More On Legal & Compliancefrom The Advisor's Professional Library
- Using Solicitors to Attract Clients Rule 206(4)-3 under the Investment Advisors Act establishes requirements governing cash payments to solicitors. The rule permits payment of cash referral fees to individuals and companies recommending clients to an RIA, but requires four conditions are first satisfied.
- RIAs and Customer Identification Just as RIAs owe a duty to diligently protect their clients privacy and guard against theft, firms also play a vital role in customer identification. Although RIAs are not subject to an anti-money laundering rule, securities regulators expect advisors to address these issues in their policies and procedures.
The Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA) have taken action against Peregrine Financial Group, also called PFGBest, a Cedar Falls, Iowa-based broker, after the discovery that client accounts that should have held $225 million only contained $5 million. In addition, the CFTC is said to be on the verge of approving the “Corzine rule” in the wake of the money’s disappearance.
The Omaha division of the FBI is investigating the matter, with the Chicago division possibly becoming involved as well. The National Grain and Feed Association was “infuriated” and demanding answers as members, many of whom had already been hit by the fall of MF Global, stood to suffer yet another financial blow as trust in markets plunged. Alarm bells should have sounded, say experts, at the firm’s use of a tiny auditor operating out of a private home.
And in an odd personal note, it was learned that PFGBest founder Russell Wasendorf Sr. (left), who had sent out invitations to a planned local wedding with his fiancée Nancy Paladino, had actually already married Paladino in Las Vegas on June 30—just three days before he signed over power of attorney to his son.
In what is seen as a black eye for the CFTC and NFA, the regulators had given a clean bill of health to PFGBest and numerous other firms in January, after undertaking an industrywide review of the 70 largest futures commission merchants to reassure clients after the collapse of MF Global in October, which was run by former New Jersey Gov. Jon Corzine, Reuters reported Tuesday. The New York Times reported that the money was discovered to be missing on Monday by the NFA, which stopped operations at the firm; that evening, Wasendorf Sr. attempted suicide outside the firm’s offices in his car. On Tuesday the firm filed for Chapter 7 bankruptcy.
At the time of the review, the CFTC said it found no "material breaches of customer funds protection requirements." Gary Gensler, chairman of the CFTC, said in the report on Tuesday that the review was conducted by the NFA and was not equivalent to a full-scale audit. The same day, the CFTC filed suit against Peregrine Financial Group and owner PFGBest, charging fraud, failure to segregate client funds and the making of false statements. It has also asked a federal court to appoint a receiver for the firm and freeze its assets.
On Thursday the CFTC was reported by unnamed sources to have already gotten three votes in favor of implementing the “Corzine rule,” proposed by the NFA, which would require top executives at futures brokers to sign off on major withdrawals from customer accounts. The rule has been under consideration since May, but seems to have found new life in the wake of the PFGBest scandal.
In the bankruptcy filing, Peregrine Financial Group was shown to have $500 million to $1 billion in assets, $100 million to $500 million in liabilities, and 10,000 to 25,000 creditors. A board resolution to authorize the filing was signed by President Russell Wasendorf Jr., who also signed on behalf of Chairman Russell Wasendorf Sr. A power of attorney dated July 3 empowered Wasendorf Jr. to act for Wasendorf Sr. should he become incapacitated.
According to a CNBC report on Thursday, "an apparent suicide note found in Wasendorf Sr.'s vehicle indicated possible accounting discrepancies at the firm, according to a police report. Authorities will not discuss Wasendorf Sr.'s condition, but a local newspaper, quoting unidentified sources, reported he is alert and responsive at an Iowa hospital, and possibly able to shed some light on the bizarre events leading up to the firm's collapse."
In its complaint, the CFTC said that records had been falsified as far back as 2010. Reuters reported that, according to a confidential source close to the situation, Wasendorf Sr. intercepted confidential regulatory documents mailed by the NFA to a post office box he had set up. The NFA had been led to believe that the address belonged to U.S. Bank, which was PFG's bank. Instead, the documents, which were used to independently verify a broker's bank balances, went to Wasendorf Sr., who forged signatures, made up bank balances, and sent the forms back to the NFA. He also stalled on signing off on electronic confirmations, which would have revealed the shortfall much more quickly.
Dozens of large farm-related businesses among the grain trade group’s members, which include more than 1,000 grain elevators, food processors and exporters, were hit with massive losses by the failure of MF Global in October. This fresh blow has NGFA members steaming—particularly at regulators.
Todd Kemp, NGFA’s vice president of marketing, was quoted saying, "We are really looking forward to a full explanation from the regulators about just what happens and how apparently it happens over a fairly long period of time before detected."
Diana Klemme, vice president of Grain Service Corp. in Atlanta, was more outspoken, saying, "The industry is infuriated over this because it affects everyone. Our customers raised the question of—if an audit doesn't catch problems, what does? In this case it was a suicide attempt. It's almost beyond belief that after MF Global that's the way a problem was discovered … You'd certainly think NFA would be suspicious of directing inquiries to a post office box … Clearly more regulation and laws do not necessarily change anything. We've got plenty of regulations and audits that didn't catch the problem."
Questions arose over why the firm appeared to be using an accounting firm that was so small it operated out of a suburban Chicago house. PFGBest had several hundred employees not just across the U.S., but also in Canada and Shanghai, and had (or was supposed to have) more than $500 million in assets. Futures industry investigators are looking into the matter even as experts say the arrangement should have sent up red flags.
The tiny Veraja-Snelling Co., based in Glendale Heights, Ill., had certified that client funds were segregated at the firm, and of course that was not the case, with more than $200 million missing from accounts. The NFA said that the accounting firm, which has no disciplinary history with Illinois financial regulators and has not been accused of any wrongdoing, audited PFGBest’s financial statements in 2011. In its 2010 report, the accounting firm said that there were no material weaknesses involving internal controls and that the "corporation's practices and procedures were adequate."
Amid the confusion over Wasendorf Sr.’s marriage, there was also outrage among some PFGBest employees, many of whom had relocated in 2009 from Chicago to the new building that housed the firm. One former employee has sued, saying that he and others in the firm’s offices in Chicago and Iowa were fired en masse on Monday without cause or 60 days’ notice, in violation of federal law.
Trade clerk Mike Leska, who worked for the firm in Chicago for six years, said he had been told that Wasendorf Sr. was conscious and had apologized for what he had done. Employees had been stunned by the turn of events. Leska was quoted saying, "It's really disgusting. We all thought he was different."
Sen. Debbie Stabenow, D-Mich., chairwoman of the agriculture committee, which oversees the CFTC, announced that the committee will hold hearings on July 17 and Aug. 1 at which regulators, reform advocates and industry groups will testify about progress on swaps and futures market reforms. Gensler is scheduled to appear at the July 17 hearing.
A former employee was reportedly worried that more action was not taken to assert the company’s innocence in an earlier case of fraud. Trevor Cook of Minnesota, who is serving a 25-year prison sentence, had run a $194 million foreign exchange-trading Ponzi scheme. PFGBest had acted as Cook's broker, and in February was fined $700,000 by the NFA for failing to notice the scheme. The broker was later sued for $48 million by the receiver seeking to recover assets from Cook's scheme.
"They never admitted they were aware of what was going on, but they didn't deny it either," said the former employee in the report.
Ironically, in 2008 Futures Magazine named the firm the 30th best futures brokerage.