Customer Safety Comes First

Barry Lind and my father, Jack Waldock founded Lind-Waldock in 1965. One of the primary compliance categories in opening a new futures account is, “know your customer.” For 35 years the business was based on genuinely, “knowing their customers.” Their belief in doing business the old school way allowed them to provide superior order execution on behalf of individual traders as well as providing them with top-level research. This process helped them to break down the barrier of institutional preferential treatment.

Refco bought Lind-Waldock in 2000 primarily for Lind-Waldock’s clean compliance record and presence in the retail market. Refco went public in 2005 and also went bankrupt in 2005 due to the accounting improprieties of Phil Bennett, their CEO. Man Financial bought the Lind-Waldock portion of Refco’s operations in the ensuing bankruptcy. Man financial went public in 2007. They retired the Lind-Waldock name in August of this year and operated under the MF Global name and have now gone bankrupt as well.

Now that the history lesson is over, lets talk about the recent developments. The primary issue at hand hinges on the sanctity of the term, “segregated funds.” Cash in a customer’s futures trading account is held in segregated funds. This money is completely separate from the clearing firm’s operating cash and is not to be mixed in with the clearing firm’s assets in any way shape or form. This is guaranteed by the various exchanges as margin collateral and is a collective covenant of all Futures Commission Merchants (FCM’s) that are members of a given exchange.

MF Global and their CEO, former New Jersey Governor John Corzine are accused of using customers' segregated funds equity to guarantee bets he made on European sovereign debt as he attempted to transition from the historical business of providing trade execution services and retail customer trade assistance to investment banking, proprietary trading and the greedy pursuit of becoming the next Goldman Sachs, his former firm. These actions are in violation of all of our governing bodies – NFA, CFTC, FINRA, etc.

The losses incurred as a result of his pursuit to be a big shot has left a $700 million dollar shortfall in MF Global’s books. Dipping into segregated funds has created an accounting nightmare as customers close their accounts and transfer to solvent brokers. The segregated funds covenant of the FCM’s with the exchanges is to guarantee the customers’ equity. This is the peace of mind that trading on an exchange versus cash markets is supposed to bring.

The $700 million dollar shortfall should be covered, whether through the joint efforts of the FCM members of the exchanges or, the exchanges themselves. To put this in perspective, the top 10 FCM’s have a combined equity of more than $1 trillion dollars and the Chicago Mercantile Exchange is valued at more than $17 billion. Therefore the $700 million is a manageable number as a portion of this capital pool.

 Customers must be made whole in order to maintain the integrity of the exchanges and instill the confidence in the investing public. The longer this thing is drawn out, the more likely this erosion of confidence in the governing bodies will devolve into retail investor panic. The remaining FCM’s as well as the exchanges must do everything in their power to prevent an easily covered black eye of a monetary issue from becoming a public perception issue more akin to a terminal disease.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.