Peregrine Financial Group, known as PFG Best, announced July 9th that customer funds were frozen after a suicide attempt by the founder, Russell Wasendorf Sr. Dan Roth, president of the NFA, said today that the NFA was "fooled" by Mr. Wasendorf.
The PFG Best situation is still being investigated and we are far from knowing 100% of the facts. However we have learned much since our last article, The Frightening Truth about PFG Best. Russell Wasendorf, Sr. has awoke from his coma and is now under arrest. He has no money to pay for an attorney so he will be represented by an appointed one.
Firms such as Fulcrum will purchase the claims of customers hoping to get more for them, by actively pursuing PFG through lawsuits and other legal means. Therefore these numbers are usually fairly accurate, as firms are willing to put their money at risk to get at least that much back, hopefully more. So we hope this is a bottom, customers could potentially receive more.
The CFTC's Gensler has admitted regulation has failed to protect the customers of PFG. With the recent collapse of MF Global, PFG Best has alerted a host of different groups such as the public, politicians, regulators, finance professionals, and others that such cases are not always isolated incidents.
Could PFG's liquidate only mode have affected the markets?
We have written a few articles on potential strategies, such as Strangle the Euro, and A Put on the Euro to Parity. Strategies to capitalize on this climate certainly will not be conventional. For example, the best CTAs at PFG all had, according to above data, an 80% - 75% drawdown this month. NFA has released a statement that this is not going to be reported as a loss, as it was not in the CTA control. While this is fair from the NFA side, and CTAs legitimately are not at fault for the PFG situation, from the customer perspective, they will realize an 80% - 75% loss this month. So from their perspective, their tangible return was a big loss this month.
If you look at the client perspective from a portfolio creation standpoint, this portion of their portfolio is a big loss. From that standpoint, it is no different than a trading loss. In a results based environment, a loss is a loss regardless if it's fraud, mismanagement, a bad strategy, or "bad luck."
Clients are supposed to do due diligence on investments. The reason for the QEP exemption on disclosure documents is because those who qualify as QEPs are exempt from retail disclosures, either because they are experienced financial professionals, or they have made many investments and are considered to be able to handle their own due diligence successfully (having many millions to invest is sort of proof that you know what you are doing with money from a regulatory perspective). However, in the case of PFG, both retail and institutional investors were wiped out. Many are currently blaming the regulators, and clearly they were worried about minutia while the elephant in the room went unnoticed, but many who worked with PFG intimately had red flags, such as Phil Flynn.
Compared to other industries, the allowed tolerance of failure is far greater by many magnitudes. For example if you purchased a car from Toyota, and you drove it for years but one day it exploded and killed your family, Toyota would no longer exist and the executives would be jailed. This could be said about many offered products. The irony is that companies such as PFG Best rely on those in "real" industries such as manufacturing and agriculture to open accounts and deposit profits they've made in the real economy. And also ironically, PFG was a large provider of legitimately needed hedging services, and was very light on speculative investments.
Similar to the credit crisis of 2007/2008 - a lack of trust formed amongst counterparties. Banks didn't trust other banks. Now producers don't trust hedgers (companies offering hedging of their legitimate business) which can greatly impact the future of the markets, since the origin of the Futures exchanges are based on a real need of producers to hedge their balance sheets by engaging in financial products such as futures contracts to protect their real, physical business.
Based on available information, there cannot be any conclusive solution other than to say that the current system is dysfunctional. Market participants from both sides of the spectrum (from state controlled socialism to laissez-faire capitalist anarchists) would agree that the PFG situation is a failure, as it was not the markets, or the controlling state, to blame for the fraud. PFG customers whose funds have been lost (frozen) are ultimately kicked out of the game, at least considering the funds they had at PFG. $200 Million is a drop in the global bucket, but their total funds on deposit were $500 Million. With only 20:1 leverage, some customers getting much more, PFG customers had a $10 Billion effect on the markets globally. From an economic perspective, the PFG situation is the economic equivalent of a default, or of a nationalization of assets. What yesterday were thought to be tradeable funds are now in a bankruptcy court.
Concluding, to do your due diligence is obvious, what is less obvious is how to do it. Previous methods obviously have failed. There are many functional methods that will work as alternatives but what is important is to change the way we think about institutions, regulation, and due diligence.
Here was a seemingly credible good looking company, fully regulated, all the while perpetrating the fraud. While there was no smoking gun, those such as Phil Flynn and probably many others, had many red flags that caused concern. Many had relied on commonly accepted cultural norms as security, such as the fact that they were highly regulated and a well known company. They were a member of the community, Russell Wasendorf Sr. was on NFA committees, and PFG had many qualified QEP clients including other institutions, agricultural hedgers, CTAs, and many others.
Unfortunately the PFG situation may bring more questions than answers, but the productive note may be that we may begin questioning those axioms which previously were accepted as axioms and now are proven to be only weak theories.
Forex Risk Disclosure - Click here to read
The risk of loss in trading foreign exchange markets (FOREX), also known as cash foreign currencies, or the FOREX markets, can be substantial.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.