Customer Protection Regulation - Study - Analysis of National Futures Association Audits of Peregrine Financial Group, January 29, 2013

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On July 9, 2012, non-clearing FCM PFGBest, formerly Peregrine Financial Group, revealed that it had frozen client accounts after its founder, Russell Wasendorf, Sr., had attempted suicide. It was later revealed that the firm had been submitting falsified bank statements to auditors from the National Futures Association (NFA), and that approximately $220 million in customer segregated funds had not been accounted for.[1]

On August 21, 2012, the NFA submitted to the CFTC a list of proposed amendments to its financial requirements of FCMs. The proposed amendments would require FCMs to provide their designated self-regulatory organization ("DSRO") with on-line view-only access to FCM customer segregated/secured amount bank account information. The amendments would also add CFTC Regulation 1.49 to the list of CFTC Regulations, that if violated, constitute a violation of NFA rules.

Read proposed rule.png

On January 29, 2013, the NFA released the findings of an investigation conducted by the Berkeley Research Group that audited the NFA's audit procedures on Peregrine from 1995-2012. The independent report includes 21 recommendations covering auditor training, hiring practices, policies and procedures, as well as testing of internal controls at member firms and better identifying of potential risk factors in futures commission merchant operations.[2] BRG reviewed more than 190,000 NFA documents containing over 3 million pages, including 166,000 emails and related attachments.

Summary of the Findings

The NFA performed 27 audits of PFG between 1995 and 2012, including d 17 unannounced annual audits conducted every 9 to 15 months, 7 audits of PFG’s branch offices, an additional audit during 2010 and two additional audits in 2011. In 7 of the 17 annual audits, NFA auditors sent a bank confirmation to U.S. Bank. The audits did not find any material issues with the confirmations until 2012, when they began using an electronic confirmation process and the fraud was uncovered.

NFA audits of PFG did not focus adequately on internal controls of PFG. For instance, some NFA auditors were not aware that Wasendorf was the only individual within PFG who had access to the original U.S. Bank statements (which provided him the ability to falsify the statements provided to PFG’s staff and NFA), or that senior PFG officials, such as the Chief Financial Officer (“CFO”) after 2006, had questionable qualifications.

NFA auditors did not fully examine the fact that PFG was losing significant money in many years, Wasendorf’s frequent and significant capital contributions, or the source of his capital contributions.

We found that NFA auditors did not express significant concerns about PFG’s reverse repurchase agreements (“repos”) and sweep accounts, notwithstanding their examination of such arrangements in several audits and the fact that PFG decided to forgo this arrangement altogether in 2009. In audits subsequent to PFG’s discontinuance of repos and sweep accounts in 2009, NFA auditors did not question this decision or why approximately $200 million was being left in a customer segregated funds account and not being invested overnight.

While the U.S. Commodity Futures Trading Commission (“CFTC”) conducted a few limited reviews of PFG over the years, there was little evidence of coordination between the CFTC and NFA with respect to their examination of PFG.

Related Document: Report of Investigation, Berkeley Research Group, January 29, 2013

References

  1. Peregrine Financial Group brokerage said to be $220 million short in customer funds. CBS. Retrieved on July 10, 2012.
  2. Peregrine fraud investigation finds shortcomings at futures regulator. Crain's Chicago Business. Retrieved on February 1, 2013.

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