[Senate Hearing 112-647]
[From the U.S. Government Publishing Office]






                                                        S. Hrg. 112-647


   THE COLLAPSE OF MF GLOBAL: LESSONS LEARNED AND POLICY IMPLICATIONS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                                   ON

      EXAMINING THE LESSONS LEARNED FROM THE COLLAPSE OF MF GLOBAL

                               __________

                             APRIL 24, 2012

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs




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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director
              William D. Duhnke, Republican Staff Director
                       Charles Yi, Chief Counsel
                     Laura Swanson, Policy Director
                      Jeff Seigel, Senior Counsel
                 Jana Steenholdt, Legislative Assistant
                 Andrew Olmem, Republican Chief Counsel
               Mike Piwowar, Republican Senior Economist
          Shannon Hines, Republican Professional Staff Member
                       Dawn Ratliff, Chief Clerk
                      Anu Kasarabada, Deputy Clerk
                     Riker Vermilye, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor

                                  (ii)








                            C O N T E N T S

                              ----------                              

                        TUESDAY, APRIL 24, 2012

                                                                   Page

Opening statement of Chairman Johnson............................     1
    Prepared statement...........................................    32

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2

                               WITNESSES

James W. Giddens, Trustee, Securities Investor Protection Act 
  Liquidation of MF Global Inc...................................     4
    Prepared statement...........................................    32
Louis J. Freeh, Trustee, MF Global Holdings Ltd..................     5
    Prepared statement...........................................    42
Jill E. Sommers, Commissioner, Commodity Futures Trading 
  Commission.....................................................     7
    Prepared statement...........................................    44
Robert Cook, Director, Division of Trading and Markets, 
  Securities and Exchange Commission.............................     9
    Prepared statement...........................................    49
Richard G. Ketchum, Chairman and Chief Executive Officer, 
  Financial Industry Regulatory Authority........................    10
    Prepared statement...........................................    55
Terrence A. Duffy, Executive Chairman, CME Group Inc.............    12
    Prepared statement...........................................    58

                                 (iii)

 
   THE COLLAPSE OF MF GLOBAL: LESSONS LEARNED AND POLICY IMPLICATIONS

                              ----------                              


                        TUESDAY, APRIL 24, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:03 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I will call this hearing to order.
    Today's hearing will examine the lessons learned from the 
collapse of MF Global. The misuse of customer accounts by one 
of the world's largest commodities and derivatives brokers has 
shaken confidence in our markets and deserves a thoughtful 
discussion of how to better protect farmers, ranchers, and 
investors going forward.
    But before we get to these important issues, I would like 
to express my deep concern that almost 6 months after MF 
Global's bankruptcy, thousands of former customers--including 
hundreds of South Dakotans--still have not recovered the $1.6 
billion removed from what should have been protected customer 
accounts. I know that the trustees, regulators, as well as the 
FBI and Justice Department continue to investigate what 
happened in the final chaotic days of MF Global, but these 
customer funds must be returned without further delay to their 
rightful owners, and those individuals and executives 
responsible for transferring these funds must be held 
accountable to the full extent of the law. Last, it is not 
acceptable for MF Global executives to be given bonuses when 
customers have not recovered funds improperly taken from them 
by MF Global, and I thank Senator Tester for his leadership on 
this issue.
    Since the collapse of MF Global in October 2011, my staff 
has worked closely with Senator Shelby's staff in conducting 
extensive interviews and due diligence with the regulators, 
self-regulatory organizations, and other parties involved in 
overseeing MF Global and its bankruptcy. We have also 
coordinated with the Senate Agriculture Committee--which has 
primary jurisdiction over matters involving commodities--in 
holding a series of bipartisan briefings for all Senate staff 
with representatives of many of the organizations before us 
today to help our constituents impacted by the firm's downfall.
    As investigators seek to recover MF Global customer funds 
and hold accountable those responsible for any wrongdoing, this 
Committee will focus our attention on preventing future abuses 
and the other critical public policy issues raised by the 
collapse of MF Global.
    Today's hearing provides a unique opportunity to ask an 
important set of questions: How can we strengthen protections 
for customer accounts at FCMs or broker-dealers, including 
those firms that hold U.S. customer funds abroad? Given the 
size of the shortfall in MF Global's customer accounts, what 
should Congress understand about the idea of extending to 
commodity accounts similar insurance protections that are 
currently available to securities accounts under the Securities 
Investor Protection Act? And how can we continue to improve 
regulatory oversight and coordination for large, complex global 
financial institutions?
    MF Global may also provide some early lessons about the 
Wall Street Reform Act since it is the first collapse of a 
major financial institution since the law's passage. For 
example, the story of MF Global teaches us that effective 
customer protection and market oversight demands that we fully 
fund our regulatory cops on the beat. In hindsight, there is 
little doubt that the regulators responsible for monitoring MF 
Global should have taken additional steps. But shortchanging 
the CFTC or SEC of much needed funding will only force them to 
delegate even more authority to self-regulatory organizations 
in a way that could impair effective market surveillance. When 
funding cuts prevent regulators from inspecting firms or 
assigning necessary staff to monitor crises, the American 
people and market confidence pay the price.
    Additionally, a key pillar of the Wall Street reform bill 
was to end too big to fail; and if MF Global demonstrates 
anything, it is that those who take risky bets that bring down 
their companies are now free to fail and will not receive any 
more taxpayer bailouts.
    To preserve time for questions, opening statements will be 
limited to the Chair and Ranking Member. However, I would like 
to remind my colleagues that the record will be open for the 
next 7 days for additional statements and other materials.
    I now turn to Ranking Member Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. Thank you for 
calling this very important hearing.
    The collapse of MF Global is one of the largest 
bankruptcies in U.S. history and the greatest consumer 
protection failure since the enactment of the Dodd-Frank Act. 
It has been 6 months or more since MF Global filed for 
bankruptcy, and the ownership of $1.6 billion in customer 
assets remains in dispute. Hundreds of MF Global customers are 
still waiting to learn how much, if any, of their funds will be 
returned to them.
    The disorderly failure of MF Global occurred despite the 
fact that it was regulated by not only the CFTC and the SEC, 
but also the Financial Industry Regulatory Association, the 
Chicago Board Options Exchange, the National Futures 
Association, and the Chicago Mercantile Exchange. The job of 
each of these regulators was to ensure that customer assets 
were protected.
    That $1.6 billion in customer assets that remain subject to 
ownership dispute reveals a serious regulatory failure, I 
believe. Accordingly, the purpose of today's hearing should be 
to help the Committee determine which regulators failed to do 
their job and why.
    To assist this effort, I asked the CFTC's Inspector General 
last November to examine the Commission's oversight and 
regulation of MF Global. The Inspector General's findings, 
along with other ongoing investigations, should assist Congress 
in its efforts to hold regulators accountable for any 
identified failures.
    I also asked the CFTC's Inspector General to determine 
whether Chairman Gensler's recusal was appropriate and whether 
he should have recused himself much earlier in the process.
    Prior to MF Global's bankruptcy, Chairman Gensler had 
multiple contacts with MF Global and its CEO, Jon Corzine, 
concerning the CFTC's regulation of the firm. If a recusal was 
appropriate, it seems it would have been more appropriate to 
start at Mr. Corzine's tenure at MF Global rather than after 
the firm had failed.
    Furthermore, this Committee's due diligence has revealed 
that Chairman Gensler played an active role in the oversight of 
MF Global during the week leading up to its failure. Yet 
Chairman Gensler's recusal now shields him from explaining his 
actions. I believe this is unacceptable. Chairman Gensler owes 
the public a full accounting of his role in the fall of MF 
Global. It appears by his absence today, however, that we will 
have to wait a little bit longer for such an accounting.
    MF Global certainly will not be the last financial firm to 
fail. Failure is an inevitable part of the free market system. 
But our goal should be not to protect the private market from 
failure. Our goal, I believe, should be to establish a credible 
regulatory system that protects consumers while leaving the 
market free to innovate and to expand. We must then hold that 
regulatory system accountable for its failures. This is 
exceedingly difficult, however, when one of the main 
participants refuses to speak here.
    I look forward to the testimony today, and I thank our 
witnesses for appearing. Perhaps 1 day, Mr. Chairman, we will 
hear from Mr. Gensler. Today does not appear to be that day, 
however.
    Thank you.
    Chairman Johnson. Thank you, Senator Shelby.
    Now I will briefly introduce our witnesses.
    Mr. James W. Giddens is the trustee for the Securities 
Investor Protection Act Liquidation of MF Global Incorporated.
    The Honorable Louis J. Freeh is a trustee of MF Global 
Holdings.
    The Honorable Jill Sommers is a Commissioner for the U.S. 
Commodity Futures Trading Commission.
    Mr. Robert Cook is the Director of the Division of Trading 
and Markets for the U.S. Securities and Exchange Commission.
    Mr. Richard Ketchum is the chairman and CEO of the 
Financial Industry Regulatory Authority.
    Mr. Terrence A. Duffy is executive chairman of the Chicago 
Mercantile Exchange.
    I thank all of you again for being here today. I would like 
to ask the witnesses to please keep your remarks to 5 minutes. 
Your full written statements will be included in the hearing 
record.
    Mr. Giddens, you may begin your testimony.

