Top down disasters in the financial markets take on many forms. Long Term Capital Management nearly brought down the financial system in 1998. We watched Lehman Brothers fail because the government didn’t think they were worth saving. We saw AIG fail due to the strategies it employed in the subprime housing markets. MF Global failed because the CEO tried to turn a brokerage firm into an investment-banking firm through one all in bet on the Euro Zone bailout. These were firm related disasters. We’ve also seen rogue traders bring down financial firms due to lack of oversight like Barings Bank in 1997 or, Lloyds of London in 2009.
These were all publicly owned companies, either through direct share purchases or, in the case of Long Term Capital Management, a hedge fund founded by some of the brightest minds in the industry. Publicly owned companies have multiple levels of oversight and audits to regularly submit so the governing bodies in their fields can protect the interest of the public investor. The investing public must rely on the given agencies that we pay for through our tax dollars to provide an adequate accounting and system of checks and balances to thoroughly scrutinize their quarterly reports. We have every right to the expectation that the agencies are performing their due diligence for our sake. Privately owned firms are not subject to the full gamut of oversight. As a private company, I comply with annual audits by our governing agencies, the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). I am required to self report our annual questionnaire and our annual update. The recent issues at Peregrine Financial Group (PFG), is simply the implosion of a 20 year con job by someone who used the respect he had fraudulently gained to perpetuate that same fraud into the future.
Beginning in 1993, Russell Wasendorf Sr. chose to fudge his financial report to the NFA to meet the minimum capital requirement for the accounts held by his firm. He claimed that this was due to a witch hunt put in place by the governing body of the futures industry and he was forced into one of two unpalatable personal choices. He could cut his overhead and use operating revenues to rebuild his minimum capital requirement or, he could lie to regulators and maintain normal operations.
His choice was self-admittedly driven by ego. Rather than accepting the rules and making necessary cuts, he fudged the numbers and worst of all, found out he could get away with it. This allowed him to continue ignoring standard business practices of profit and loss, expansion and contraction by fudging the numbers to boost operating revenue. The boost in operating revenue led to the construction of a top shelf office building in 2009, a private jet and other luxuries that could not be afforded on actual operating revenues.
Our firm was fortunate not to have been caught up in this mess. We had been exploring deals with a new Futures Commission Merchant all spring and in some areas PFG had the best available options. We ended up with Straits Financial. I have known the Chief Operating Officer of Straits for more than 20 years. He was the head risk manager throughout my time in Chicago and taught me an awful lot about transparency. He brought that same philosophy to Straits. The clincher was the monthly public accounting of all customer funds and locations of those funds BEFORE the MF Global debacle became a story. It’s simply the right way to do business.
Futures trading is risky. So is trading stocks, bonds or real estate. We’ve been in the business long enough to know that your money is safe when you call for it and it gets deposited in your bank account. Paper is simply paper. To that end, I frequently suggest that customers only keep enough capital in their accounts to allow them to trade effectively. Removing excess capital also keeps a trader’s risk tolerances in check. This is exactly what we told the Wall Street Journal when we spoke to them on July 17th. I do the same things for customer accounts that I do for my own. On Transparency is key and personal cash in your personal account is King. We preach and preach that the only way to get ahead in the next 10 years is through the active management of your own capital. In this era of constantly changing rules and precedents, we must protect capital from trading, regulatory or, corporate malfeasance. Trade efficiently. Trade humbly. Sleep well.
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.
