Investment pundits have identified at least 15 distinct types of investment risks. Now, we can add another: broker risk.
After the Bernie Madoff scandal, investors again saw that sociopathic money managers could steal entire accounts. Now, investors have seen that entire brokerage firms can similarly confiscate customer money, even though it is supposedly held in segregated accounts; which cannot be co-mingled with non-customer, corporate funds.
The latest scandal comes from MF Global, a huge managed futures firm which diverted about $1.2 billion in customer funds into its corporate account. That money was invested in non-U.S. government securities via a series of hybrid financial transactions.
The Commodity Futures Trading Commission (CFTC), the federal regulator of the futures markets, said it had finalized rules to make it tougher for futures firms to access customer money months ago. But when Jon Corzine, the CEO of MF Global, and former governor of New Jersey and senator (D-NJ), objected to the plan, the CFTC acquiesced and delayed the rule’s implementation.
For its regulatory acquiescence, the CFTC was rewarded with the bankruptcy of MF Global, headed by Corzine, on Oct. 31, 2011. Corzine resigned from MF Global a few days after the firm went bankrupt. But with the damage was already done, the CFTC then enacted rules intended to protect customer assets.
In a gross understatement, CFTC Chairman Gary Gensler, formerly of Goldman Sachs, said “I believe that this rule is critical for the safeguarding of customer money,” even though the hunt for the missing customer funds is ongoing.
But speaking before the Senate Banking Committee on December 6, Gensler recused himself from the MF inquiry because he was a colleague of former MF Global CEO Corzine when Corzine was chairman of Goldman Sachs. Interestingly, Gensler did not recuse himself when the CFTC deferred action on the rule to protect customer assets after Corzine appeared before the CFTC in November.
At that same Senate hearing, the CFTC said it had failed to locate about $1.2 billion in customer funds.
On December 13, two of MF’s top executives–Bradley Abelow, MF Global’s chief operating officer and Mr. Corzine’s chief of staff when he was governor of New Jersey, and Henri J. Steenkamp, the firm’s chief financial officer–both testified that they are not sure where the missing $1 billion went. Steenkamp, who as CFO made an estimated $500,000 annually (plus bonus), according to the New York Times, said it was not part of his day-to-day responsibilities to oversee customer funds. For his work, Abelow made $1.5 million annually.
Neither Abelow, Steenkamp nor Corzine have been accused of any wrongdoing.
Another Blow to Investor Confidence
As a former customer of MF Global, this could easily have been my money that vanished. It was just a matter of luck and timing. I closed my account months ago, but like any investor, would never have any clue that MF was investing heavily in European debt, and would misdirect my money to cover their bets.
It now seems that “safekeeping customer money” has become another empty marketing slogan. Remember that pension fund assets accumulated by TWA, and Robert Maxwell, to name a few, were all in segregated accounts until those supposedly-protected cash reserves were identified as general corporate assets by the takeover artists of the Seventies and Eighties. In the 1980s, pension fund assets were used in two-thirds of that decade’s largest buyouts.
Pension assets were also sold or re-directed from workers to management as part of a wealth transfer plan that began in the 1990s. In the book, “Retirement Heist,” Wall Street Journal reporter Ellen Schultz said corporations transferred wealth over the past 20 years by transferring pension assets from thousands of workers to a small handful of executives.
Even the famous Social Security “lockbox,” identified by Al Gore in the 2000 presidential campaign was a designated separate account for recipients until it too was raided to meet other federal obligations. Interestingly, in 1999, Republican Congressman Wally Herger sponsored a “lockbox” bill in the House of Representatives. This law would have restricted Congress from using money borrowed from the Social Security program to spend on other government programs. It passed the House by a vote of 416 to 12.
But when this bill went for a vote in the Senate, it was blocked by a filibuster conducted by Democrats. All 55 Republicans voted to allow the bill to move forward. All but one of 45 Democrats voted to block the bill, and one Democrat did not vote.
Crusaders and Fiduciaries
Larceny does not have many new patterns, only new variations.
And since robbery is part of the human condition, the law has devised ways to keep it intermittently in check. For example, safeguarding other people’s assets and personal property dates back to the Crusades when English royalty created a formal system of entrusting other knights with the responsibility of safeguarding the property of journeying warriors. This led to the medieval concept of being a fiduciary.
Today, the financial services industry and its federal regulators are still debating whether brokers and financial advisers should be considered fiduciaries.
In light of the misuse of billions of dollars in customer funds, pension assets, and other investor money by professional managers, it is astounding that the financial services industry still insists that the case for financial professionals to be considered fiduciaries requires more evidence.