  STATEMENT OF JAMES W. GIDDENS, TRUSTEE, SECURITIES INVESTOR 
          PROTECTION ACT LIQUIDATION OF MF GLOBAL INC.

    Mr. Giddens. Chairman Johnson, Ranking Member Shelby, and 
Members of the Committee, thank you for inviting me to testify. 
I take seriously my duty as the trustee of MF Global Inc. to 
treat commodities and securities customers and general 
creditors equitably. I would like to provide some proposals 
that may merit further study and, of course, input from 
regulators, industry experts, and the public.
    A lack of supervision and inattention to maintaining 
segregation of customer accounts caused the shortfall of 
customer funds. Thus, a possible remedy is imposing personal 
liability on senior officers and directors when there is a 
regulatory shortfall.
    Consideration should also be given to requiring not only 
financial operating principles but senior officers, including 
the CEO and the CFO, to certify compliance with commodity 
segregation requirements on a much more frequent basis.
    Second, I suggest the establishment of a commodities 
customer protection fund. We found that more than three-
quarters of the commodities customers had accounts of a value 
of less than $100,000 each. Thus, a fund providing for 
protection of up to a maximum of $100,000 would have made a 
substantial number of the claimants whole within days of the 
bankruptcy filing.
    Third, we have learned that many commodities customers have 
not fully understood the nature and risk of certain financial 
products in which their funds were invested. Currently, 
commodities customers are not subject to suitability 
requirements as are securities customers. In my view they 
should be.
    As a fourth suggestion, futures commission merchants might 
be required to segregate an amount in excess of 100 percent of 
customer funds. That would help ensure that there is a 
sufficient cushion at all times for commodities customers.
    Let me now turn to funds held for U.S. customers trading on 
foreign exchanges. Under current rules, FCMs are not required 
to calculate the segregation requirements for foreign trading 
in the same way as they do for domestic trading. Reliance on 
this alternative calculation resulted in a substantial 
difference in funds segregated. The alternative calculation, 
had it been in place, would have required a greater 
segregation. The alternative calculable should be eliminated.
    Finally, I believe there is a great need for international 
cooperation on insolvency laws. Customers would benefit from 
greater harmonization of the rules governing the segregation of 
customer funds for both commodities and securities customers. I 
have been engaged in active discussions since November with the 
administrators of MF Global U.K. Ltd. concerning the return of 
approximately $700 million commodities customers' property. 
This dispute is now being submitted to the U.K. courts for 
resolution.
    In concluding, my staff and I continue to work as quickly 
as possible to return assets to all claimants. We have 
distributed in excess of $4 billion. We have sought court 
approval to distribute an additional $685 million to 
commodities claimants.
    Thank you, Chairman Johnson, Ranking Member Shelby, and 
other Members of the Committee for this opportunity to testify 
before you.
    Chairman Johnson. Thank you.
    Judge Freeh, please proceed.

 STATEMENT OF LOUIS J. FREEH, TRUSTEE, MF GLOBAL HOLDINGS LTD.

