It took us a bit to get around to writing this post. We went back to watch and re-watch the Congressional hearing yesterday in front of the House Committee, where both Gensler and NFA President Dan Roth testified on the PFGBest case. Much was said about new electronic confirmation systems, and questions were raised about who else might have known about the fraud at PFGBest. Here are things that were NOT addressed:

• The NFA hiring and training practices of auditors, facilitating the use of inexperienced, uninformed individuals analyzing some of the most complex financial firms in the world.
• The purported letters sent to both the NFA and CFTC raising concerns about segregated account balances with PFGBest as early as 2004.
• The alleged 2007 balance discrepancy that was “rectified” by an unconfirmed fax from an unconfirmed number.
• The allowance of such a long time period between the initial demand for electronic confirmation authorization by the NFA and Wasendorf, Sr.’s final authorization, which has been presented as a matter of months.
• The lax manner in which the spot checks on FCM segregated account balances were executed following MFGlobal, using no more than ordinary measures to ensure safekeeping despite major reservations on the safety of the system.
• The relationship between client funds being wired to JPMorgan and their ultimate transfer to U.S. Bank, and the opacity in which the relationship operated.

The entirety of the hearing amounted to a tee ball game with toddlers, ultimately devolving into a rhetorical sparring match over the legitimacy of Dodd Frank. Questions posed to Mr. Roth, in particular, were nearly apologetic in their tone, as if to imply a sense of remorse for the inconvenience of his required presence. In some ways, it rivaled the Dimon hearing in its weak and conciliatory demeanor.

There was a single, solitary moment of appropriate response out of Congressman Southerland of Florida, but even that was off base in some ways, and eventually kicked off the Dodd-Frank grandstanding that would dominate the remainder of the panel. However, we’ve transcribed the relevant portions of his statement below, because it’s important to recognize both the truths and inaccuracies in his comments, and the reasons for our frustration with them:

I’ve gotta take deep breath, because you guys got some major problems. And it would be very convenient to blame the lack of regulation. You know, I’ve been a state regulator, or appointed to serve as the chairman of regulatory boards. Mr. Lukken, you mention educating customers. Well, that’s great. That’s great. You mention that with depressed futures volumes, historically low interest rates, and an ultra-competitive pricing model, FCMs are under tremendous financial strain. Well, bless your heart. My heart bleeds for you.

I’m being a little facetious there, because it doesn’t. My heart bleeds for the thousands of hard-working men and women that have been damaged permanently because of your inaction. You know, it’s not a sin of commission that you’re guilty of; it’s sin of omission. My family business is in an industry that we help self-regulate. And as a chairman of boards in South Florida, I have handed down death sentences to businesses that have violated the public trust.

You know, your challenges are not depressed futures volumes. Your challenges are not historically low interest rates. Your challenges are not ultra-competitive pricing models or the tremendous strain financially. Gentlemen, you represent an industry that has an integrity crisis. An integrity crisis. And you can’t build a marriage, a family, a small business, a state, a country- you can build nothing of value that can withstand the long haul apart from integrity.

I’m led to believe that for 20 years this company fooled you. You’re the frontline. You’re it. To whom much is given, much is expected. I have little pity for you. I have anger for what I’ve heard here today.

You know what? We talk about “studying.” Well that’s great. Study it- do something. We talked about insurance- the Securities Investor Protection Commission, how it needs to be spread- well, by God, do it! Make it happen! Restore public trust!

You got an integrity problem, and we- as members of Congress- we can’t solve your problem. We can sit here and express anger from those that we represent that have been harmed by the inaction of this industry. I shiver to think- what else is out there? It terrifies me! And Mr. Chairman, I gotta tell you- my blood is boiling… Your inaction is destroying lives, and it angers me.

To Congressman Southerland and the rest of the committee, we want to thank you for addressing these issues publicly. And Congressman Southerland, we agree that the bulk of the responses you have heard from both the NFA and CFTC have been little more than promises of future fixes. Explanations of what happened with PFGBest, in particular, have been weak excuses derived from justifications that fail to keep the core purpose of these bodies in mind: protection of the investing public.
Congressman, you came so very close later in your comments to hitting the nail on the head, when you argued that the regulators themselves needed a closer look. We couldn’t agree more, which is why we’ve been circulating a petition to that effect. Our advocacy for enhanced regulation, in many ways, goes back to the fact that those “minding the shop,” as one of your esteemed colleagues phrased it, are not instilling faith in the security of the markets, and we want to ensure that protections, much like the SIPC insurance coverage extension you referenced, are in place to hedge against against mistakes or incompetency at the hands of the regulators which could cause investors to incur undue losses.

