Until the collapse of MF Global, that’s a question I thought I’d never have to ask.
Brokerage firms are required by law to maintain segregated accounts holding all client assets, including stocks, bonds, mutual funds, money market funds and cash. The law was passed after the 1929 crash, in the depths of the Depression, to make sure that customer assets were there at all times, ready to be disbursed even if everyone asked for their money at once.
This obligation to protect customer assets “is considered sacrosanct,” Robert Cook, director of the division of trading and markets at the Securities and Exchange Commission, told me this week. “It’s considered a sacred obligation.”
Lehman Brothers may have engaged in many foolhardy practices, but even in the firm’s last days, when officials were desperate for cash, no one dared touch customer assets, which remained safely segregated despite the firm’s collapse.
And then came the revelation that an estimated $1.2 billion in customer assets had vanished at MF Global, the large brokerage and futures trading firm headed by Jon S. Corzine, the former Goldman Sachs executive and Democratic politician, that collapsed in late October after a catastrophic bet on European sovereign debt.
How could such a thing happen? I had always assumed it was impossible and that strict internal controls existed at all brokerage firms so that firm officials couldn’t tap segregated customer funds even if they were willing to break the law. Thanks to MF Global, it’s now apparent that isn’t necessarily true. “If people are determined to misuse customer funds, they will misuse them,” said Ananda Radhakrishnan, the director of the division of clearing and risk at the Commodities Futures Trading Commission.
That’s because the commodities and securities industry is mostly self-regulating, and self-regulation ultimately depends on the integrity of the regulated. Broker-dealers — securities firms that execute trades of stocks, bonds and other assets for customers — are overseen by the S.E.C., while futures commission merchants, which trade commodities, derivatives and futures, are regulated by the C.F.T.C. Like most large brokerage firms, MF Global was both a broker-dealer and a futures commission merchant, though its primary business was commodities futures trading.
The federal regulators issue and enforce the rules, but day-to-day oversight for securities firms is delegated to the Chicago Board Options Exchange, a for-profit company, and the Financial Industry Regulatory Authority, or Finra, a nonprofit organization financed by the brokerage industry. For commodity dealers, it’s the National Futures Association and the Chicago Mercantile Exchange. They conduct periodic examinations and audits and, in addition, member firms are required to have internal controls and compliance mechanisms to make sure that customer assets remain safely segregated at all times.
Typically, this requires transfers from segregated accounts (other than at the customer’s request) to be approved by multiple officials, including in many cases, the firm’s chief financial officer and chief compliance officer.
“It’s not a low-level functionary,” a regulator said. “It’s someone who has real standing. Most customer assets are held at the biggest firms and they have scores of people involved in this process.”
Susan Thomson, a spokeswoman for Merrill Lynch, the nation’s largest brokerage firm, said that any transfer from segregated accounts there required “at least three checks and possibly more.” Officials from operations, regulatory reporting and collateral are usually involved and sometimes compliance officials, as well. “There are multiple streams of responsibility. You have management accountability in each of those streams on a daily basis,” she said.
MF Global also had internal controls and a chief compliance officer, which raises the question: How did the customer assets ever leave the segregated accounts to begin with? In testimony on Capitol Hill on Thursday, Mr. Corzine only added to the mystery. He said that transferring customer funds was “a complex process” and, asked who could execute such a transfer, said “I wouldn’t know probably who that person is.”
Article source: http://feeds.nytimes.com/click.phdo?i=fb13460a3454317f6627dceb6cbe237b