after they were smacked with a hefty fine and lawsuit over their forex dealings. Those who have been in the futures industry long enough will tell you that any FCM that’s been around for longer than a blink has at least one of these on their record, necessitating contextualization in their consideration, and after hearing from several within the company that the lawsuit was “frivolous” and checking with our own attorney’s on the possible effects of having to pay the entire fine – we did not feel immediate action was necessary with our accounts there, though we did begin establishing additional FCM relationships in addition to the backups we already had in place.

It was around 2:30 PM on Monday that the calls started. Initially, it was another industry participant who wanted to know if we’d heard the news- PFGBest had been put on liquidation only following an apparent suicide attempt by Wasendorf. The story, in our minds, seemed absurd, but before we could even get off the call, other FCMs were calling, offering their support in our time of need. We tried calling the trading desks at PFGBest, and hit a continuous busy line. After finally making contact with members of other departments at PFGBest, the rumors were confirmed. Russ Wasendorf Sr. had attempted to commit suicide, and the firm was, indeed, on liquidation only.

At 3:09 PM, we received the following email:

We began to prepare the necessary paperwork for a bulk transfer of our customer accounts to another FCM, talking with other FCMs we work with to see who could facilitate the transfer the easiest. In the meantime, we called our contacts throughout PFGBest, hoping for more clarity. Here we learned that one of the Iowa PFG employees had seen from her office window that Wasendorf’s car was parked in the company lot in a different place than it should have been. Wasendorf’s son was notified of the irregularity, and upon going down to the car found his father locked in his car with a tube attached to the exhaust in an apparent suicide attempt. The suicide note indicated something along the lines that they would find an accounting error in the company books.

At first, we had hoped, especially knowing Wasendorf, that the “error” would be (relatively speaking) small- perhaps relating to his personal trading account or some kind of tax discrepancy. It wasn’t long before the NFA released a report that quashed those hopes. It contained the following affidavit:

There was no misunderstanding. Fraud was committed. PFGBest had submitted false confirmations of account balances. And segregated funds- ours and that of our clients- was missing. Those we spoke with at PFGBest claimed they had been taken off-guard just as much as we had, and we then heard reports that, following a staff meeting this afternoon, some employees began to pack up their desks.

As of last night, we had granted our managers discretion in choosing whether or not to liquidate positions. As of this morning, we’ve received word that Jeffries raised margin requirements for all PFGBest accounts, knowing the firm could not meet the financial obligations and it would force the positions into liquidation. The following email was received this morning:

And all of this a mere months after Wasendorf, Jr. promised the world that PFGBest was no MF Global.

Missed Opportunities

The situation right now is fuzzy at best. We don’t know where the $220mm is, and we likely won’t for days at a minimum. We don’t know whether the situation will be handled via receivership, a la REFCO, or like a Broker Dealer bankruptcy via SIPC as MF Global was (please don’t do that again). What we do know is that this catastrophe is the inexcusable consequence of deceit and ineptitude.

It was eight months ago that we laid out the steps that needed to be taken to set the futures industry back on track, and despite the best efforts of many a well intentioned futures markets participant, very few have been taken. Since the message has clearly not been received, let’s revisit the changes we need, shall we? Maybe this time, people will listen.

Extend SIPC protection to futures investors.

SIPC protection is currently only offered to securities customers- meaning only those trading stocks and bonds are covered in the case of their broker losing their money through a bankruptcy. 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.

As such, we propose that regulations governing the SIPC be amended to ensure protection of futures clients’ holdings as well, with guarantees on the individual account level (the sub-account of the customer segregated account on the FCM’s books) and not just the main overall account level containing all of the customer funds.

The CME and ICE should cut 10% off their marketing budget and put that to lobbying Congress for this protection. This isn’t 1970, when stocks and bonds were the only game in town. If the world turns to the CME to manage risk, the CME needs to turn to Congress to lower the risk of managing that risk. While there was some discussion in the months that followed the MFGlobal collapse of creating an entity similar to SIPC for futures investors, no action has been taken, leaving PFGBest clients wondering what comes next- ourselves included.

