Every five years, the Commodity Exchange Act must be “re-authorized” by Congress. The Senate is gearing up for that process now. We hope that strengthening customer protections will be the result of these Congressional deliberations.
Re-authorization presents an opportunity to change the law which governs our industry. The primary goal of re-authorization of the Act this time around should be to remove any doubt that customers are first in line in a bankruptcy over everyone else.
Congress intended to give commodity customers priority over all other creditors in a commodity broker bankruptcy. The reason for this is simple: if customers do not have priority, they are nothing more than general creditors and the segregation protection is a paper tiger. As one PFGBest customer put it at the Creditors' Committee meeting, "you mean the guy who cuts the grass at their office has an equal claim on my money?" All a broker has to do to subvert the rules is move customer funds out of segregation and they lose their protection. With priority over other creditors, no matter what the commodity broker converted customer funds into, customers have a right to their money ahead of other creditors.
The rules that govern commodity broker bankruptcy are legion. Primarily, there are two statues: the Bankruptcy Code (Title 11, specifically Subchapter 4 of Chapter 7) and the Commodity Exchange Act (Title 7 Chapter 1), which authorizes a set of administrative rules drafted by the CFTC known as the Part 190 Rules. These rules work together to establish two estates in a commodity broker bankruptcy: a customer estate into which all customer assets flow and a fund of estate property into which all of the broker's assets flow. The statues and rules agree that customers have priority over everyone else (except the administrators) with respect to their pool of assets in the customer estate. However, when a shortfall is present at the customer estate, they conflict as to how customers are treated with respect to the estate assets.
The Part 190 Rules define customer property as all assets of the FCM estate needed to satisfy customer claims, so if they prevailed customers would be paid back before general creditors. The Bankruptcy Code defines customer property more narrowly and prescribes that claims not satisfied by the customer estate are to be treated as those of general creditors of the estate. Generally, statutory law trumps administrative law, so--Houston, we have a problem. And I don't know if you've been following the press lately, but shortfalls in customer property seem to be on the rise.
The trick here is to give customers priority without having to lobby for changes to the Bankruptcy Code. It is hard enough to change one act of Congress, let alone a second which is protected by well-funded and connected lobbyists whose clients owe their livelihood to its provisions. The way to get what we want without starting a fight we cannot win, is to amend the Commodity Exchange Act to require the creditors and affiliates of FCMs to subordinate their claims below customers of the FCM.
The Bankruptcy Code fully accepts that a debtor may have subordination agreements with its creditors. Subordination of all FCM creditors would put customers first in line without having to change two acts of Congress. Moreover, it would speed distributions to customers in a bankruptcy. The SIPA Trustee in the MF Global case had to reserve customer property against large claims on the customer estate by MF Global's holding company and affiliates. If their claims were subordinated by law, the Trustee would be free to release more customer property quicker, as there would be no need to hold it back to cover an adverse ruling against the estate.
There are other changes which the Senate will consider during re-authorization which are important as well. These range from offering retail forex customers protections similar to segregation to increasing criminal penalties for violating segregation rules. These are important changes as well and should be given their due consideration. But we must sort out the priority of customers first. Otherwise customer account segregation is nothing more than a slogan. We invite you to contact us with your ideas and comments.
John Roe and James Koutoulas are NFA Board members in the CTA Category. They are also the Founders of Customer Commodity Coalition (CCC). Email them at jroe@btrtrading.com and jk@typhoncap.com.
