August 31, 2012
Last November, in the wake of MF Global, I suggested that firms entrusted with customer funds be subjected to regular and robust deep data dives. I said that we needed to ensure the money was there all of the time and not just take folks' word for it. With the collapse of Peregrine Financial Group, it has become even more apparent that such customer protections are needed.
However, just saying that something should be done obviously doesn't make it happen. We are all aware of what have been termed "magic words" in the—well, let's call them, the "illusionary arts." While saying words like "abracadabra," "hocus-pocus" or "alakazam" may seem to instigate various supernatural forces to make impossible things occur, that's not how it works in real life, and certainly not much "magic" ever happens in government. We don't need words that make people disappear or allow a magician to pull a rabbit out of a hat, but we do need to put in place our regulatory magic words to actually do what some of us have been suggesting for quite some time. In our world, we do these things which might seem like regulatory rhetoric, but actually have important meaning for how our financial sector operates.
Our staff has worked diligently on customer protection issues. We've heard from various stakeholders and talked amongst ourselves. We've listened and learned a lot. But, it is time for us to get on with it and put in place our magic words to better protect customers and consumers alike. From my perspective, we should do at least four things in this regard:
1. Mandate Direct Access to Electronic Bank Records
There are still some futures commission merchants (FCMs) that don’t provide self-regulatory organizations (SROs) or the Commission with electronic access to their bank records. We should institute a policy of zero tolerance for such firms. If they don't allow direct access to electronic banking records, let’s immediately deny their ability to hold customer funds.
2. Require Standardized Audits
That means ensuring when front-line oversight and examinations are conducted by a SRO or a designated self-regulatory organization (DSRO), that an FCM is audited by the same standards required by the Commission. These standards should include, at a minimum, testing internal controls, and thorough examinations driven by the risk profile of the FCM. The auditing standards we set forth should be sufficiently comprehensive such that the basic customer protections of the Commodity Exchange Act (such as the protection of segregated customer funds) are ensured.
3. Institute Liquidity Notification Levels
We should institute two alert action stages (levels). Liquidity Level One should be a circumstance in which an FCM is approaching a problematic liquidity event and the firm may encounter difficulties meeting obligations. Liquidity Level One should require the FCM to immediately notify the Commission and other pertinent regulatory authorities when, for example, the firm is placed on “credit watch” or a bank or other financing entity withdraws credit facilities or an affiliate experiences a bankruptcy. Liquidity Level Two should be a circumstance in which the FCM no longer has enough liquidity (cash, access to credit, etc.) to continue operations. In such a situation, the FCM must transfer customer accounts to another FCM. Furthermore, the Commission should institute an "escape hatch" procedure in which a FCM that can’t demonstrate its access to adequate liquidity with verifiable evidence maybe required by Commission action to transfer its customer accounts to a solvent FCM.
4. Improve Consumer Education and Customer Disclosure
The Commission should also require disclosures to existing customers and provide transparent business activity information for consumers. Many individuals involved with the MF Global debacle wrote to me and expressed concern that they didn't fully understand the activities with which the FCM was involved. As the futures industry moves toward more retail-oriented businesses and in order to ensure more transparency and consumer-customer education, we should require FCMs to disclose the business activities in which it engages—including proprietary trading activities and the risks associated with those activities. This will provide an opportunity for consumers to make better-informed decisions about where to place (or not place) their hard-earned money.
Futures Insurance Fund
Finally, while it is outside of the regulatory purview of the Commission, and would require a statutory change, the Commission should encourage Congress to address the lack of a futures insurance fund. It makes no sense that such insurance protection is afforded to banking customers and those who invest in securities, yet not people that invest in futures. The funds of futures customers are every bit as significant as those of other customers. They should not disappear—presto chango—like a bad magic act.
In this regard, I have put forward a specific proposal (the Futures Investor and Customer Protection Act—FICPA) for which there have been many positive comments. Like our regulations, however, things just don't happen. I know these take time: "Kazaam kalamazoo a new law for you," is not how a bill becomes a law. Nonetheless, I am hopeful that my colleagues and others will let their views be known on this important matter of customer protection.
None of this may be particularly magical but these steps, and others, will go a long way toward protecting customers and making sure they don’t get fooled again. While I'm not prejudging what the Commission will do on these issues, it is my hope and expectation that my colleagues and I move expeditiously to enact these necessary customer protection reforms soon.
Last Updated: September 5, 2012