Welcome back, Meta-Traders.
It has often been said that nothing new ever happens in the world of trading and investing. And while that may be the case, nature sometimes has a way of whacking you in the head, from an unexpected direction and at an unexpected time.
Thus was the case this past week with the announcement of the attempted suicide of PFG Best founder and Futures industry icon Russ Wassendorf. And that news was accompanied by a raft of other disturbing developments:
- Wassendorf attempted to commit suicide, unsuccessfully, and instead ended up in the hospital in critical condition. He has since recovered and is now in police custody.
- Wassendorf left a note in the car that stating: "I have committed fraud ..I feel constant and intense guilt.”
- Allegations indicate that the fraud as continued for decades and involved using customer funds and fraudulent bank statements to deceived customers, regulators, employees and the very community where Wassendorf did business.
- Apparently, USD $200 million of customer funds are missing and PFG is now the target of investigations by the NFA, FBI and the US Justice Department.
What makes this case so disturbing is that Wassendorf was an industry icon. For over 10 years, I have been reading and benefiting from free trader education from Stock Futures and Options Magazine which continued in glossy print for many years and went all-electronic in the past year or so. I regularly commented on recent Facebook posts from Phil Flynn, Debbie Carlson and other industry figures.
Also, Wassendorf built an 18-million company headquarters in Cedar Falls, Iowa (shown above) which included day-care, a 4-star cafeteria and state of the art geothermal climate-control technology. He employed industry heavyweights and published their analysis and trading techniques in a separate publishing arm in support of the brokerage. He was a pillar of the community, trader, activist, business owner and employer.
But in the end, it was all a lie. The suicide notes says: "I was forced into a difficult decision: Should I go out of business or cheat?" he wrote. "I guess my ego was too big to admit failure. So I cheated." And he cheated by violating the most fundamental rules of the brokerage industry, by using customer funds to keep afloat a failing business.
Even more disturbing was how he deceived the regulators. PFG Best was regulated by National Futures Association or NFA. This is the same organization that regulates Future and Forex Brokers in the US. Apparently, when NFA required proof of bank deposits, Wassendorf redirected the request for bank confirmation to a destination at a post office box, and simply crafted fake bank statements using a combination of photoshop, excel spreadsheets and laser and ink-jet technology. Apparently, no-one else was complicit in the fraud including his son, Russ Wassendorf Jr who was also a victim of the fraud and has been cooperating with the authorities in the investigation.
As if all this wasn’t enough, we have a recent history of spectacular industry and regulatory failures from MF Global, Refco and the biggest fraud of all from Ponzi schemer Bernard Madoff. Each case was large, spectacular and utterly undetected by the regulators whose very job it is to keep the customer’s money safe! I believe most of the missing funds were recovered in the case of MF Global.
A recent news story from Forbes.com indicates that an independent web site http://www.confirmation.com – which provides a simple 3rd party confirmation of bank deposits independent of both the regulator and the company – brought down the fraud at PFG Best. For many weeks and months Wassendorf has resisted use of confirmation.com to validate his bank deposits. And the very prodding of this organization brought the fraud to light before it got larger and took down more victims.
Fortunately for me, I did not lose any money in this fraud. But it seriously undermines my confidence in the money and regulatory establishments in nearly every respect. Clearly, the single-person nature of the fraud does not extend to every public company and regulatory institution. But it does call into question the financial security of the companies I routinely do business with.
Along those lines, I took a look at the Web site for E*Trade Securities, the brokerage which holds the majority of my financial assets. All the way at the bottom of the Web site is a link to an item called “Statement of Financial Condition”. The most recent statement is preceded by a letter by auditor Deloitte and Touche with the following text:
“We conducted our Audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statement is free of material misstatement. An Audit also includes consideration of internal controls over financial reporting as a basis of designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion..."
I take this statement to mean the auditors can be fooled by simply presenting them with fraudulent or incorrect data. So what is an investor to do, can any brokerage be trusted to keep your money safe?
Customers of banks in the United States are protected by failure of the bank by the Federal Depositors Insurance Company or FDIC. Customers of securities companies are protected by the Securities Investors Protection Corporation or SIPC. I checked the SIPC Web Site at http://www.sipc.org and found that my brokerage E*Trade Clearing LLC is indeed a member of SIPC. I also found that the clearing firm for PFG Best “BEST DIRECT SECURITIES LLC” is also listed as a member of SIPC on the SPIC web site. That means that PFG Best customers should get their money back although the SIPC Web Site indicates it can sometimes take many months for customer to get their money back if financial fraud was involved in the claim.
Clearly as a brokerage customer, there are more ways to lose money that just making bad investment choices or having the markets move against you. So what are the key takeaways here?
- Examine the statement of financial condition of the broker that holds your funds.
- Examine the Annual Report of the Brokerage Company or LLC and try to determine if the brokerage actually generates enough in commissions to meet their operating costs.
- Understand what are the entities that protect your funds (FDIC, SIPC) and verify that your brokerage is actually a member of that site from the SIPC or other Web Site
- Understand the limits of the protection provided by that entity and be prepared to lose anything above those limits unless they are covered by another insurer.
Do some diligence on the firms you work with to protect yourself from financial fraud.
Be careful out there and have a great week.
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