    Mr. Freeh. Thank you very much. Good morning, Chairman 
Johnson and Senator Shelby and your colleagues. Thank you for 
the opportunity to appear here.
    You have my opening statement. I just want to highlight a 
few things for you and leave sufficient time, obviously, for 
your questions and my colleagues on the panel.
    I was appointed as the Chapter 11 trustee effective 
November 28th of last year. There are, in addition to MF Global 
Holdings, five other subsidiaries to which I am acting as the 
Chapter 11 trustee.
    I think everyone understands the functions of the Chapter 
11 trustee very distinct and very different from my colleague 
Mr. Giddens. Under the Bankruptcy Code, my obligation is to 
investigate the acts, conduct, look at assets, liabilities, and 
the financial condition of the debtors, among other things.
    Unlike Mr. Giddens, who is charged primarily with the 
return of customers' investment property, the responsibility of 
the Chapter 11 trustee is to maximize the value of the estate 
for the creditors, and we have a list of many creditors, 
including the top 20, which is, I believe, in the materials.
    When I was appointed in November, I landed in the middle of 
a number of issues: first, very ongoing, active investigations 
by the agencies represented here this morning; in addition to 
two Federal prosecutors' offices, as well as the SIPA trustee.
    One of my first challenges was to understand what documents 
the Chapter 11 trustee and the estates controlled so I could 
make some arrangements and ensure that the investigators could 
access the information they needed without compromising any of 
the privileges that I have a fiduciary responsibility to 
protect.
    So we looked at thousands of materials. My team and I, 
which consists of lawyers, financial experts, and 
investigators, determined what the materials were over which we 
had authority and jurisdiction. We reviewed thousands of pages, 
and we then set in place a process that would quickly produce 
the documents to the investigators. We did a limited waiver of 
the existing privileges that may appertain to the Chapter 11 
trustee, and I was happy to say that ultimately all those 
issues were resolved, and the process of producing evidence to 
the investigators has gone forward expeditiously.
    We are very sensitive, of course, to the fact that many 
customers have lost huge amounts of money and collateral that 
was entrusted to, in this case, the subsidiary MF Global Inc. 
We have scrubbed our own cash collateral upon direction by the 
bankruptcy judge to make sure that none of the cash collateral 
in the estate is in any way related to or would be part of the 
customer accounts. And we concluded, with no disagreement from 
Mr. Giddens and his staff, that the cash collateral that the 
estates now possess does not include misappropriated or 
misdirected customer funds.
    Let me also talk and I am pleased to be able to talk about 
the subject of bonuses. This was raised very appropriately, 
Senator Tester, by you and your colleagues. The source of this 
was, as you know, a media report, and I do not have control 
over what is in the media, no more than anybody in this room 
does. But I want to make it very clear it was never my 
intention to pay any bonuses. I never had a plan in place to 
pay any bonuses to senior executives. I read the story with a 
lot of surprise. There had been no discussions between myself 
and my staff about bonuses to senior executives. And bonuses 
are not part of my consideration now, and they have not been in 
the past. So I want to be as clear as I can about that.
    My responsibility as trustee is to maintain the people that 
I need right now to help administer a cost-efficient and well-
administered estate. So there are 15 employees. These are 
noninsider employees who worry about tax, who worry about 
financing, unwinding transactions. They are all working at this 
point on salaries. The three senior executives who have been, I 
believe, before the Senate are working also on salaries.
    If I have to negotiate with any of the employees, the 
noninsiders, the 15 employees, to stay onboard because there is 
a $22 million tax refund that I need to get for the estate, 
they have the expertise and the experience, you know, I will 
set fair and competitive salaries with them. If they do not 
agree with that, then that is not going to work out.
    I want to remain transparent, as I must in this bankruptcy 
process. Everything I do is subject to review not just by the 
trustee but the bankruptcy court. All of our fees, all of our 
expenses have to be reviewed there. So I want to conduct the 
Chapter 11 debtor estates with full transparency and 
cooperation.
    In closing, I just want to say I have worked very 
cooperatively with Mr. Giddens. Our staffs are in sometimes 
daily contact. We meet on a regular basis. There will be times 
when our interests diverge, just as the interests of other 
parties in this very complex and, I think, long-running 
bankruptcy will occur. But we have some very clear and 
immediate common goals, which is to get as many assets back to 
the estates as possible. And then ultimately courts in England, 
perhaps the bankruptcy court in New York will ultimately make 
decisions about how those assets are distributed. But sharing 
the information, getting the assets, returning them is a very 
common critical need.
    From the perspective of the SIPA trustee, I very much 
endorse the six very important considerations that he sets 
forth, particularly on the international cooperation. We have a 
lot of assets, we believe, that are in the U.K., but the U.K. 
has a separate administrator. There is a separate court system. 
We do not have privity as the holdings company to challenge and 
file some of the claims and the subsidiary Inc. will do. But it 
is a very difficult task to get facts and retrieve assets 
overseas, so some restrictions about how segregation should be 
mandated for U.S. investors overseas I think is a key one from 
the point of view of the Chapter 11 trustee, and I would just 
emphasize that.
    Thank you very much.
    Chairman Johnson. Thank you.
    Commissioner Sommers, please proceed.

