The latest stain on the world of trading and finance is still darkening, but once again it appears that millions of dollars in customer funds have been misappropriated.
This time it's Iowa-based futures broker Peregrine Financial Group / PFGBest, which dealt another blow to investor confidence after over $200 million of customer money couldn't be accounted for. If this sounds familiar, it's not your imagination.
Last fall, commodities firm MF Global, run at the time by ex-Goldman Sachs chief, ex-New Jersey Governor and Senator Jon Corzine, went out of business after alarming questions arose about its handling of its customers' accounts. Reuters noted that the size of the Peregrine controversy was "modest relative to the estimated $1.6 billion missing from MF Global's accounts." But the amount is secondary to the notion that it's yet another case of alleged malfeasance in finance and broken customer trust.
Here's a quick look at a few of the other recent scandals that have drawn the public's ire:
- A multibillion-dollar trading loss at JPMorgan Chase
- The Barclays LIBOR manipulation case
- HSBC and a probe into money laundering
- A Georgia money manager goes missing amid an embezzlement investigation
- A rogue trader and a $2 billion loss at UBS
- Raj Rajaratnam gets nailed for insider trading
You get the idea. So now one of the key questions for professional traders, for investors, for financial firms and for lawmakers, is the regulatory response. At the moment, Wall Street's current oversight regime doesn't exactly appear capable of keeping the markets in line, but that's not because there's a deficit of agencies and rules.
Dodd-Frank is now two years old. The following bodies already exist, as do thousands of specifications associated with their functions: The Securities and Exchange Commission, the Financial Industry Regulatory Authority, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the Securities Investor Protection Corporation and a slew of various state-level agencies. Plus, the Justice Department gets involved in some probes, there are congressional committees, both standing and specially formed, etc. This list could go on and on.
Quantity Vs. Quality
A new report from Deloitte, timed to the anniversary of Dodd-Frank, says that "regulatory concerns drive not only tactical, day-to-day decision making [at banks], but strategy level decisions as well." Is it not enough? That might be the wrong thing to ask, according to conversations this week with one of the U.S. financial system's top regulatory voices, along with various market participants.
The regulator here is Sheila Bair, former chair of the FDIC and now senior adviser to The Pew Charitable Trusts and chair of the Systemic Risk Council. In the accompanying interview with Aaron Task, Bair spends time discussing whether the financial system is better and safer for investors than it was in the recent past.
"There are new regulations that are substantial," she says. "It's safer, but it's not as safe as it should be."
In a follow-up interview, she offered further thoughts on Wall Street's string of black eyes and whether more regulation is in fact the answer. "It's a cultural problem," she says of the scandals, adding that it would be a mistake to be enamored with the idea of self-policing markets. In theory, the market could impose checks on nefarious deeds and simultaneously reward business being done the right way, she says, but that's not how it works in the real world.
"The regulatory culture needs to be enhanced as well," she says. "Regulators need to understand they protect the public, and Congress needs to recognize that, too." And, of course, keeping up with misdeeds is difficult. "You regulate one activity, another pops up," she says.
Naturally, she's right. Historically, Wall Street has been a lot smarter, or at least a lot more capable of changing tack, than those doing the watching.
Todd Harrison (@todd_harrison), founder of Minyanville.com, points out that markets operate in real time, whereas the regulatory environment moves much more slowly -- and therein lies one of the key risks with regulation. "You don't make smart, educated decisions when you're in the midst of a crisis," he says.
Prior to founding Minyanville, Harrison spent several years on Wall Street, including stints on the derivatives desks at Morgan Stanley and Galleon Group, and later as president of the $400 million hedge fund Cramer Berkowitz.
Harrison doesn't believe the fraud is endemic to the financial industry. In fact, he says, there are people who do still want banking and finance to be a noble profession. But as we all know, you won't read many headlines about those folks.
"I think you need smarter regulations," he says. "It's not a question of quantity, it's a question of quality. I'm long the quality and short the quantity. Simplify things, but enforce them."
About That Enforcement
Like traders, regulators tend to make news when they err, either intentionally or unintentionally. Considering they're human, the mechanism is bound to have faults, some minor, others not as much. The law firm Davis Polk estimates only 37% of the 221 rule-making deadlines have been met since Dodd-Frank was passed.
None of this means we won't see more rules imposed. It might even mean the opposite as various agencies move to convince the public they're all over it.
Danny Riley (@MrTopStep), one of the principals at MrTopStep.com and a Chicago-based trader for more than 30 years, says there's no doubt that "everybody's on alert" for more regulation. From his place in the trading pits, he's already seen the impact underway. "It's had a huge shrink-down effect on the floor" that has lessened volume, he says.
"We suspect there's going to be a lot more of it (regulation). You get something like PFG, that's not helping, either."
His site has a fascinating front-row account of the PFGBest fiasco, and it is recommended reading. Here's an excerpt:
"MF Global had us angry, but this time, it's personal. Our clients have money with PFGBest. We have money with PFGBest. We were misled by senior leadership that we trusted in business. We were let down by regulators. We were failed by our government."
Watch a congressional hearing sometime. Or think back to the case of the SEC and its pornography-downloading staff members. Invariably, you'll see at least some lawmakers who do not seem quite up to the task of creating and enforcing legislation around the complexities of modern finance.
Nevertheless, CFTC Commissioner Bart Chlton is clearly of the mind that rules are necessary, which he addressed earlier this week with the Dodd-Frank anniversary at hand. "We need the funding to enforce [rules]. Plenty of folks still seem to think they can get around the rules. Plenty of folks in this town seem to think we don't need umpires. Do we? That's a clown question, bro. "
In other words: More regulation is coming, ready or not.