Establish regulation outlining standard operating procedures in the wake of an FCM bankruptcy.

Part of the reason that the MF Global situation was so chaotic was the result of poor planning. Positions were stuck in limbo. There was no infrastructure for facilitating an orderly transfer of accounts, which led to an ad-hoc distribution among arbitrarily selected FCMs without the transfer of legal documents- including those necessary for a CTA to trade on behalf of a client. Without any stipulations regarding timeframe, the process was drawn out to the detriment of all parties involved. Add to that a failure to effectively communicate what was going on to the clients involved, and it’s no wonder the situation turned into the nightmare it did.

In the wake of both the Refco and Sentinel scandals, one would think that remedies would already have been put into place for such administrative Bermuda Triangles, but unfortunately, that did not occur. In order to prevent such a disorderly dissemination from occurring again, we suggest that new regulations be developed; outlining exactly what is to happen in the event of an FCM going bankrupt. The old plan seemed to be, wait for a suitor to step up and take on all of the accounts. That clearly worked out wonderfully this time around. Coming up with standard operating procedures outlining the immediate impact on open positions, where the client funds are to be transferred to and within what timeframe, and so forth would help avoid the confusion we’ve seen to date.

This was probably the easiest change we proposed, but steps have yet to be taken to even draft such procedures.

We’ll add a new twist to this solution, saying that such a blueprint or plan should also cover what to do in the case of an FCM being found to have a shortage in customer funds.

Establish regulation under which language must be added to all creditor agreements for any registered FCM in which those creditors agree to the assignment of the customer segregated accounts as the primary lien holder on all assets of the company.

Under current provisions, segregated accounts are given what is, in our minds, inadequate protection during the bankruptcy process. True, their accounts cannot be tapped to meet outstanding financial obligations of the bankrupted FCM, but there’s also no guarantee of those funds being made whole in the event of a shortfall, nor protection from a too big to fail bank like JP Morgan sending in armies of attorneys arguing that their claim should take precedence over the customers. While clients may, after a pro-rata distribution, file a claim with the Trustee in an attempt to get their missing money back, it appears that there are back door methods for big creditors like JP Morgan Chase and those who held MF Global bonds to get in front of the customers in the claims process. As TheStreet summarized:

“The group of customers, led by James Koutalas, chief executive of a Chicago-based commodities trading firm, are taking issue with a lien and other protections offered to JPMorgan in exchange for a $8 million loan the bank extended to MF on the first day of its bankruptcy, according to the report. That would allow JPMorgan the right to some assets over other creditors.”

In our minds, segregated account holders should absolutely come first in the claims process. Unlike the creditors and bold holders, who knowingly accepted the risk of default when they handed over their money, MF Global clients were paying MF Global to hold their funds- not lose them. With this in mind, we believe that the law must designate segregated accounts as the primary creditor if an FCM goes belly up, ensuring that, should there be a shortfall in client segregated funds, available assets of the bankrupt FCM will be tapped to make those accounts whole before any other creditor gets their day in court.

Again, a missed opportunity in the industry. There is no such protection here. In the MF Global case, founder of the CCC, James Koutoulas, indicated that the declaration of bankruptcy by the securities side of the business helped enable JPMorgan to stand first in line for reimbursement of debts. While PFGBest was primarily focused on clearing futures and forex, they, like MFGlobal, have a smaller securities arm. Oh, and guess what? Some of the funds for the firm were being held at JPMorgan here, too. We have no idea whether tomorrow will bring news of receivership or bankruptcy, JPMorgan liens or otherwise, but should the case be bankruptcy, our concern is that the industry’s failure to act in this area of regulation could end up burning investors once more.

