Financial History Issue 118 (Summer 2016) | Page 36

Headline from the Philadelphia Inquirer during the Crash of 1987 .

Hulton Archive / Getty Images pro rata basis , and each would share equally based on the percentage of the shortfall .

For example , if a segregated account should hold $ 100 million of customer assets , but only $ 98 million was in the account at the close of a business day , there would be a 2 % shortfall . If the customer had deposited $ 100,000 with that FCM to meet his margin requirements , then he would only receive $ 98,000 back , taking into effect that shortfall .

Notable Bankruptcies : Lehman , MF Global and Peregrine

There have been some noteworthy FCM bankruptcies in recent years . The largest involved Lehman Brothers , which filed for bankruptcy in September 2008 . On Monday , September 15 , Lehman had approximately $ 10 billion in customer assets . By the close of business on Friday , September 19 , all futures positions had been either transferred to other FCMs or liquidated , and all customer assets were properly transferred without a dollar lost by any of Lehman ’ s futures customers . It showed that if an FCM follows the applicable laws and regulations , then the system works .

That is not always the case , however . On October 31 , 2011 , another large FCM , MF Global , filed for bankruptcy with a shortfall of approximately $ 1.2 billion in customer funds . While MF Global ’ s customers did eventually receive 100 % of their assets , they initially got back only 70 %. The remaining 30 % was transferred to them over the next few years .

A few months later , another FCM , Peregrine Financial Group , filed for bankruptcy with a shortfall of approximately $ 200 million . That FCM only had $ 400 million in customer assets , so the shortfall totaled nearly 50 %. Because of these two bankruptcies and the resulting shortfalls in their customer segregated accounts , a number of regulatory changes have recently taken place . Most notably , all FCMs and their custodian banks holding customer assets must now report their account balances each morning to the regulators . Thus , the regulators can now compare the amount that should be held in its customer segregated account to the totals shown in its various custodian accounts . If any significant difference occurs , the regulators can take immediate action to determine the reason for the difference . Prior to this rule , FCMs only reported their balances on a monthly basis .

Another major regulatory change requires the CEO or his designee to approve any transfer of 25 % or more out of the customer segregated account . Most FCMs today deposit a large amount of their own capital into the segregated account to ensure , to the extent possible , that no shortfall in the account will occur . This FCM capital investment is called the “ residual interest .” Once the FCM ’ s capital is so deposited into the customer segregated account , it is deemed to be “ customer property .” This means that if the FCM fails for any reason , its capital so deposited will first be treated to protect the FCM ’ s customers and may not be used by any of its creditors until the customers receive 100 % of their assets back .

Assuming the FCM is doing well but wants to transfer back some of its own capital that was held in the customer segregated account , » continued on page 38

34 FINANCIAL HISTORY | Summer 2016 | www . MoAF . org