 STATEMENT OF JILL E. SOMMERS, COMMISSIONER, COMMODITY FUTURES 
                       TRADING COMMISSION

    Ms. Sommers. Good morning, Chairman Johnson, Ranking Member 
Shelby, and Members of the Committee. Thank you for inviting me 
today to discuss the collapse of MF Global, lessons learned, 
and policy implications.
    On November 9th of 2011, the Commission voted to make me 
the Senior Commissioner with respect to MF Global Matters. This 
authorizes me to exercise the executive and administrative 
functions of the Commission solely with respect to the pending 
enforcement investigation, the bankruptcy proceedings, and 
other actions to locate or recover customer funds or determine 
the reasons for the shortfalls in the customer accounts. While 
I am happy to be here today to testify, the scope of my 
election as Senior Commissioner for MF Global Matters does not 
extent to the market-wide policy implications arising from MF 
Global's failure. Chairman Gensler remains in charge of 
directing Commission staff to develop recommendations for 
enhancing Commission and designated self-regulatory 
organization programs that are related to the protection of 
customer funds and has instructed staff to do so.
    My focus has been on making sure that the Commission is 
doing everything it can to facilitate the recovery of customer 
funds and to bring those responsible for any violations of the 
Commodity Exchange Act or Commission regulations to justice.
    Towards those ends, over the past 5\1/2\ months Commission 
staff has conducted a thorough analysis of the books and 
records of MF Global and continues to work closely with the 
trustee in the SIPA bankruptcy.
    We are also engaging in a comprehensive and ongoing 
enforcement investigation. It is imperative that the 
Commission, the industry, and the Congress identify and assess 
the causes for the collapse and shortfall in customer funds and 
to take corrective action where possible. We must do everything 
in our power to restore confidence in the futures markets so 
that producers, processors, and other end users of commodities 
can once again hedge their price risks without fear of their 
funds being lost or frozen.
    Section 4d of the CEA and Commission regulations require 
that an FCM holding customer funds treat such funds as 
belonging to the customer at all times. FCMs are prohibited 
from using a customer's funds to margin or guarantee the trades 
or contracts of another customer or of the FCM. And the FCM 
must maintain sufficient funds in segregated accounts to cover 
the net liquidating equity of each of its customers at any 
given point in time.
    Our regulations also require an FCM to hold customer funds 
deposited for trading futures and options listed on foreign 
boards of trade in separate accounts known as ``Part 30 secured 
accounts.'' The Part 30 rules provide for an alternative 
calculation of the amount of funds required to be segregated 
that does not afford the same protections as the net 
liquidating equity calculation that is used for Section 4d 
funds. This is something that I think should be changed.
    The Act and the Commission regulations establish a 
regulatory structure where frontline financial regulation is 
performed by designated self-regulatory organizations. The 
Chicago Mercantile Exchange and the National Futures 
Association are the two primary futures market DSROs. FCMs are 
subject to CFTC-approved minimum financial and reporting 
requirements that are enforced in the first instance by the 
DSROs. Many FCMs are also registered with the SEC as broker-
dealers. These duly registered broker-dealer FCMs are subject 
to the jurisdiction of both the CFTC and the SEC.
    To ensure that all activities of a broker-dealer/FCM are 
properly reviewed, futures and securities regulators, including 
SROs, coordinate their regulatory oversight. This coordination 
includes periodic meetings of the Inter-Market Financial 
Surveillance Group.
    MF Global was duly registered BD-FCM and, therefore, was 
subject to the jurisdiction of both the CFTC and the SEC. The 
CME was the DSRO for MF Global's futures markets activities and 
had primary responsibility for overseeing the FCM's compliance 
with capital, segregation, and financial reporting obligations 
required by the CFTC.
    Prior to the bankruptcy, the futures and securities 
regulators shared information and examination results regarding 
MF Global. In August of 2011, MF Global filed revised financial 
statements and regulatory notices with the CFTC as a result of 
additional capital charges that FINRA and the SEC required the 
broker-dealer to take on with regard to certain repo-to-
maturity transactions on foreign sovereign debt. At 
approximately the same time, the SEC staff contacted CFTC staff 
to inform us of the capital charges. The CFTC staff also 
consulted with CME, FINRA, and CBOE regarding the imposition 
and rationale for these additional capital charges.
    Commission staff consulted with domestic and foreign 
regulators during the period of October 24th through October 
31st, as well as in the critical hours leading up to the 
bankruptcy filing. At the direction of Chairman Gensler, 
commission staff continues to review customer fund protection 
provisions of the Commodity Exchange Act and our Commission 
regulations to identify possible improvements.
    While the staff has not yet proposed amendments to the 
Commission, it is expected that they will make recommendations 
in several areas. At a minimum, I believe that changes should 
be made to our Part 30 rules so that customer funds held for 
trading on foreign markets are subject to the same net 
liquidating equity calculations as Section 4d funds, that more 
information be provided to customers regarding how their funds 
are held and invested, and that more frequent reporting be 
provided to regulators and that FCMs' internal controls for the 
handling of customer funds be strengthened.
    I understand the severe hardship that MF Global's 
bankruptcy has caused for thousands of customers who have not 
yet been made whole. These customers may have correctly 
understood the risks associated with trading futures and 
options, but they never anticipated that their segregated 
accounts were at risk of suffering losses that were not 
associated with their trading. The shortfall in customer funds 
was a shock to the market from which we have not yet recovered.
    I believe the Commission can make improvements to our 
regulatory oversight of FCMs and DSROs to help restore 
confidence in the futures markets, and I will help the 
Commission and Congress to implement the rules necessary to 
enhance our ability to protect market users and to foster open, 
competitive, and financially sound markets.
    Thank you.
    Chairman Johnson. Thank you.
    Mr. Cook, please proceed.

  STATEMENT OF ROBERT COOK, DIRECTOR, DIVISION OF TRADING AND 
          MARKETS, SECURITIES AND EXCHANGE COMMISSION

    Mr. Cook. Chairman Johnson, Ranking Member Shelby, and 
Members of the Committee, good morning. My name is Robert Cook, 
and I am the Director of the Division of Trading and Markets at 
the Securities and Exchange Commission. Thank you for the 
opportunity to testify on behalf of the Commission concerning 
the lessons learned and policy implications of the collapse of 
MF Global.
    The bankruptcy of MF Global has resulted in serious 
hardship for many of its customers, who have experienced 
significant delays and uncertainty with respect to their 
ability to access their own assets. More broadly, the failure 
of MF Global and the shortfall in customer assets highlight the 
need for financial firms and for regulators to remain vigilant 
in ensuring that customer assets are appropriately protected.
    SEC rules are designed to protect customer property by 
prohibiting broker-dealers from using customer funds and 
securities to support their proprietary positions or expenses. 
Broker-dealers that hold securities or cash for customers must 
maintain physical possession or control over securities that 
customers have paid for in full and cannot use these securities 
to support the firm's own business activities. Further, when 
broker-dealers extend credit to allow customers to buy 
securities on margin, the rules strictly limit how much of 
those securities the broker-dealer can pledge to finance the 
credit it has extended to customers.
    The rules also protect cash held for customers or derived 
from customer securities by requiring the broker-dealer to 
maintain a reserve in a bank account for the exclusive benefit 
of customers in an amount that exceeds the net amounts owed to 
customers. These funds cannot be invested in any instrument 
that is not guaranteed by the full faith and credit of the U.S. 
Government.
    Together with applicable SEC capital requirements and 
protections under the Securities Investor Protection Act, this 
regime is designed to ensure that if a broker-dealer fails, 
customer securities and funds will be available to be returned 
to those customers. The preferred method of returning 
securities customer assets in a SIPA liquidation is to transfer 
those assets to another broker-dealer. On December 9th, the 
bankruptcy court approved the initial sale and transfer of 
substantially all securities custody accounts to a solvent 
broker-dealer. This sale and transfer applied to approximately 
318 accounts held for nonaffiliated securities customers. The 
trustee has reported that since the transfer, nearly all former 
MF Global securities customers have received 60 percent or more 
of their account value; 194 customers have received the 
entirety of their account balances. We understand that those 
194 customers include anyone entitled to SIPA protection with a 
net equity claim of up to $1.25 million.
    Generally, the rules governing protection of customer funds 
and securities have worked reasonably well over time, but we 
are considering whether there are ways that they can be 
strengthened. For example, the SEC has proposed to clarify and 
strengthen the rules governing audits of broker-dealers, 
including an auditor's examination of the effectiveness of 
broker-dealer controls relating to the custody of customer 
assets. The SEC also continues to work with the self-regulatory 
organizations, or SROs, to strengthen broker-dealer financial 
responsibility requirements.
    For example, in June of last year, the SEC approved a FINRA 
rule requiring the establishment of registration, 
qualification, examination, and continuing education 
requirements for certain operations--or ``back office''--
personnel, including those who handle customer assets. This 
rule should help ensure that those responsible for these 
operations are fully versed in their legal obligations, 
including those relating to the segregation and protection of 
customer assets.
    In February of this year, a modernization task force formed 
by SIPC issued 15 recommendations to the SIPC Board, including 
proposed statutory changes. The SEC staff is evaluating these 
recommendations as well, several of which are directed to the 
scope and dollar limit of protection for individual customers 
in a SIPC liquidation.
    The SEC is also engaged in a number of efforts, both 
domestic and international, to share more and better data and 
qualitative assessments of firms and markets and to do so in a 
timely way. Some of these efforts involve improved coordination 
with the SROs, including establishing more frequent meetings 
with certain SROs with financial oversight responsibilities.
    Thank you again for the opportunity to testify on this 
important subject, and I look forward to answering any 
questions you may have.
    Chairman Johnson. Thank you.
    Mr. Ketchum, please proceed.

 STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND CHIEF EXECUTIVE 
        OFFICER, FINANCIAL INDUSTRY REGULATORY AUTHORITY

    Mr. Ketchum. Chairman Johnson, Ranking Member Shelby, and 
Members of the Committee, thank you for the opportunity to 
testify today. My name is Richard Ketchum, Chairman and CEO of 
the Financial Industry Regulatory Authority, or FINRA.
    When a firm like MF Global fails, there is always value in 
reviewing the events leading to that failure and examining 
where rules and processes might be improved. Clearly the 
continued impact of MF Global's failure on customers who cannot 
access their funds is of great concern, and every possible step 
should be taken to restore those accounts as quickly as 
possible.
    With respect to oversight of MF Global's financial and 
operational compliance, FINRA shared oversight responsibilities 
with the SEC, of course, and the Chicago Board Options 
Exchange, which was the designated examining authority, or DEA, 
for MF Global. When FINRA is not the DEA for one of its 
regulated broker-dealers, we work closely with the DEA and 
routinely analyze the firm's FOCUS report filings and annual 
audited financial statements as part of our ongoing oversight 
of the firm.
    While that monitoring focuses on a broad range of issues, 
it is particularly relevant to note that our financial 
surveillance team placed a heightened focus on exposure to 
European sovereign debt, and during April and May of 2010, we 
began surveying firms as to their positions in those 
instruments.
    In a review of MF Global's audited financial statements 
filed with FINRA on May 31 of last year, our staff raised 
questions about a footnote disclosure regarding the firm's 
repo-to-maturity, or RTM, portfolio. During discussions with 
the firm, FINRA learned that a significant portion of that 
portfolio was collateralized by approximately $7.6 billion in 
European sovereign debt. According to U.S. GAAP, RTMs are 
afforded sale treatment and, therefore, not recognized on the 
balance sheet. Notwithstanding that accounting position, the 
firm remained subject to credit risk throughout the life of the 
repo.
    Beginning in mid-June, FINRA, along with the CBOE, had 
discussions with the firm regarding the proper treatment of the 
RTM portfolio. Our view was that while recording the repos as 
sales was consistent with GAAP, they should not be treated as 
such for purposes of the capital rule given the market and 
credit risk those positions carried. As such, we asserted that 
capital needed to be reserved against that position.
    FINRA and the CBOE also had discussions with the SEC about 
our concerns. The SEC agreed with our assertion that the firm 
should be holding capital against these positions. The firm 
fought this interpretation throughout the summer, appealing 
directly to the SEC, before eventually conceding in late 
August.
    MF Global infused additional capital and made regulatory 
filings on August 31st and September 1st that notified 
regulators of the identified capital deficiency and the change 
in net capital treatment of the RTM portfolio.
    Following this, FINRA added MF Global to alert reporting, a 
heightened monitoring process whereby we require firms to 
provide weekly information, including net capital and reserve 
formula computations.
    During the week of October 24th, as MF Global's equity 
price declined and its credit rating was cut, FINRA increased 
the level of surveillance over the firm. At the end of that 
week, FINRA was on-site at the firm, with the SEC, as it became 
clear that MF Global was unlikely to continue to be a viable 
stand-alone business. Our primary goal was to gain an 
understanding of the custodial locations for customer 
securities and to work closely with potential acquirers in 
hopes of avoiding SIPC liquidation. As has been widely 
reported, the discrepancy discovered in the segregated funds on 
the futures side of the firm ended those discussions.
    While FINRA believes that the financial securities rules of 
the SEC combined with SIPC create a good structure for 
protecting customer funds, firm failures provide an important 
opportunity for review and analysis of where improvements may 
be warranted.
    FINRA has identified changes that can be made to better 
protect customers and their funds through both our own 
rulemaking process and also in terms of our coordination with 
our regulatory counterparts.
    Most recently, FINRA and the Chicago Mercantile Exchange 
established regular coordination calls so that our respective 
staffs can share information about the approximately 50 firms 
that are both broker-dealers and FCMs. In addition, we have 
initiated a series of briefings on select firms for domestic 
and international regulators of securities and futures. Our 
next briefing will be in June, and we have expanded the list of 
the regulators and SROs included in the event.
    We have also continued our work on rulemaking efforts aimed 
at enhancing financial surveillance. Starting in October, 
FINRA-regulated firms must file additional financial and 
operational reports that capture more granular detail about a 
firm's revenues and expenses. And last week, FINRA's board 
approved an additional report that would inform the assessment 
of off-balance-sheet activities on firms' net capital, 
leverage, and liquidity.
    FINRA shares your commitment to reviewing MF Global's 
collapse. We will continue to review our own rules and 
procedures and reach out to our fellow regulators to identify 
areas where current processes may be enhanced.
    Again, thank you for the opportunity to share our views. I 
would be happy to answer any questions you may have.
    Chairman Johnson. Thank you.
    Mr. Duffy, please proceed.

 STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, CME GROUP 
                              INC.