New Concerns

Unfortunately, it’s not just a matter of the same problem popping up again. Putting aside personal involvement, the aspect of this situation that is so desperately disconcerting relates to the regulators. The PFGBest case highlights additional problems in the regulation of the futures industry- particularly relating to the competency of the CFTC and NFA.

We now know that there were false statements made all the way back in 2010. We know that the NFA is the self-regulatory agency charged with overseeing PFGBest. Think it through:

• Regulators conducted spot checks on all FCMs following the MF Global bankruptcy. No action was taken against PFG at the time.
• Regulators have been in the process of conducting a regular audit of PFG for the past several months- an audit which takes place on an annual basis. In our experience, both with Attain and other firms, this includes direct contact with the banks holding firm and customer money to confirm the numbers provided by the firm being audited. In fact, the NFA just switched to a 3^rd party firm to conduct these confirmations, aptly named confirmation.com. Below is an example of just such a digital confirmation request generated by this confirmation software.

Sample Confirmation Authorization Request from NFA

• FCMs are required to provide daily and monthly segregation reports. These only require confirmation of the accuracy by the individuals submitting the report, but the NFA still failed to even due a minimum in vetting of these reports.
• According to the NFA, “A Form 1-FR for the FCM’s or IB’s fiscal year-end must be certified by an independent public accountant.” Who was the auditor who confirmed the balance of money at U.S. Bank? And did the NFA properly analyze the audit?

The failure of the NFA to catch this apparent fraud is a travesty, at best. As members of the NFA, it is our dues that pay for the “regulation” provided by the NFA. Excuse us, but can we have our money back?

Outside of our frustration as members, it has become abundantly clear that our regulators are asleep at the wheel. The NFA answers to the CFTC, and the CFTC is to answer to Congress. Yet, the CFTC clearly failed to monitor NFA responses to the MF Global crisis, and we saw in the MFGlobal Congressional proceedings that our elected officials are more interested in political grandstanding than thorough investigation and effective questioning. Perhaps more importantly, they have little to no understanding of the way the markets they regulate over oversee operate.

So, what, exactly do we want to see happen in the coming days and weeks to address this egregious failing?

• Timely liquidation of all PFG related assets to satisfy the shortfall of client funds.
• If there is still a shortfall – the CME and other major players in the industry stepping up to make customers whole (yes, it sets a precedent, but you will earn it back 10 fold in karma and respect)
• A full investigation of PGFBest by the Attorney General, along with prosecution to the fullest extent that the law allows for any crimes committed, either by auditors, the firm or individuals within.
• A full investigation into the practices and behavior of the NFA, and, should the findings support it, prosecution of the NFA for losses incurred due to their failings.
• Congressional hearings on the failings of the NFA and CFTC in this instance without the soft balling seen in Dimon’s questioning.
• The commission of a report by the Government Accountability Office into the practices of futures SROs, the CFTC, and Congress in terms of efficacy and consistency.

While the solutions we discuss may seem, at times, lofty, they could not be more necessary. This isn’t just about a couple hundred million in client funds. This is about the existence of an entire global marketplace.

Talking Consequences

You hear of banks being too big to fail, but this is a totally different level of significance. This is an industry that is tooimportant to fail. The recency of the MFGlobal scandal, coupled with this new crisis at PFGBest, has decimated confidence in the futures industry. Take one glance at the Twitter feed for PFGBest right now, and you’ll find a litany of comments regarding the “death” of the futures industry. If people cannot trust their FCMs to safeguard their funds, they will pull the money out of the markets. What happens when futures markets become shells of themselves?

John Highland, CIO of United States Commodity funds, explained in a post we put out on oil speculation several months ago, “We go back to the 1970′s where OPEC posts the price of oil. You don’t like it? Tough. Maybe we go to a market like Iron Ore, where six private companies hold shadowy negotiations to set the price in an opaque manner. The third choice is that you have more participants involved, but because of the inability for players to hedge their positions, you’d be far more susceptible to higher price volatility, and, on average, higher prices.”

