Regulator twice failed to find fraud at Peregrine
The Commodity Futures Trading Commission conducted examinations at failed Peregrine Financial in 2007 and 2008, but CFTC Chairman Gary Gensler Gensler told senators Tuesday that his agency relies on industry-funded self-regulators.
The U.S. Commodity Futures Trading Commission (CFTC) reviewed operations at failed Peregrine Financial Group at least twice since 2006 without detecting the fraud that led to the collapse of the futures broker and a $200 million shortfall in client funds.
The agency conducted examinations at Peregrine in 2007 and 2008, according to a list of CFTC reviews obtained through a public-records request.
The list, which includes reviews between 2006 and Nov. 9, 2011, does not detail what records or procedures examiners evaluated.
A third review was listed in 2011. A CFTC official said the 2011 exam was scheduled to oversee compliance with foreign-exchange regulations but didn't take place because of limited resources. The official spoke on condition of anonymity because the agency was still reviewing the matter.
Peregrine is under investigation after Chairman and Chief Executive Officer Russell Wasendorf Sr. attempted suicide. Wasendorf had written a signed statement that he committed fraud for two decades at his Cedar Falls, Iowa-based company, according to a criminal complaint.
"Although we do not yet know the full facts of what happened in this matter, the system failed to protect the customers of Peregrine," CFTC Chairman Gary Gensler said in testimony at a Senate Agriculture Committee hearing Tuesday. "Just like the local police cannot prevent all bank robberies, however, market regulators cannot prevent all financial fraud. But nonetheless, we all must do better."
Gensler told reporters after the hearing that the agency will review the CFTC's documents from 2007 and 2008, and "pull those files to see how we can do this better."
The CFTC sued Peregrine over the shortfall July 10, less than a year after being scolded for poor oversight after the collapse of MF Global Holdings, which left an estimated $1.6 billion gap in customer funds.
Lapses in federal oversight have triggered a political backlash from U.S. lawmakers and others. The Securities and Exchange Commission is still working to restore its reputation after failing to detect Bernard Madoff's multibillion-dollar Ponzi scheme, which came to light in 2008.
Gensler has said that the CFTC relies on industry-funded self-regulators — including the National Futures Association (NFA) and CME Group — to conduct routine oversight of futures firms, in part because its $205 million budget is inadequate.
"They're the front-line regulators and we oversee them," Gensler said at the hearing Tuesday. "I do think we need to do more and review that relationship to make sure we're doing the right things at the CFTC when we examine the examiners, so to speak, to ensure their audits are full."
The CFTC will review the National Futures Association's self-regulatory responsibilities, Gensler said at the agriculture hearing. Gensler said the "investors here at Peregrine got let down."
Although day-to-day oversight is handled by the futures association, the CFTC retains the legal power to conduct direct oversight when it chooses. The agency used that power to conduct 146 reviews of futures brokers during the nearly six years included in the public records request.
"I'm losing faith in self-regulation unless there is adequate, tight oversight by the agencies we fund," Sen. Tom Harkin, D-Iowa, said at the hearing.
Futures regulators, including the National Futures Association and CME, are conducting a new industrywide review of brokers' bank accounts to ensure the integrity of customer funds, a person briefed on the matter said Monday. The person spoke on condition of anonymity because the review hasn't been publicly announced.
Public records indicate Peregrine had at least one previous violation related to treatment of customer funds. In 1996, Peregrine paid $75,000 to resolve National Futures Association claims that the company engaged in false and deceptive promotion and failed to accurately calculate segregated funds, according to records posted on NFA's website.
After the MF Global collapse, CFTC led a review with NFA and CME of the 70 futures brokers that hold customer funds, including Peregrine.
On Jan. 25, the CFTC announced that customer funds at the brokers were properly segregated. The agency said the review was a "snapshot" of the industry's compliance with regulations and didn't involve a "lengthy examination" of the brokers, according to a statement from the CFTC. The review relied on brokers' records and didn't involve regulatory officials independently confirming balances of customer funds at other entities.
"We are appalled by the recent violations of customer segregated funds that have shaken the very core of our industry," CME Group said. "Without question, the current system in which customer funds are held at the firm level must be re-evaluated."
The CFTC's five commissioners are considering a draft of new regulations to increase customer protection in the futures industry, Gensler told reporters after the hearing. The draft includes allowing regulators to have electronic access to bank accounts and custodial accounts for futures commission merchants, he said. There isn't a date set to vote on the proposal.