THIS POST IS FOR INFORMATION ONLY AND DOES NOT CONSTITUTE LEGAL ADVICE.
Sir Templeton, we disagree. This time, it really is different.
Though I quipped PFGBest was an MF Global redux, Mr. Wasendorf's brokerage firm is unlike MF Global in many ways. These differences will result in a different tack for PFGBest's case, plotting a different course for its customers-- though they may end up at the same destination as MF Global's victims. Only time will tell, but we wanted to offer our best guess as to how this process will proceed for PFGBest customers.
Please note that this is our opinion and we discourage anyone from acting based on the opinions set forth below. This article is for informational purposes only.
What are the differences between PFGBest and MF Global?
PFGBest is a privately held non-clearing FCM which filed a voluntary application for Chapter 7 Bankruptcy. As a non-clearing FCM, PFGBest's designated self-regulatory organization (DSRO) was the National Futures Association (NFA). At this time, we do not know the complete legal structure of PFGBest, but their corporate timeline mentions an entity called Wasendorf and Sons, Inc. as well as 'wholly owned subsidiaries' like PFG Canada and Best Direct Securities, LLC. To our knowledge, all affiliates are owned by Mr. Wasendorf. That will make things easy on bankruptcy attorneys and customers alike.
MF Global was a public company traded on the NYSE, structured as a holding company--MF Global Holdings Ltd, Inc.(MFGH). MFGH owned many subsidiary operating and finance entities. Its MF Global Inc. subsidiary (MFGI) was a clearing FCM with dual registration with the SEC as a broker-dealer. This is the entity which housed MF Global's customer property and brokerage operations for both securities and commodities. As a clearing firm, MFGI's DSRO was an exchange, not the NFA--in their case, the Chicago Mercantile Exchange (CME).
MF Global's bankruptcy is much more complicated. The MFGH parent filed a Voluntary Petition for Chapter 11 Bankruptcy, more commonly known as reorganization bankruptcy. The Securities Investor Protection Corporation (SIPC) filed for a liquidation of the MFGI subsidiary under the Securities Investor Protection Act of 1973 (SIPA), as MFGI was a SIPC member firm. This means MFGH creditors have a Chapter 11 Trustee working on their behalf, while customers at MFGI have a SIPA Trustee working on their behalf.
PFGBest owns a subsidiary firm which is also a broker-dealer member of SIPC: Best Direct Securities, LLC. But as this operation is maintained in a separate corporate entity, the SIPA statute does not apply to the PFGBest entity, which houses its commodity brokerage. As such, PFGBest's bankruptcy will be administered according to the Chapter 7 Code and relevant portions of the Commodity Exchange Act (CEA). Chapter 7 means liquidation, not reorganization. PFGBest will not survive to do business in its current form or as a new entity. Very simply, PFGBest is out of business. Its assets will be sold for the benefit of its customers and creditors. A Chapter 7 Trustee has been appointed and a Receiver has been appointed. The Trustee handles work on PFGBest's estate while the Receiver will handle Mr. Wasendorf's personal assets and estate. So what does this process mean for PFGBest's customers?
How will customer property be treated?
Generally, PFGBest's assets will be split into two funds: a fund of customer property and a fund of estate property. Customer property consists of all cash, securities and specifically identifiable property tendered to PFGBest by its customers. The assets of PFGBest will go into its fund of estate property.
If there was no shortfall in customer property, the NFA would seek to bulk transfer customer accounts with positions intact to a new receiving FCM. The bankruptcy's administrative costs--fees of attorneys for the Trustee, forensic accounting, staff, etc.--would be paid for from the fund of estate property. The Trustee would commence a claims process, marshal assets and distribute funds to legitimate claims according to priorities in the Bankruptcy Code. Generally, this would be to cover administrative fees first, secured creditors second (lien holders) and unsecured creditors last.