“No one will finance an oil company at the current rates in this scenario, but if we assume that they would, all the sudden, you can no longer [transparently evaluate the prices as collateral], so you either charge them more, which leads to higher prices [transferred to the consumer], or you loan them less, which will lead to less capacity coming on stream.”

So either we go to a dictated price, a shadowy oligarchy determined price, or a small market that’s rolling dice and exposed to maximum risk, all of which lend themselves to higher price volatility. Oh, and financing complications result in higher commodity prices across the board.

Think this is all just hot air? IHS released a report which detailed the impact of trading limitations- not the decimation of futures markets, but trading limits- in the energy sector. Their take? Severe limits alone would have such an impact on liquidity, price volatility and transparency that we’d be staring down massive costs to our economy.

Source: IHS

Again, this was just derived off of limits being put in place. Imagine the consequences we would face should our futures markets fall into a state of utter dysfunction.

Final Word

Let us make this clear- we are positively irate. We feel we have been betrayed by our business associates, regulators and government. We know the best course of action is to be level headed and deal with the facts as they come in, but the Chicago in us isn’t about to take this laying down. We have offered our resources to the CCC, and will do all we can to do right by our customers. You can follow along on our blog and on Twitter for ongoing coverage. We’re not anticipating a lot of sleep in the coming weeks.

This isn’t just about our business- it’s about clients, and their hard earned money. It’s about their lives’ savings and the futures they’ve been building. If this sounds personal, it’s because it is. Our clients are our family. And we’re not giving up without a fight. That’s a promise.

This piece originally published as an Attain Capital Weekly Newsletter.

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To read more Managed Futures research pieces, visit Attain’s Managed Futures Newsletter archive and our Managed Futures Blog.

DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts.

The mention of asset class performance is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.) , and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices: such as survivorship and self reporting biases, and instant history.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.

Copyright © 2011 Attain Capital Management, licensed Managed Futures, Trading System & Commodity Brokers. All Rights Reserved. Reprinted with permission.

As a partner and head of the financial services group at law firm Sadis & Goldberg, as well as vice president at the Hedge Fund Association, Ron Geffner has a vested interest in seeing how regulatory reforms tied to the Dodd-Frank and JOBS acts play out. His clients are hedge funds, and it will be his job to help his clients deal with the new rules. So far, he’s not liking what he’s hearing from regulators.

Geffner said recently that some of the discussions about certain JOBS Act rule proposals have him thinking the country has passed a “regulatory tipping point.”

“We have too many regulations right now and they keep cranking them out as if there are more trees to knock down and more paper to burn,” Geffner said.

In particular, Geffner said he does not like three Dodd-Frank and JOBS act-related rule proposals he has heard about:

1. Increasing the qualifying requirements for accredited investors. The SEC adopted this provision last year. It basically eliminates a person’s residence from the net worth calculation. Geffner said as of 2007, studies showed 4% of the U.S. population met the requirements to be considered accredited investors, and thus were eligible to invest in alternative strategies like hedge funds. Stiffening the qualifying requirements by raising the asset threshold will make an already small investor pool even smaller, Geffner said, depriving the alternatives industry of capital it needs to invest in securities nobody else wants to buy, or can buy. “The alternatives space is one of the last bastions of hope where people can go to buy Level III and distressed assets,” Geffner said.

2. Requiring legends for alternative investment products to differentiate them from retail products.. Geffner called this a pointless exercise. “It’s not a retail product, so why the legend? Any time you put a legend on something, like cigarettes, it’s designed to keep the industry from growing.”

3. Increasing the burden on managers to ensure purchasers are accredited. Geffner said adding a step whereby investors would have to submit personal financial information to a third party for vetting will cause some accredited investors to just say no. This leads back to his first point about further limiting an already limited source of capital for alternative investment funds.