    Mr. Duffy. Chairman Johnson, Members of the Committee, 
thank you for the opportunity to testify respecting lessons 
learned from the collapse of MF Global. I have previously 
testified respecting MF Global's misuse of segregated customer 
funds and CME's efforts on behalf of customers. Today I will 
summarize our efforts in the industry's to restore customer 
confidence.
    The shortfall in customer segregated funds was limited to 
the funds under MF Global's control. The customers' funds held 
in segregation by CME's clearinghouse to cover futures 
positions were complete. Our ability to transfer the positions 
and the collateral of our customers was undone by a provision 
in the Bankruptcy Code requiring pro rata loss sharing among 
all customers. We believe that Congress can help protect 
customers whose collateral is safeguarded at a clearinghouse. 
It can do that by changing the Bankruptcy Code to permit 
clearinghouses to transfer fully collateralized customers to 
other clearing members despite a failure of their clearing 
member.
    The industry is united in its search for solutions that 
will restore confidence in regulated futures and derivatives 
markets. Obviously, changes in the Bankruptcy Code are not easy 
or quick, and it is constructive to look at a wide range of 
actions that can be implemented without legislation.
    CME Group, along with other exchanges and the National 
Futures Association, has proposed four forms of intensified 
reporting to prevent misuse of customer funds. The Futures 
Industry Association, on behalf of its members, also proposed 
enhanced reporting and greater transparency. CME Group is 
already implementing proposals which will include:
    One, mandatory daily reporting of segregation statements by 
all FCMs;
    Two, additional surprise reviews of customers' segregated 
accounts;
    Three, a requirement that the FCM's CEO or CFO sign all 
payouts of customer segregated funds exceeding 25 percent of 
excess segregated fund amounts, plus immediate notification to 
CME;
    And, four, a bimonthly report reflecting how segregated 
funds are invested and where they are held.
    CME has also challenged the industry and the Commission to 
consider whether other solutions will better serve the 
interests of customers and the industry. In addition to the 
proposed amendment of the Bankruptcy Code, CME is working with 
its clearing members to find a structure that will protect 
their collateral against fellow customer and fraud risks. We 
are committed to finding a solution that will provide strong 
protection for the segregated funds of futures and swap 
customers from a legal, operational, and cost/benefit 
perspective without destroying the industry's business model.
    In addition to these regulatory initiatives, we also 
recently launched the CME Group Family Farmer and Rancher 
Protection Fund. This fund is designed to protect family 
farmers, family ranchers, and their cooperatives in the event 
of shortfalls in segregated funds. We hope these steps will 
give additional confidence to U.S. futures markets after the 
actions and failure of MF Global. The misconduct of MF Global, 
however, should not serve as a reason to undermine the current 
system of frontline auditing and regulating by clearinghouses 
and exchanges.
    Some critics suggest that the current regulatory system is 
compromised by conflicts of interest. There are no conflicts of 
interest in CME's duties to the CFTC, to its customers, and its 
shareholders. CME's duty to its shareholders requires that it 
diligently keep its markets fair and open by vigorously 
regulating all market participants.
    Federal law mandates an organizational structure that 
eliminates conflicts of interest. The current regulatory model 
has served the futures industry, its customers, and the public 
very well. We look forward to working with the Congress and the 
regulators to enhance customer protections and foster 
confidence in our markets.
    I thank you for your time this afternoon.
    Chairman Johnson. Thank you. I would like to thank all of 
our witnesses for their testimony. As we begin questions, I 
will ask the clerk to put 5 minutes on the clock for each 
Member.
    Judge Freeh, just to be clear, given that $1.6 billion of 
customer funds have yet to be recovered due to mismanagement or 
possible illegal transfers by MF Global, can you commit to us 
today that your office will not be seeking bonuses for any 
former or current MF Global employee?
    Mr. Freeh. Yes, Senator.
    Chairman Johnson. Mr. Giddens, if some type of SIPC-like 
insurance coverage had been in place for commodities accounts, 
how would that have impacted the transfer of client positions 
to other FCMs as well as the claims distribution process for 
former customers of MF Global? Do you believe that Congress 
should study and revisit the idea of extending to commodities 
accounts an insurance coverage similar to that provided for 
securities accounts under the securities Investor Protection 
Act?
    Mr. Giddens. Senator, yes. SIPC proceedings, which govern 
the liquidation of broker-dealers, contain essential and well-
established procedures for contemplating and facilitating 
transfers of accounts to other solvent broker-dealers and 
provide mechanisms for the prompt payment of customer claims. 
All of this is greatly facilitated because there is the 
financial support of the SIPA fund, which has in the case of 
SIPA several billion dollars of assets and the ability to 
assess the industry for additional funds.
    Those funds would assist if it were necessary to cover 
shortfalls to enable a trustee to transfer accounts to other 
solvent--by analogy, to other solvent FCMs. I think as Mr. 
Duffy was alluding to, there are problems here because under 
the statute you have to distribute equally on a pro rata basis.
    So, yes, I believe that if you had a fund which would give 
you more flexibility as a trustee, you could more rapidly 
transfer accounts and at least have that available in your 
arsenal of things to move things along.
    Chairman Johnson. Commissioner Sommers, could you describe 
any legal actions or other efforts the CFTC is taking to 
recover the more than $700 million of U.S. customer funds being 
held in the U.K.? How has the work of the CFTC in this area 
been coordinated with Mr. Giddens' efforts to protect U.S. 
customers subject to CFTC Regulation 30.7?
    Ms. Sommers. Thank you, Senator. The CFTC does not have the 
authority to bring an action in the U.K. court proceeding, but 
we are, as we are in the United States, working very closely 
with Mr. Giddens and his staff, the law firm that he has hired 
to represent the bankruptcy in the U.K. in front of the English 
court, and we will continue to monitor all of the different 
actions that happen in that proceeding.
    Chairman Johnson. Mr. Giddens, do you have anything to add?
    Mr. Giddens. Just to confirm that we do confer frequently 
with the CFTC about the strategy in the U.K. and the nature of 
the legal issues. Equally, we have, to the extent we can, 
shared information with Judge Freeh regarding that proceeding. 
Our view, of course, is that all of those funds in the U.K. are 
segregated assets that belong to the 30.7 customers of the 
broker-dealer.
    Chairman Johnson. Mr. Duffy, do you have any views on the 
FIA recommendations offered last month to better protect 
segregated customer accounts? Also, would it be valuable for 
SROs and the CFTC to receive daily electronic backup 
documentation on these accounts directly from exchanges, 
clearinghouses, and custodial banks in order to confirm that 
the self-reporting of seg funds by FCMs is accurate?
    Mr. Duffy. Let me take the latter first. As far as the 
daily reporting from the SRO and the CFTC to the exchanges, I 
am a big believer, Senator, in transparency and real-time 
