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MF Global's Bankruptcy Spurs Proposed New Rule for Customer Funds

Source: WSJ

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Posted on 21 Mar 2012

In the wake of MF Global Holdings Ltd.'s bankruptcy last year, exchange operators and a futures-industry regulator are working on new rules that would restrict what brokerage firms can do with customer money.

One proposal, which some regulators have dubbed the "Corzine rule" after former MF Global Chairman and Chief Executive Jon S. Corzine, is gaining momentum as more drastic ideas, such as setting up a new customer-insurance program, have run into resistance.

The new plan, outlined earlier this month by the National Futures Association and discussed at an industry conference last week, would require a futures-firm principal to sign off before certain large transfers of customer funds are made.

"This won't be the only response, but it's another way we can safeguard customer funds," says Daniel Roth, president and CEO of the NFA, an industry-funded watchdog.

MF Global filed for bankruptcy Oct. 31, after customers and trading partners became nervous about the firm's exposure to European debt and fled. Regulators are still looking for an estimated $1.6 billion missing from customer accounts.

The proposed rules wouldn't be the first regulatory response: In December, the U.S. Commodity Futures Trading Commission approved new restrictions over how customer money could be invested, in an effort to better safeguard that money. The CFTC, which has yet to approve the futures association's idea, has been receptive and a final rule could be implemented as early as this summer, according to Mr. Roth. A CFTC spokesman had no immediate comment.

A committee that included NFA and four exchange operators—including CME Group and IntercontinentalExchange—earlier this month recommended the "Corzine rule" along with several other changes stemming from the MF Global matter. The full NFA board is scheduled to vote on the changes in May.

While there is support for the proposal, its implementation could raise questions, such as how exchanges would be able to stop moves of customer money and whether rule makers should pass new policies before a full explanation has been offered as to why money went missing at MF Global.

Here is how the rule would work: Any time a futures brokerage wanted to transfer more than 25% of its excess funds in a customer account to a firm-based account, a principal at the firm, such as the CEO, would have to approve it. The firm also would need to provide "immediate notice" to regulators.

In MF Global's case, CME Group CME +1.50% said in a timeline provided to Congress that it didn't find out about an Oct. 28 transfer out of MF Global's customer accounts until three days later. The Oct. 28, transfer, which totaled about $175 million, occurred after an overdraft was identified in an MF Global account at J.P. Morgan Chase JPM +0.84% & Co. in London.

The Oct. 28 trade happened in the morning, according to people familiar with the matter and documents reviewed by The Wall Street Journal. That afternoon, MF Global officials told CME that it had about $200 million in "excess segregated funds" the previous night. In other words, nearly 90% of the firm's money housed within the customer account would have gone away with the $175 million transfer.

Under the rules of futures trading, firms are allowed keep their own money in customer accounts to provide better customer service. But in MF Global's case, the firm dipped into the customers' funds when its own funds ran dry amid a panic about the firm's finances.

"We don't want a situation where a firm can" dip into customer segregated funds "and have a CEO say I didn't know," Mr. Roth said, referring to Mr. Corzine's testimony to Congress in December that he didn't know about the deficit in customer funds until Sunday, Oct. 30, days after the shortfall had actually developed. A spokesman for Mr. Corzine declined to comment.

Other MF Global executives have provided similar testimony about when they found out about the shortfall.

Some industry watchers have called for restricting the ability of futures firms to house their money with customer money in the first place. Mr. Roth also said that regulators were looking at whether transfers from customer accounts should be prohibited before a brokerage reported its customer-account levels from the previous night. Currently, such calculations don't need to be completed and reported until early afternoon.

A CME spokeswoman says exchange officials "fully support" being notified when a futures brokerage makes a big transfer. It "conceptually supports" the idea of restricting customer money transfers before the previous day's segregated funds levels are reported, but "more work needs to be done to vet the idea," the spokeswoman added.

Some industry officials say requiring more approvals for big transfers from customer accounts could help confidence while other changes are contemplated. "Most firms probably do it already," said Gary DeWaal, general counsel for futures brokerage firm Newedge Group. "To require it isn't a bad idea."


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