More rules increase the compliance costs to managers, increase the costs to government to implement the rules and costs the industry assets and talent because of the chilling effect of the new rules on managers and clients. “I want to fight stupidity. There’s a lack of clarity as to what the laws are and how they’re enforced,” Geffner said. “You see it every day. People are afraid to act.” For an entrepreneurial business like hedge funds and alternatives, that means trouble.

Geffner certainly sounds like a man fed up with the direction of things at the regulatory level. And while at first glance it might seem odd for a lawyer whose clients would pay him to help them navigate the new rules to be against those new rules, it’s likely Geffner sees things from the other side. More rules could raise barriers to new fund managers and cause existing fund managers to quit, thus costing him business. And he said he doesn’t think the new rules will do anything to protect investors. They are a show, much like the hearings involving JPMorgan Chase Chief Executive Jamie Dimon, where lawmakers speechified but ultimately accomplished nothing.

It’s unclear at this point what the state of any JOBS Act-related rules is. SEC Chairman Mary Schapiro told the House Oversight Committee on Thursday [June 28] that the commission will not meet its July 4 deadline to adopt final new JOBS Act rules. One of the hold-ups, she said, was the provision that fund managers more thoroughly vet investors.

Former FDIC chair Bill Isaac says that Jamie Dimon’s issues with the current state of financial regulation are legitimate and that the Dodd-Frank bill was a lost opportunity to make meaningful reforms. (more…)

John Kemp is a Reuters market analyst. The views expressed are his own.

Major swap dealing banks and associations representing the financial services industry have been engaging intensively with the U.S. Commodity Futures Trading Commission (CFTC) over the last two years to shape the myriad new rules the commission has been crafting to implement the 2010 Dodd-Frank Act.

Since 2010, the CFTC has published a brief summary of all meetings between outside organizations and commissioners or staff about the implementation of Dodd-Frank regulations, in a bid to improve the transparency of the rulemaking process. The records provide only very limited information about the participants at each meeting and the topic(s) discussed. But they do provide some indication of the intensity and focus of interactions between industry and the commissioners.

The table below summarizes meetings between each of the five commissioners and the major banks and financial services lobbying organizations since the start of 2012, compiled from records published on the commission’s web site:

It overstates the total number of meetings since some are counted more than once, when a commissioner met more than one bank or organization at the same time.

For example, on March 13, CFTC records show Commissioner Scott O’Malia held a single meeting attended by representatives from Credit Suisse, Goldman Sachs, JPMorgan and Barclays as well as Newedge and Professor Ron Filler from New York Law School, to discuss “general” rulemaking.

Nevertheless, a broad pattern emerges of engagement between the industry and different commissioners since the start of the year.

The records show a much higher level of interaction (measured by phone calls and meetings) with O’Malia (a strong advocate for rigorous cost-benefit analysis) and the newest commissioner Mark Wetjen (who was only sworn in last October and is seen as a possible swing voter) than any of the three others.

—John Kemp

Written by Bob English

Ahead of Tuesday’s Senate Banking Committee hearing on MF Global, we present the April 20 installment of Capital Account with Lauren Lyster, featuring futures industry veteran guest, Mark Melin. Ms. Lyster pulls no punches in the opener:

Has the case really gone cold? Or, are those who are in charge of the investigation, the “regulators” and the trustees, simply spraying teflon on every piece of sticky evidence that could lead to criminal prosecutions–and, ultimately–the recovery of stolen customer money?

We wish that MF Global were just a one-off affair–a bad apple, if you will. Unfortunately, it seems more likely to us that this is another milestone in the history of what we see as criminality, which has swept through the financial services industry, like some sort of Medieval Black Plague–the Black Death for capital formation. It seems the only time people are held accountable anymore, is when they commit crimes that affect the super-rich.