PFGBest has a shortfall in customer property, which the NFA has pegged at more than $200 million. Mr. Wasendorf's statements indicate that this money has been spent. As a result, instead of an immediate bulk transfer, customer assets were frozen and their positions were liquidated. The Trustee has received approval for PFGBest to continue operations for 60 days, so he can prepare final statements for customers and determine what assets are available for distribution. The Trustee will see what amount of property he can safely return to customers at once via a bulk transfer and will initiate that process if it is possible. However, most likely a claims process will be required to return at least some property to customers.
Customer property does have priority over all other classes in bankruptcy except one: administrative fees. If the fund of estate property held $0, the Trustee would pay administrative expenses from the fund of customer property. Until the Trustee can marshal assets for PFGBest's estate, he will have to reserve customer property against administrative expenses and claims made against that property by third parties. While most of those third party claims should have no reasonable basis for success, the Trustee still has to reserve capital toward them.
The question then arises as to what priority customers have over the fund of estate property, as that property would not technically be defined as 'customer property' in the CEA. The view could be taken that once all assets defined as 'customer property' have been distributed, customers then become general unsecured creditors of the debtor's estate and are subject to a ratable distribution of the fund of estate property. However, as the NFA noted in its Amicus Brief filed in the MFGI case, "if funds segregated were to lose their character as commodity customer property when a commodity broker violated the segregation requirement, the customers' priority would be dictated solely by the commodity broker's compliance or non-compliance with the segregation requirements." This would negate vital property protections of the CEA.
The Brief notes that Congress' intent was that "funds required to be segregated be treated as belonging to customers even when segregation does not occur." Moreover, the NFA notes that the Senate explained that "a customer need not trace any funds in order to avoid treatment as a general creditor." The long and short of this is that the court will have to decide what priority customers have over the fund of estate property. We will argue that customers have a priority over all creditor claims and we hope the Trustee will agree.
Sub-classes of customers
Within the fund of customer property, customers will be divided into public and non-public customers of PFGBest. Generally, public customers are those who are unaffiliated with PFGBest. Non-public customers are family members or persons or entities with a close affiliation with PFGBest. Non-public customers are Associated Persons of PFGBest, employees of PFGBest and wholly owned affiliates of PFGBest. Accounts held by or for the benefit of introducing brokers, CTAs or CPOs are considered public customers of commodity firms.
Non-public customer property will be subordinated to public customer property, though it still maintains the priority over all other classes in bankruptcy (except administrative fees).
Sub-classes of customer property
Within the fund of customer property, there are several sub-classes of that property according to the relevant regulations of the Commodity Exchange Act and Title 17 of the Code of Federal Regulations (CFR) where CFTC regulations are published. Those include the following:
- Regulation 4(d) Segregated Property - see 17 CFR § 1.20 - cash and marketable securities which were held to margin positions on US domiciled futures exchanges held as 'segregated';
- Regulation 30.7 Secured Property - see 17 CFR § 30.7 - cash and marketable securities which were held to margin positions on foreign domiciled futures exchanges held as 'secured';
- Specifically Identifiable Property - see 17 CFR § 190.01(kk) - warehouse receipts, bills of lading, e.g. gold receipts, silver certificates, etc.;
- Other customer property - forex funds.
In the case of MF Global, over $800 million in 30.7 funds were held at foreign affiliates at the time of MFGI's collapse. These funds became entangled in foreign bankruptcy proceedings exacerbating the shortfall in property. As PFGBest is not a clearing FCM, it does not transfer funds to foreign affiliates for trading purposes. Most foreign trading was facilitated through PFGBest's clearing firm. Therefore, it is unlikely that any money will be held up in foreign proceedings. The only PFGBest foreign affiliate of which we are aware is PFG Canada and they claim to have 95% of customer funds accounted for, with the remainder covered by their Canadian Investor Protection Fund.
