The largest U.S. grain trade group was stunned by the latest scandal to hit the futures industry when Iowa-based brokerage PFGBest collapsed after regulators accused the firm of misappropriating customer funds.
"Even though we don't know at this point the scope of Peregrine's agricultural customers or their grain customers, it is troubling to have another failure this soon after MF Global at a time when presumably there was enhanced oversight by regulators," Todd Kemp, vice president of marketing for the National Grain and Feed Association, said.
NGFA members, who include more than 1,000 grain elevators, food processors and exporters, are still reeling from the collapse of giant broker MF Global just nine months ago when $1.6 billion in segregated customer funds disappeared, hitting dozens of large farm-related businesses with massive losses.
Peregrine Financial Group, PFGBest's regulated unit, filed for bankruptcy on Tuesday in Chicago after regulators accused it of misappropriating customer funds for more than two years.
The Commodity Futures Trading Commission (CFTC), which along with industry regulators had given a clean bill of health to dozens of brokers following spot checks in January, alleged that Peregrine Financial Group and its owner, Russell Wasendorf Sr, had defrauded customers and lied to regulators in order to hide a shortfall that now exceeds $200 million.
Kemp said even if the potential losses among its members from accounts at PFGBest ended up as a fraction of the losses at MF Global, the latest scandal eroded confidence in the futures markets and regulators and signaled a need for further scrutiny and change.
"We issued some preliminary recommendations back in April and more recently some recommendations to the CFTC and the Congress for some policy changes that we think are more important now than ever to enhance customer protections both before and after a bankruptcy or a liquidation situation," Kemp said.
Those proposed changes included daily public reporting of segregated fund investments and other improved market transparency measures; more detailed and frequent audits of brokers; and rigorous review of capital requirements for qualifying brokers.
"We are really looking forward to a full explanation from the regulators about just what happens and how apparently it happens over a fairly long period of time before detected," Kemp said.
Diana Klemme, vice president of Grain Service Corp in Atlanta, which serves many agricultural hedgers in the futures markets, said the PFGBest news is exactly what the grain business did not need at a time confidence in the markets was beginning to rebuild after the MF Global fiasco.
"The industry is infuriated over this because it affects everyone. Our customers raised the question of -- if an audit doesn't catch problems, what does? In this case it was a suicide attempt. It's almost beyond belief that after MF Global that's the way a problem was discovered," Klemme said.
PFGBest was not a clearing member of a futures exchange like the CME Group, so oversight for its activity fell to the CFTC and the National Futures Association, a self-regulator for the trillion dollar derivatives markets.
"You'd certainly think NFA would be suspicious of directing inquiries to a post office box," Klemme said.
Russell Wasendorf Sr, PFGBest's founder and chairman, intercepted confidential regulatory documents that were mailed by the NFA to what it believed was U.S. Bank, a person close to the situation told Reuters on Tuesday. Wasendorf forged signatures and fabricated bank balances on the documents and simply mailed them back to Chicago-based NFA, the person said. The scheme apparently began to unravel as the NFA shifted to electronic confirmations.
The CFTC complaint, which relies on many of the details released on Monday by the NFA, the broker's main regulator, said the bank account that PFG reported was holding $225 million in 1,845 customer accounts actually contained less than $10 million.
The exact number of accounts that were tied to agricultural futures positions is not yet known. CME grain traders said that significant selling came into the grain markets late Monday and continued overnight, which seemed to be traders closing out positions. PFGBest's clearing firm, Jefferies & Co, said on Tuesday it had liquidated accounts of PFGBest starting on Monday when the firm missed a margin call, or a request for more funds to hold trading positions.
The spokesman for the Iowa Department of Agriculture said on Wednesday that although concerned farmers had been calling in for reaction and advice to the news, few had so far said they had accounts at PFGBest. The Minnesota and Nebraska departments of agriculture said as of Wednesday afternoon they had not yet received any farmer calls regarding PFG.
"Just shows the need for some type of insurance type coverage to pursue whether full segregation of funds is a viable alternative," Klemme said of another idea floated in the grain trade after the collapse of MF Global and waves of criticism for CFTC and the CME in subsequent months. "Clearly more regulation and laws do not necessarily change anything. We've got plenty of regulations and audits that didn't catch the problem."
Iowa Secretary of Agriculture Bill Northey said the problems at PFGBest added to concerns about how safe farmers' money is at brokerages after the collapse of MF Global.
"It causes questions into the regulation," he said. "Who was watching it and how easy is it to figure out the financials of the companies involved?
"I certainly have heard folks suggest that we ought to think of having some way of having insurance that would insure those accounts," Northey added. "I don't know that we want to make life terribly more complicated and expensive -- but at least some way to insure those accounts."