Bernie Madoff is a prime example…Madoff is securely behind bars, but Jon “Teflon Don” Corzine is busy ordering carmel-Frappuchinos at the local Starbucks as he goes to shop for office space in New York…bothered only by the low din of discontent emanating from the blogosphere (and shows like this, Capital Account). What a nuiscance we must be to the new God-fellas of Wall Street…

Nuiscance, indeed, to which we hope we are part. Here is a link to the entire episode, in which Ms. Lyster and Mr. Melin cover the following salient points, all pointing to a criminal intent to commit fraud, as well as the role of regulators and investigators:

Why was the MF Global back office cleared out with three top personnel allowed to leave, just as the firm was exeriencing its most serious liquidity (ahem solvency) crisis in its soon-to-be-terminated existence?

Why were C-level executives, far from being sequestered by investigators and being placed in an information silo, allowed to run the company for six weeks (prior to Mr. Freeh being installed as Trustee of the Holdings company)?

Why did Lois Freeh wait until early March to have MF Global Holdings USA declare bankruptcy, the very entity that retained the few remaining executives and employees and may have been cash-rich?

Why did Federal criminal investigators fail to so much as question Mr. Corzine nearly six months after the crime?

Why were large counterparties paid with wire transfers, when requests from lowly customers for wires were converted to checks (which ultimately bounced)? “Sloppy is when you don’t do things consistently. Sending all checks to customers and all wires to counterparties–that’s consistent.” See here for details published by John Roe of the Commodity Customer Coalition.

Why were the final days characterized as so “chaotic” when a properly programmed iPhone or Android smart phone (sorry, RIMM) should have been able to handle what amounts to maybe a few dozen megabytes of transfer instructions?

Just what were the details surrounding the successful lobbying effort by top level MF Global execs that effectively postponed reforms on rules that would limit use of customer funds (coincidentally, or not perhaps, just ahead of a $325 million bond offering by MF Global)? [For more details, see our prior piece from this week, which includes exclusive CFTC emails on the issue.]

Even Chuck Grassley, the sponsor of the now-widely criticized 2005 bankruptcy reform act, has stated, “The bankruptcy laws are written to ensure that company executives who were involved in the demise of a company because of fraud or mismanagement shouldn’t be eligible for bonuses,” Mr. Grassley said.

More broadly, MF Global customers have an absolute right to clawback of questionable margin payments and asset transfers from the broker unit that occurred in the weeks leading up to the firm’s demise because there was a clear pattern of intent to deceive investors and customers alike–from manipulating regulators and the regulatory process to changing business practices in the final wee–all of which ensured that customers would be last in line for the remaining morsels of the MF Global carcass. (And, as we have pointed out since early November, 2011, the very nature of the Corzine Trade from Day One was such that all the risk was put in the customer brokerage house, while profits were diverted to an offshore business unit).

“Fraud” is the operative word here. There is no dispute that the Commodity Exchange Act (sic, the law) has been broken, but until fraud is investigated, customers are at the mercy of a very fuzzy and opaque legal process.

It’s time for Congress to put pressure on those in charge of this investigation and oversight to break their own glass of silence and dare them to utter the magic “F” word.

To view the full video interview with Lauren Lyster and Mark Melin click here.

Bob English is the author of this article, the opinions expressed are entirely his own. View his work at:

http://english.economicpolicyjournal.com/2012/04/mf-global-roundup-so-far-great-escape.html

I would start this article the same way I start all conversations about hedge fund marketing, with a simple disclaimer: I am not a lawyer; this is not legal advice.

What I am is a public relations professional with more than twenty years of experience in representing asset management firms. During that time, I have witnessed, and through our firm supported, the extraordinary rise of both the mutual fund and exchange-traded fund industries. This rising tide lifted many boats. New magazines and websites were launched, reporters were hired, and advertising and branding firms were founded to meet the enormous demand for financial services marketing expertise. It has been a tremendously exciting couple of decades.