The upshot is that there is likely to be little distinction between 4(d) and 30.7 funds in the PFGBest bankruptcy. Instead, the distinctions will fall on specifically identifiable property (SIP) and forex funds. Holders of SIP will likely be permitted to negotiate with the Trustee regarding how their property is liquidated. Most likely SIP customers will be given the option to send in cash to cover the loss from the fraud and retrieve their property in total or they may have the Trustee liquidate it for them. As we are unaware of the structure of PFGBest's forex trading, we are unable to predict on how forex funds will be treated at this time. We will update this post with that information as soon as it is ascertained.
What does PFGBest have in assets?
In their bankruptcy filing, PFGBest stated that it held between $500 million and $1 billion in assets and $100 million and $500 million in liabilities. Hopefully, this is true. Given Mr. Wasendorf's attempted suicide and confession, the filing is likely based on a false or flawed assessment of PFGBest's financial condition. We simply cannot know what PFGBest is worth until the Trustee starts unwinding the firm.
How will customer property be distributed?
The Trustee will have to petition the Court to distribute customer property. Because there is a shortfall in customer property, customers are subject to a pro rata distribution of the assets in the fund of customer property. The Trustee generally will have two processes to return customer funds: a bulk transfer process and a claims process. The claims process is left somewhat to the discretion of the Trustee and is discussed below. The bulk transfer process involves moving accounts and assets, all or in part, to new brokerage firms. It is our understanding that this has already happened for PFG Canada customers (to RJO Canada). We will advise the Trustee to use the bulk transfer process for whatever assets he is able to as quickly as is possible.
How will the claims process work?
To our knowledge, there has never been a claims process for a Chapter 7 liquidation of a commodity firm involving a shortfall of customer property. The court will have to consider and approve a proposal from the Chapter 7 Trustee for a claims process. In the MFGI case, the SPIA statute required a specific claims process to return customer property. Given the accounting systems in place for customer accounts at FCMs (Sungard's GMI), we felt a formal claims process was unnecessary. We proposed a fast mechanism involving negative consent letters, which we will propose again for the PFGBest bankruptcy. Since SIPA does not apply to PFGBest, the Trustee has more latitude in determining the claims process.
Here's how that negative consent process would work. The final account statement would be sent to the account holder at the address of record. The customer would have a short window to raise an objection to the net equity amount on that statement. After the window to object closes, the Trustee would be able to determine the amount allowed to each customer quickly and make distributions accordingly. He would be able to make those distributions in bulk to the customer's new account or via check to the customer directly.
Unfortunately, we were unsuccessful in obtaining this process for MF Global customers due to specific SIPA limitations, though we were able to speed up and simplify the MFGI claims process. The Part 190 regulations governing commodity broker bankruptcy offer a great deal more discretion to the Trustee in determining how the claims process will work. We hope the PFGBest Trustee will seriously consider our proposal for a claims process.
If the claims process were to proceed as MF Global's, here is how it would work. A final statement date will be selected and that will be the evidentiary basis for a customer claim. The Trustee will establish and publicize a claims process whereby customers fill out a claims form and submit their evidence. A longer window of time will open in which customers can file their claims. The Trustee will then verify the claims individually and allow amounts based on the books and records of PFGBest. Customers will then receive claim determinations from the Trustee noting the amount of their claim for which they can receive recoveries. Distributions could be made via check.
General creditor claims (brokers, those who did business with PFGBest) will likely take the form of a standard bankruptcy claims process.
If stolen customer money has been spent, how can the Trustee go about recovering it?
There are many avenues to recovering assets to repay customer losses from PFGBest's fraud which are available to the Trustee. The easiest is liquidating the property of PFGBest's estate and using the proceeds to pay customers. We know this at least includes PFGBest's real estate assets and any proprietary assets. There will likely be a Directors and Officers liability insurance policy which can be sued. The Trustee will then go after the personal assets of Mr. Wasendorf and perhaps those of his family, becoming a creditor of the estate of which the Receiver is in charge. Trustee Bodenstein has publicly noted that PFGBest will likely be the largest creditor of the Wasendorf personal estate.
