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Lauren Teigland-Hunt

“The insolvency regimes for U.S. broker-dealers and commodity brokers protect customer assets in very different ways and have never been harmonized despite calls to do so in the wake of Lehman’s collapse,” says Lauren Teigland-Hunt, managing partner. “MF Global represents the first significant liquidation of a brokerage firm that was jointly registered as a broker-dealer with the SEC and a commodity broker with the CFTC.”

The distinctions between the insolvency regimes for broker-dealers and commodity brokers can be summarized as follows:

• U.S. securities laws create an insurance system that requires an SEC-registered broker-dealer to join the Securities Investor Protection Corporation (“SIPC”). SIPC collects fees from its members to create a reserve fund that can be used to reimburse customer losses (up to a maximum of $500,000 per customer) in the event of a broker-dealer insolvency. Broker-dealers are therefore typically liquidated in accordance with the provisions of the Securities Investor Protection Act (“SIPA”), and a SIPC-appointed trustee oversees the liquidation.
• In contrast SIPA does not apply to commodities brokers, which are instead liquidated in accordance with the provisions of Subchapter IV of Chapter 7 of the U.S. Bankruptcy Code. The regulatory regime applicable to commodities brokers does not provide for SIPC-type insurance protection but instead requires CFTC-registered commodity brokers, or futures commission merchants (“FCMs”), to segregate customer funds from the funds of the commodity broker in a separate bank account that is clearly designated as belonging to customers. Segregation in this manner is intended to ensure that, in the event of an FCM bankruptcy, customer funds would be identified as such and would not be available to other creditors of the FCM. A trustee overseeing the liquidation of an FCM is required to apply the CFTC’s “Part 190” rules for FCM insolvencies, which call for the determination of various account classes that govern the manner in which the trustee calculates the amount of each customer’s claim against an insolvent FCM.

The conflicts between the securities and futures regimes for insolvent brokers were nearly put to the test when Lehman Brothers Inc. (“LBI”)—also a dually registered BD/FCM—failed in 2008. Teigland-Hunt says a potential crisis was avoided, however, because the sale of LBI’s futures business to Barclays Capital was arranged shortly before LBI’s liquidation proceeding was commenced by SIPC on September 19, 2008. As a result, the trustee for the LBI liquidation (who happens to be the same trustee for MF Global) applied only the SIPC regime when unwinding LBI and did not contend with applying the CFTC insolvency regime for FCMs simultaneously.

“The potential impact of malfeasance on customer recovery from a BD/FCM is just one of the issues that these conflicting regimes fail to address with clarity,” says Ms. Teigland-Hunt. “For example, if customer funds were inappropriately diverted from an insolvent broker’s futures customer accounts but not the securities customer accounts, should futures customers bear the resulting losses alone and spare securities customers the consequences of such behavior?

Or should customers of a failed BD/FCM share ratably in losses induced by fraud?”

With over 40 of the 50 largest FCMs also registered as broker-dealers, the failures of MF Global and LBI underscore the importance of revisiting the potential benefits of developing a more consistent customer asset protection regime that balances the interests of protecting customer assets as well as the integrity of the financial markets in the event of the failure of a major brokerage firm.

Source

Press Release

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