reporting, so it is kind of hard to argue with that. The 
reality is what are the practicalities of getting that done. 
Even if we were to have it on a real-time basis, if people were 
having multiple books or doing nefarious activities, it would 
still be very difficult to detect what happened in the MF 
Global situation. So as much as I support real-time tie-outs, I 
think there is a lot of information that still needs to go into 
that.
    As far as the FIA's recommendations on the signoffs and 
some of the things that they have proposed, yes, the CME Group 
is very supportive of their recommendations.
    Chairman Johnson. I note that Senator Shelby has 
temporarily left the Committee hearing to attend an 
Appropriations hearing, and he will be back. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and I thank all of 
you for your testimony.
    I sit through most of these hearings, and today it almost 
gives you a headache to think about all the various regulators 
involved in one entity, and we created that, you all did, and 
so I am not criticizing that. But it does seem like there are a 
lot of silos and various areas that each of you look at that do 
not overlap properly. And what I would like to do is ask Mr. 
Giddens and Judge Freeh: What happened? What happened to the 
customer accounts? How did the money end up in places that it 
was not supposed to end up? We have talked about everything but 
that here today.
    Mr. Giddens. Our analysis of what happened and where the 
money went I think is substantially concluded. That is the 
first phase of the process. Because of the liquidity crisis in 
the last week, something like $105 billion in cash went out of 
the firm to banks, depositories, some to commodities customers, 
some to securities customers in what on the surface appear to 
be ordinary commercial transactions. A great deal of this was 
caused by customers leaving the firm and asking that their 
assets be transferred out of the firm. Also, the firm had to 
scurry around to find additional collateral. Additional 
collateral was required with respect to the repo-to-market 
transactions which went from something like $200 million to 
maybe $900 million additional collateral required.
    In these firms, cash is moved around from various accounts 
on a daily basis, and it is possible that if mistakes are made 
and you say we have excess in one category, we can use that 
category to move it to another, and with so much happening in 
the last week and so many volumes of transactions, that is 
where we think the--what accounts for the mistakes.
    So we can trace where the cash and securities in the firm 
went, and that we have done. The second more complex phase, 
which we are also aggressively pursuing, is to get as much of 
that back if we have an appropriate legal theory to do that, 
and we have done that. We have had some success to date, and we 
will continue to pursue that with a goal of getting back as 
much of the property as we can.
    Senator Corker. Let me ask you this question. We kind of 
all get the picture of what happened. A lot of money was moving 
around quickly. The firm was in a desperate state. With all of 
that occurring, regardless of, you know, the umpteen million 
regulators that look at this, the fact is--how do you keep that 
from--how do you keep at the end money going out of a customer 
account inappropriately to some other place? I mean, how can 
even a regulator at that instant keep that from happening?
    Mr. Giddens. Given the fact that so-called operational 
personnel can move funds and have authority to do it, it is 
almost not possible to build a foolproof system which would--
the checks that you have or the reporting requirements and also 
the totaling up on a daily basis of what the segregation 
requirements should be, if there are substantial mistakes in 
that, it permits someone to say theoretically I have an excess 
in the commodities funds; therefore, I can transfer that to the 
securities accounts, or vice versa.
    We had an example shortly--after I was appointed, I had a 
call from MF Global itself saying we have wrongly transferred 
$220 million from the securities accounts to the commodities 
accounts, and we would like to reverse that. How that was done 
or who authorized it or whatever, you know, we cannot say. But, 
clearly, there were mistakes being made, and part of this--as I 
say, the process is that most people do not realize that 
relatively low-level operational people in any given time have 
the authority to transfer hundreds of millions of dollars----
    Senator Corker. Was there an investment committee? Is there 
personal recourse to the executives when these kinds of things 
happen? Is there a way to deal with them on a personal basis 
against their personal assets? And, second, was there any kind 
of investment committee or internal controls that existed there 
to keep this kind of thing from happening within the firm? And 
if not, are there other firms, to your knowledge, that have 
these same problems?
    Mr. Giddens. On the personal liability, I think there are--
my own personal view and the view of people working with me is 
that there are discrepancies so that seniors and higher-ups who 
do not directly authorize the young vice president to move 
money are probably--it is very difficult to suggest that they 
are personally liable. And that is one of the reasons I 
suggested that we look at that and begin to consider saying it 
is not enough when you are managing the firm, determining the 
investments and the overall strategy, if you in effect create 
the liquidity crisis, that you will bear some responsibility if 
there are shortfalls in customer property. I think it is 
certainly----
    Senator Corker. I know I am running out of time. Were there 
internal controls or an investment committee? Was there any 
discipline within the firm that kept one person from making a 
big bet and the company going haywire?
    Mr. Giddens. My understanding was there was an investment 
committee. There were risk officers at the firm. There were 
examples of where recommendations were not taken by the risk 
officer, and under perfectly legitimate corporate structures, 
senior officers could choose to ignore that.
    Our view of MF Global from our analysis of its operations 
was that the firm was poorly capitalized and had liquidity 
crises, highly leveraged before Mr. Corzine came to the firm, 
and, in fact, those problems continued. They certainly went 
through the motions of having operational supervision and risk 
supervision and the like. How effective that was I think is 
demonstrated by the ultimate failure of the firm.
    Senator Corker. Mr. Chairman, thank you for the time.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Thank you all 
for your testimony.
    Mr. Giddens and Mr. Freeh, let me ask you, I just heard 
your response to Senator Corker's last question that MF Global 
was poorly capitalized and had a liquidity crisis, that it was 
highly leveraged. Was that in essence the harbinger of its 
doom?
    Mr. Giddens. That was certainly a large contributing 
factor, so that if they had a crisis, there was not much of a 
cushion to fall back on. I think also it would be the nature of 
their investments in risky European sovereign debt of countries 
such as, I believe, Italy, Spain, and Ireland, with the result 
that since those were purchased on margin, the margin amounts 
and the collateral put up had to be continually increased. So 
that toward the end, as I recall, something in the neighborhood 
of $200 to $300 million in margin became closer to $900 million 
in margin that had to be put up. So all of that created much 
more severe strains on the firm.
    Mr. Freeh. Senator, also, in addition to that, a critical 
factor was really the inability of its IT and technology system 