Since there is an outright confession of actual fraud, the Trustee can use the clawback provision of the Bankruptcy Code should he be able to find any transfers PFGBest or Wasendorf made to avoid bankruptcy. We think it is especially instructive for the Trustee to look at the hasty wedding of Mr. Wasendorf a few weeks prior to his suicide attempt. If he moved assets to his wife, family or other insiders, this would constitute a preferential transfer and the Trustee may be able to recover those assets. Generally, there is a 90 day look-back on preferential transfers to family.
As for broader clawbacks against former PFGBest clients who withdrew their property prior to the fraud's discovery, that seems doubtful. PFGBest wasn't simply a Ponzi scheme. There were real world market gains and losses made by traders within the segregated account for their own benefit. Customers of PFGBest were not investors in a Madoff Securities-like scheme. PFGBest's scheme rested on top of its customers actual participation in the market. It follows from these facts that most customers were unaware of the fraud and had good faith reasons for transferring their funds. Though the Trustee may use clawbacks against former customers on a limited basis, such as those with inside information, it would be difficult to justify it against the broader constituency of public customers.
What can the CCC do to help customers?
The CCC stands ready to assist PFGBest customers much in the way that it has assisted MF Global customers: legal representation, public advocacy and guidance. Our co-counsel for MF Global was conflicted out of servicing the PFGBest case. We are in the process of engaging new co-counsel for PFGBest. We will then obtain standing and begin to represent the interests of customers to the Court. We will provide these legal resources on a pro bono basis and make paid legal services of our co-counsel available to those who wish to be individually represented.
We will provide guidance on the claims process once it is determined, which may include a claims guide and conference calls to discuss proper completion and filing of the claims form. The CCC will remain a forceful advocate for industry reform. As always, we will continue to provide the most up to date information we can via our website and social media presence.
Can I sell my claim?
For customers who are interested in selling their claims to a buyer of distressed debt, we will help consolidate that market for PFGBest customers to the extent possible so they may obtain the highest offers from reputable firms (current bids are 25.5% or .255 cents on the dollar). The distressed debt market is sort of the Wild West. These deals do not constitute securities and their transactions are not governed by the SEC. Generally, a firm will represent a buyer who wants to purchase claims at a discount for a profit. That firm will offer to buy your claim for a percentage of the total claim. You will receive cash for the rights to the claim—and this means all the rights to the claim. Any future recoveries--be they from the Trustee, class action lawsuits, insurance—will go to the buyer of the claim and not you (as the seller of the claim). You will be effectively removed from the bankruptcy.
We do not advise or discourage you from considering the sale of your claim. Please consider your personal financial condition when considering accepting an offer from a claims buyer.
What about lawsuits?
A class action law suit against PFGBest is in the works, but it will take time to consolidate the class, appoint lead counsel and lead plaintiffs, etc. We will keep customers updated as to the status of the class action. As for suing regulators or other culpable parties, that is unlikely to happen quickly, speed the return of customer funds or increase the probability of recoveries in the short term. The Chapter 7 Trustee is best situated to pursue immediate recoveries for customers. As opportunities for legal action develop outside of bankruptcy, we will keep customers apprised of the details and how to get involved.
What can I do to help?
The CCC is an all-volunteer organization. We rely on donations to defray legal expenses in representing customers in the two FCM bankruptcies in which we are involved. As much as it pains those who have recently had their pocket picked to give money, we encourage you to do so to the extent possible by your financial situation. For very little money, we were able to speed up the distributions of customer property to MF Global customers by over 6 months.
You can also contact your legislators and let them know what has happened to you. Encourage them to open their doors to the CCC. Stay tuned to our website for various micro campaigns with which we will need your assistance.
We hope this information is helpful. As hard as it is to do--and believe me I know--try to be patient with this process. We hope there will be some positive development soon for customers and brokers of PFGBest.