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