Following the NFA’s finding of fraud at PFG, the regulator launched a system to monitor daily activity of segregated client account totals. The fraud was based on ownership misappropriation of customer deposits. Similarly, the MF Global scandal was based on intermingling client funds to meet the firm’s proprietary trading margin requirements. As a result of the illegal usage of client money, the NFA created a policy where Futures Commission Merchants (FCM) would provide read-only access of segregated fund bank accounts and real-time notifications of transfers. The data would then be compared to net deposit figures that FCMs are required to provide.
The data monitoring was conducted through a partnership between the NFA and CME. In a letter to Forex Magnates that was meant to highlight some of the regulators’ accomplishments, they explained the arrangement stating that the “NFA and the CME confirm all balances in all customer segregated bank accounts on a daily basis. FCMs file daily reports with NFA and the CME, reflecting the amount of customer funds the FCM is holding. Through a third party vendor, NFA and CME get daily reports from banks for the over 2,000 customer segregated bank accounts maintained by FCMs. We then perform an automated comparison of the reports from the FCMs and the reports from the banks to identify any suspicious discrepancies.”
In regards to the above mentioned third party vendor, the NFA partnered with hedge fund administration firm AlphaMetrix360, a subsidiary of alternative investment marketplace, AlphaMetrix. NFA monitoring using AlphaMetrix360’s technology began in February of this year.
Currently, the NFA has announced in a letter to FCMs that as of October 29th, data will no longer be collected by AlphaMetrix360, with financials to reported directly to the CME. The change occurs as its parent group AlphaMetrix has been beset with financial woes. Acting as matching system between investors with traders and fund managers, AlphaMetrix operated a commodity pool (CPO). Following reports of delays to its third party managers, AlphaMetrix issued a letter to clients that it was “working within the capital markets to improve its short-term cash flow”, but that client funds were safely deposited with FCMs (full letter). The company has also fired its CFO in response to the company’s financial problems.
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In regards to the NFA, in its letter to FCMs, the regulator made no mention of the problems at AlphaMetrix, other than stating that it was in their plans to operate monitoring systems in house, as they said “As you know, NFA and CME Group launched an initiative in February 2013 that automated the collection of end-of-day account balance information for customer segregated accounts. To launch the program, NFA and CME Group contracted with AlphaMetrix360, LLC (AM360) to serve as its third-party data aggregator. Since that time, NFA and CME Group have taken steps to develop the systems needed to perform this function on their own.”
Restoring Exchange Trust
In regards to the NFA, the regulator has been in a battle of attempting to reestablish client faith following the MF Global and PFG scandals. With fund oversight coming under fire, the immediate effects of the fraud led many traders to shift overnight funds to larger and more reputable firms. The fund rotation occured even as the CME had been a beneficiary of the 2008/09 global financial crisis, as it won new business thanks to its central counterparty model. The misappropriation of segregated funds showed that even when removing counterparty risks, investors are vulnerable to internal broker fraud. Therefore, the application of the NFA’s daily monitoring was viewed as a means to return confidence to the greater exchange based central counterparty model.
With AlphaMetrix360 being ousted due to questions of its own operators being able to pay its partners, it inevitably raises the question of ‘who is watching the watchmen?’