But where our views diverge is the matter of industry integrity. You seem to frame it as an issue with the people in our industry, and in specific cases, your assessment is probably accurate. Corzine- a man of poor integrity. Wasendorf, Sr.- a man of poor integrity. They’re the men you’ll hear about in our industry, and in these cases, you are correct.

But what you won’t hear about is the commodity trading advisor who did everything by the book, took care of his clients, provided a robust and unique investment opportunity to the public, and had to shutter his doors as a result of this scandal. He is a man of integrity. What you won’t hear about is the guaranteed introducing broker, formerly affiliated with PFGBest, who stood by his clients at every turn, and is still fighting for the return of their funds, even though his business is essentially dead in the water. He is a man of integrity. What you won’t hear about are the dozens of firms who have attempted to work within the self-regulated industry to propel internally guided reforms, and never received a response from the NFA on the matter, though they would argue they faced increased scrutiny in the aftermath. Those are men of integrity.

This industry is filled with participants whose anger over this situation far exceeds anything you could possibly comprehend. It is ripe with people who fight, day and night, for the protection of their clients’ interests. It is swelling with those who want nothing more than an efficient, stable regulatory climate in which they can function. Our industry is replete with men and women of integrity, thank you very much.

That being said, the integrity of our processes should be under scrutiny, but this was largely lost in today’s hearing. The committee instead focused on the processes which have been addressed already, and on political posturing over Dodd-Frank itself. While this may make for excellent PR and sound bites, it does little to service the investors for whom you have such concern.

Question the NFA hiring processes for auditors. Question their training regimen for these auditors. Question whether their auditors must be assessed for competency on the matters they were trained on prior to being dispatched to the field. Question how frequently these inexperienced auditors are even accompanied by their supervisors, despite their lack of specific industry knowledge. Question the behavior of auditors on site.

Call for all internal communications related to PFGBest financial surveillance and general audit procedures to be provided to Congress. Inquire about the missed red flags we’ve all read about. Press the NFA on how closely they listen to their members when concerns are expressed, and how they respond. Ask these members to come provide you with corroboration for the claims made by NFA leadership regarding their efficacy as an SRO- we can rattle off a list a mile long of individuals who would have valuable insight for you.

You’re right that we are self-regulated, but we can personally attest to the fact that, as members, we are powerless to affect the kinds of changes you reference without your assistance. We have personally attempted to work within the system to propel reform. We have sent letters to Dan Roth himself, identifying issues with NFA procedure and policies. Despite the frankly, frequent attempted correspondence, we have, to date, received only one response. Mr. Roth simply indicated that he, himself, did not believe there was a problem; adding in what is now a quite questionable and ironic piece of logic, “NFA has utilized this process for nearly two decades.”

One letter was the end of discussion, and the end of our supposed ability to affect change in a self-regulated industry.

One might question why the members don’t rally as a collective for these changes. Some have tried, but when there is a pervasive fear of NFA retribution throughout the industry, it should come as no surprise that such initiatives rarely gain traction. Industry groups like the FIA, which testified yesterday, may propose general reforms, but we’ve yet to see such an organization step up to the plate in terms of reforms needed within the NFA itself.

We cannot extend SIPC coverage to futures investors. But you can. We cannot reform the bankruptcy code. But you can. These kinds of changes do not represent the expansion of regulation, but the implementation of protections in the face of regulatory shortcomings. Both elements need to be addressed, but frankly, we cannot do it on our own, self-regulated or not.

Those in this industry that boast high levels of integrity want, more than anything, to be able to stand behind the integrity of our processes and our markets as well, but we cannot get there without your assistance. We urge you to start asking the tough questions, digging beyond the politically correct surface, and joining in arms with those in our industry that have been fighting this fight for longer than you have known about its existence.

Our call for a Congressional investigation of the NFA still stands, because yesterday did not come anywhere close to fulfilling its need.