Fallout From MF Global: Should Brokers Be Allowed To Speculate?

| About: MF Global (MFGLQ)

The November 7 Financial Times reports that MF Global’s (OTC:MFGLQ) retail customers have been placed at risk by the bankruptcy process:

"While customer positions were successfully moved, 40 per cent of their margin, or the deposit needed to make a transaction, was held back at clearing houses as ordered by a US bankruptcy judge.

This raised the risk of widespread margin calls, or demands for additional deposits, from brokers, which could lead to a sell-off in markets from stock index futures to oil.”

The CFTC and the exchanges stepped in to ameliorate the problem. But damage to retail customers who never stood to gain at all from MF Global’s risky investments remains a distinct possibility.

The law is supposed to protect customers’ accounts by requiring that they be segregated from other activities of the broker. But in practice, when a broker fails, it often takes several days for the customer accounts to be sorted out and transferred to a solvent institution. In the meantime, the markets do not stand still, possibly leaving the customers at the mercy of the markets’ movements.

Why should this be? Why should a broker not be a broker? Why should a broker be permitted, in the same entity, to speculate with its own funds? I recognize that has been the traditional way that the business has been run. But why should it continue to be run that way? After all, from the Buttonwood Agreement in 1792 until May 1, 1975, New York Stock Exchange brokers fixed commissions. That “tradition” did not prevent the SEC from, eventually, declaring price fixing to be illegal. And the markets have benefitted enormously from that action, as spreads dropped from an eighth to a penny or less, and transaction costs have plummeted.

Perhaps the MF Global failure should be the catalyst for a study of why retail customers should be at the mercy of their brokers’ speculations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.