Views on improving the integrity of global capital markets
18 November 2011

MF Global – Dodging Customer Protection Rules

There is some good news but mainly bad news in my MF Global saga. The good news: my missing MFG money is safe and I will be getting it back in “due course.” I was told that 60 percent of the funds were in the process of being transferred. I think that means to me, but apparently “due course” does not mean this week, or even the next. So the check is not exactly in the mail.  

Meanwhile, it is also encouraging to see the array of very stringent “customer protection rules” from both the CFTC and the SEC at play here. All of it featured prominently on the MF Global website. For example, SEC Rule 15c3-3 prohibits any broker-dealer like MF Global from using customer assets as working capital. This oddly-numbered rule is supposed to ensure that the funds MFG holds for its 50,000 customer accounts are used only to finance customer (that’s me) liabilities, and not to finance its proprietary positions.  

Two components to customer asset protection are key: actual possession and control of all securities by the broker, and maintenance of the customer’s cash in a special reserve bank account. That special account must be separate from any other bank account of MFG. In fact, it is so special that MF Global calls that the “cardinal safeguard,” which should mean my money was not used to speculate in European sovereign bonds. Fingers crossed. 

What’s more, MFG, under Rule 15c3-3, was required to perform a weekly examination and calculation of the amount in the reserve fund to determine if it met the “reserve formula” requirements. If not, MFG would have been required to deposit cash or securities equal to the amount required under the reserve formula. 

That is where the good news ends. It sounds like all that customer money required to be in the account and segregated might not have actually been there. And since it’s only a weekly check on the account, what was there on Friday might not be there on Tuesday. The story only gets worse. 

Any doubt over whether things are amiss at MF Global was laid to rest with a rash of subpoenas and comments from a CFTC board member that the circumstances surrounding MF Global are “suspicious as heck.” It is one thing to hear media speculation about MF Global, it is another to hear it from the regulator supposedly overseeing the firm. Add to this revelations of various accounting practices at MFG having similarities to Lehman’s off-balance-sheet repos (i.e. hidden), and the story begins to take an ominous turn. 

What about all those fancy SEC and CFTC rules? We need a new rule: 15c3-3-Pay Attention! We can only hope someone is actually keeping an eye on customer funds and how they are being handled by brokers generally. And we sure hope it is not just on Fridays. 

Keep track of my MF Global odyssey here and offer your own comments. While I make light of my situation, it does not hide the fact that this is dreadful and serious business for many customers. What it says about industry ethics and regulatory capabilities will be fully revealed, to borrow the phrase, in due course.

About the Author(s)
Kurt Schacht, JD, CFA

Kurt Schacht, JD, CFA, is the Senior Head, Advocacy Advisor, Capital Markets Policy at CFA Institute, where he oversees advocacy efforts and the development, maintenance, and promotion of the highest ethical standards of practice for the global investment management industry.

1 thought on “MF Global – Dodging Customer Protection Rules”

  1. Stephen says:

    Forgive my ignorance but where are the banks in all this? Segregated accounts or trust accounts should have special status and must be handled with care as the consequences for clients can be severe in situations like this. Do the banks not have an obligation to report suspicious cash movements in segregated accounts i.e. lots of money on Friday no money on Tuesday something’s going on here we should report it. Or is this another case of the banks disavowing any responsibilities to protect the financial interests of the investing
    Unlicensed.

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