Just a few days removed from the National Futures Association’s live fire drill to reexamine and perhaps retool its audit functions, the CME Group brought its fire hose in the form of a letter to customers on Monday.

In the letter, CME’s leaders Terry Duffy and Phupinder Gill proposed that clearing houses or other depositories hold all customer segregated funds, with any interest earned going back to the FCMs.  This third-party custodian model has been around for decades, for managed futures firms, hedge funds and other institutions that need their cash separate and secure.

My house was broken into this weekend. The back door was forced and when that didn’t give way the thief broke the door glass and opened the dead bolt by hand. From there he rifled through a few drawers – he or she took a laptop, small electronics, most of our jewelry, then stuffed them in my favorite backpack and was gone.

I live on the north side of Chicago about a mile away from Wrigley Field. The police came and looked over the scene, dusted for fingerprints but got nothing. I was disturbed and felt violated, edgy and angry at the guy who took our stuff. And I was hopeful the cops would catch this person and bring him to justice. But that’ll likely not happen.

In a way, it’s a metaphor for how the victims of the MF Global case and the Peregrine Financial Group (PFGBEST), and ordinary taxpayers feel today. Someone broke into their account and stole their money. Russ Wasendorf Sr. got caught, but only after 20 years of stealing customer funds and then writing a suicide note detailing the fraud. The MF Global case is still ongoing and many in the industry wonder if there will ever be charges filed against anyone at the company.

With each new story about PFGBEST and Russell Wasendorf, Sr., new red flags are springing up. In yesterday’s story from Bloomberg we found out a bunch of PFG employees were taken on a trip to Italy where they stayed at luxury hotels.

Then there is the jet, and the $18 million corporate compound built after the financial crisis caused interest rates to plummet along with trading volumes.

There is the social climbing, along with the expensive celebrity sponsorships at FIA and CME Group events. There is the expensive glossy “vanity” magazine which cost $100,000 a month just to print, Russ Jr. once told me.

The sole practitioner accountant working from a home office is a nice touch and a genuine red flag.

The cake topper is the P.O. box for the bank statements, which is so confounding as to be mind boggling.

Yep, more red flags are blowing with each new story about Wasendorf Sr.

by James Gellert, Chairman and CEO, Rapid Ratings International
Edward Chambliss, Senior Vice President, Rapid Ratings International

For the second time in less than a year the futures industry has been rocked by the implosion of yet another well-known FCM, Peregrine Financial Group, Inc. This time the collapse took place against a backdrop of formal CFTC allegations, from the start, of the misappropriation of customer funds. While PFG was nowhere near MF Global in the size and scope of its business, the firm enjoyed added industry prominence as a “thought leader” and promoter of ”best practices” growing out of its special efforts to instruct large numbers of individual traders by means of the periodicals and books it published over many years.

By John J. Lothian

Sometimes you need to use your outdoor voice.  Sometimes inside.  When I heard yesterday that the NFA procedure for verifying the bank balances at U.S. bank for Peregrine Financial Group was to send a request for verification letter to a post office box, I used my outside voice again.  I then used my “I need to be careful not to bring down the building voice” when I heard that the post office box was registered in the name of Russell Wasendorf, Sr.

This is what I was told by regulatory sources yesterday and which Ann Saphir reported at Reuters.  And I still don’t believe it possible, but it is.

If you hear a man yelling loudly, or crying softly in the CBOT Building, it might just be me.

By John J. Lothian

I am not a futures broker… anymore that is.  Wow!  What a feeling!  (See Taking My Own Advice from Friday for why.)

Since 1984 I have worked for a futures brokerage firm, been a futures broker, or a proprietary trader.  Of course, since 2000 or 2003, depending on your perspective, I have been in the media business too.

As a futures broker, you have a lot of risk.  Your clients are risk takers.  They are speculators who have assumed the risk of hedgers.  Or, your clients are hedgers.  And they are laying off their cash market risk in the futures markets.

By John J. Lothian

Recently several friends of mine have come to me after having been terminated by their brokerage firm or proprietary trading firm employers.  I listened to their stories then gave them a pep talk about the bright opportunities in front of them in light of all the changes occurring the markets and industry.  This week I took my own advice.

Yesterday, I resigned as a branch manager of The Price Futures Group, Inc., my employer since November of 1997.  In December of 2011 I had stepped down as President of the Electronic Trading Division of the Price Group when we moved John J. Lothian & Company, Inc. to new offices in the CBOT Building.  You could say my brokerage business was a casualty of the success of John J. Lothian & Company, Inc. and its media business.  You could also say that MF Global’s bankruptcy was the final straw that killed it.

By John Lothian

As I was listening to one of the High Frequency Trading subcommittee reports at the Technology Advisory Committee Meeting  of the Commodity Futures Trading Commission a week ago, I took umbrage at some of the language being used to describe trading.

Specifically, I mentioned that I abhor the use of the words “bet” or “betting” to describe what a speculator does.  My words startled one of the subcommittee members who was delivering the report.

I said, there is a difference between betting and speculating.  I then gave my definition of each.  Betting is the creation of risk where there was none before.  Speculation is the assumption of risk that previously existed.  I gave the example of saying “I bet I can run faster than you” to explain betting.

A speculator speculates.  They assume risk in a market that another participant does not want to hold any longer.  Long hedgers need speculators willing to be short.  Short hedgers need speculators willing to be long.  Other speculators need other speculators to give them the liquidity to change their minds about the market direction.  All of this is assumption of risk for a contract with a viable economic purpose where some participants have an economic interest in the underlying instrument or commodity and the speculators have a view of the value of the same.

Yesterday was my first meeting in Washington, DC as a member of the CFTC’s Technology Advisory Committee, or TAC 2.0 as it is called. The meeting featured reports from working committees on aspects of high frequency trading, or HFT, as well as presentations about SEFs. The first task from Working Group #1 was to define what HFT is.

The working or provisional definition of HFT from Working Group number #1 was:

High frequency trading is a form of automated trading that employs:

(a) algorithms for decision making, order initiation, generation, routing, or execution, for each individual transaction without human direction;

(b) low-latency technology that is designed to minimize response times, including proximity and co-location services;

(c)  high-speed connections to markets for order entry; and

(d) high message rate (orders, quotes or cancellations).

Other working groups had more granular assignments, some which depended somewhat on the definition of Working Group #1. Working Group #3, which featured representatives from the CME, ICE, NFA and others gave a report that says all the information the regulators need to analyze HFT and other forms of trading is already available.

By John J. Lothian

David Downey is as pugnacious as he is passionate. He has battled and won, retired, and come back to battle again. Current CEO of OneChicago, he is a man on a mission to bring understanding and respect for OneChicago and its products. It is a fight he believes in and one he does not plan on leaving unfinished.

I first met Downey on the Internet back in its Wild West days. I interacted with him on the same online venues where I came across Jon Matte, now COO of John J. Lothian & Company, Inc. and assistant editor of this newsletter. Downey stood out then and he still stands out today.

At one point when I was unsure of the direction of the industry and the future of the introducing broker model, I approached Downey for some industry networking and idea sharing. He bought me a drink and told me he would not even talk to me until I read a book he suggested. The book was “The Innovator’s Dilemma” by Harvard professor Clayton Christensen. I have told this story before here.