Over the last few years, I have seen the hedge fund industry moving along a somewhat similar path asnew funds were launched and fund managers grappled with growth and the need to attract new assets. As with mutual funds, new publications have sprung up to cover the alternative investing industry, and existing news outlets have reporters dedicated to hedge fund coverage. Where there was once a single reporter who covered the industry episodically, there are now reporting teams, covering strategies, managers, and asset flows on a daily or sometimes intra-day basis. Like many other things in modern life, the pace of these developments continues to accelerate even as the conversation moves from the private to the public arena.

But while the media world was changing, the regulatory proscriptions that governed interaction with that world were not. The prohibition on advertising has always been clear. However, unlike mutual funds and ETFs, the ground rules for hedge fund managers interacting with reporters have remained more opaque. On the one hand, it is common to see hedge fund managers featured on the cover of major investing publications and appearing on CNBC; on the other, I have heard of funds that apparently go so far as to refuse to include a phone number on their website for fear of running afoul of the non-solicitation regulations. It’s beyond my brief to comment on which of these approaches is the correct one. As an observer, however, I think it’s fair to say that a regulatory regime that is able to incorporate two such widely varying interpretations is in need of some clarification.

The net result has been a decision by most managers to avoid the press altogether. There are at present roughly 9,500 hedge funds and fund of funds, and hundreds of new funds are launched every year. On the evidence, most of the managers of these funds appear to view marketing as akin to grabbing a dangling wire: it may or may not be live, but why risk getting burned to find out? The media, of course, is governed by a different set of rules. Backed by the First Amendment they can write whatever they want, as long as it’s accurate. This has set up a tension between the two sides that until recently showed few signs of being resolved.

Now along comes the recently signed JOBS Act, which includes proposed clarifying language with regards to the solicitation issue. From what I have read, it recommends allowing hedge funds to market more freely while continuing to restrict investment in the funds to accredited investors and qualified institutions. This is imminently sensible. After all, no matter how many times you see a hedge fund manager on CNBC, you can’t invest just by dropping a check in the mail; at a minimum, you still have to meet the threshold criteria as defined by law.

What this will lead to remains anyone’s guess. Many hedge fund managers will no doubt continue to prefer to stay out of the limelight. Others may see an advantage in publicizing their investment strategy, market outlook, and historic performance. If history is any guide, there is certainly leverage to be had, in terms of reaching new audiences. At the moment, the conventional wisdom has it that the smaller, newer funds may be the more enthusiastic adopters of the opportunity to market more broadly. This may open the door for qualified investors to discover managers and funds that were previously unknown to them. Time will tell.

The growth of the mutual fund industry supported the creation of thousands of allied jobs in publishing, advertising, and public relations, among others. Because the market for hedge funds is more narrowly defined, the impact is not likely to be as great. Nonetheless, by more clearly defining what constitutes “solicitation” – and thereby opening the door to advertising and public relations efforts by the hedge fund community – it will create new business opportunities for firms like ours, new opportunities for the funds themselves, and, almost certainly, new jobs as well.

Mike MacMillan is the founder and president of MacMillan Communications (www.macmillancom.com ), a New York-based public relations firm founded in 1996 that focuses almost exclusively on the financial services industry. He can be reached at mike@macmillancom.com.

Former Securities and Exchange Commission chairman and current Kalorama Partners CEO Harvey Pitt tells Reuters correspondent David Clarke the new law allowing small investors to directly fund start-ups will put an already beleaguered SEC under greater strain.

“The SEC is going to have to spend a lot of time monitoring these companies to make sure that investors aren’t defrauded,” Pitt says. “That means that their enforcement resources which are already strained beyond belief will be strained even further. So I think all in all, the SEC needs a great deal more money than it’s being given currently as more and more responsibilities are put on its plate. The solution would be to allow the SEC to become self-funded to let those people who benefit from regulation actually pay the costs instead of having tax payers pay that cost. If we did that, the SEC could get the resources it needs but the budget wouldn’t be influenced to an iota and that would be a positive.” (more…)