to just keep pace with the trades and to even record them. In 
the last few days, there are many nonrecorded trades. Even now, 
to reconstruct what happened there is very difficult. The IT 
system and the technology, you know, was not equipped for the 
frenetic pace of trading in the last several days, and that 
combined with the miscalculation using the most generous term 
at this point, subject to investigation, of what was segregated 
and what was not segregated, and the inability to control and 
track the trades in the accounts was just a perfect storm for 
the disaster that occurred.
    Senator Menendez. So you clearly had between poor 
capitalization, liquidity crisis, highly leveraged, and 
inferior technology, a structural problem at MF Global.
    Let me ask you this: Has it been part of your effort and 
review to determine what individuals at what level--I am trying 
to think here of structure more than individuals, but what 
individuals created the set of decisions that created the 
challenge that we have?
    Mr. Freeh. Yes, Senator. That is a subject both of my 
investigation and Mr. Giddens. We are looking to determine the 
available causes of action, including fraud, lack of fiduciary 
responsibility.
    Senator Menendez. And where are you in that investigation 
at this point?
    Mr. Freeh. We are just beginning it, sir.
    Senator Menendez. Just beginning it. So you cannot identify 
at this point the responsible parties?
    Mr. Freeh. I could not do that fairly at this point.
    Senator Menendez. Let me ask you this, Mr. Giddens. You 
suggested in response, I think, in earlier testimony that 
director liability might be a preventative measure. Isn't there 
director liability here now?
    Mr. Giddens. There well may be, and we are looking at that. 
If there were breaches of fiduciary duty that are actionable, 
we will pursue them.
    Senator Menendez. Ms. Sommers, on December 11th, the CFTC 
finalized a rule prohibiting the investor of customer funds in 
foreign sovereign debt securities. If the rule had been 
finalized before the collapse of MF Global or not overturned in 
2005, does the CFTC believe that MF Global would have avoided 
collapse?
    Ms. Sommers. No, sir.
    Senator Menendez. OK.
    Ms. Sommers. The investments under 1.25 are the permissible 
investments that the FCM can use to invest customer funds that 
are in segregation, but they cannot be used by the FCM 
themselves to invest it for the FCM's own gain.
    Senator Menendez. What is the likelihood of--my 
understanding is you have identified where the money is. What 
is the likelihood of recovering it on behalf of all of those 
individuals whose money is abroad?
    Mr. Giddens. With respect to the $700 million that was 
represented to the U.S. customers as being segregated for them, 
our position is that under U.K. law, that money should be 
treated as segregated customer funds. And I think we are 
reasonably confident of a positive outcome from the U.K. 
courts, but there is no guarantee of that.
    Senator Menendez. One final question. Mr. Duffy, clearly 
what a company does in the first instance is the challenge. We 
would expect them to do the right thing, both legally and 
substantively and ethically. But in the absence of that, is 
there anything in this experience that says to you, heading 
CME, that there is something structural that needs to be 
changed to be able to at least mitigate the extent? My 
understanding is that there was a $700 million--some-odd 
instance in which they would have--reporting would have 
indicated that funds were commingled. That could not be stopped 
because it already was done. But might it have mitigated going 
to $1.6 billion.
    Mr. Duffy. Again, the number of $1.6 billion, you would 
have to ask Mr. Giddens where that came from. Our number is 
significantly lower, and we are referring to the U.S. number 
around $700 million as missing. And anything that we could have 
gained by the experience, I think that we have done everything 
as a DSRO. We have reviewed all of our practices going back 
looking through the whole forensic analysis of MF Global, and 
we feel very strongly that we did all the things that were 
appropriate.
    I think Mr. Giddens said something that was very important 
just a moment ago. He said that the company has a liquidity 
crisis, and their increases went from $200 to $900 million on 
their margin calls. That money had to come from somewhere, and 
if there was a liquidity crisis, where was that money coming 
from? So I think that is a very important point in this hearing 
today. So that is one of the things I have learned.
    As far as going forward, I think that the CME is--without a 
doubt, that is the biggest part of what we do as a DSRO, is to 
protect the integrity of our markets and our clients.
    Senator Menendez. So there is nothing structurally that you 
have learned from this?
    Mr. Duffy. I do not believe there is anything structurally 
wrong with the process sir.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Johanns.
    Senator Johanns. Let me just say thank you for being here.
    Mr. Giddens or Judge Freeh, either one of you maybe would 
be equipped to answer this. I am trying to get a perspective 
here just in terms of time. You said, I think, Mr. Giddens, 
when former Senator Corzine came on board, there were problems 
with this firm. They had liquidity problems and that sort of 
thing. As I understand it, that would have been in the scope of 
$200 million at that point in time? Is that what you found?
    Mr. Giddens. No, Senator. I was just alluding to the fact 
that the evidence we see is that from 2008 on, MF Global was 
either losing money in an operating sense or was highly 
leveraged. And so it was a firm which had financial 
difficulties when Mr. Corzine came in, and that is simply to 
say that--the liquidity crisis was certainly not as severe as 
it was in the final weeks, in October of 2011.
    Senator Johanns. That is what I was trying to get at here. 
Everything I have heard through hearings like this and reading 
testimony, et cetera, was that in the final weeks of MF Global, 
the sky fell in. Now, my understanding--and to me it seems so 
basic, you know, even having been a lawyer where you maintain a 
trust account, somebody gives you money, you put it in a trust 
account. You are not authorized to say, gosh, kind of a rough 
month this month, clients are not paying their bills or 
whatever, so I will just borrow money out of the trust account. 
But that is, in effect, what they did here, right?
    Mr. Giddens. The analogy is good, but what they can do 
perfectly legally through fancy footwork and accounting each 
day is look at funds that are theoretically in a so-called 
trust account and say we now have excess, because money is 
moving in and out daily among--as we have a chart in here to 
indicate--between the broker-dealer, the FCM accounts, the 
segregated accounts, to European subsidiaries, to banks, 
depositories. So it is all very fluid. So the concept that 
there is a frozen trust account that you cannot touch is not 
the way it operates in the real world. And it operates in such 
a sense, if you do a calculation and somebody in Chicago says, 
well, we have calculated with have $200 million excess so we 
can now use that as collateral and transfer that to the broker-
dealer account equally, as in the example I gave, a transfer 
was made from the broker-dealer segregated fund on the last day 
of $220 million maybe on the assumption that they had excess. 
But the rules of the regulators and the way this worked and 
maybe the way it has to work is that the money is really not 
frozen and can easily be moved around.
    There could be much stricter safeguards, some of the things 
Mr. Duffy was talking about in terms of making people 
responsible at the top, which I was talking about, and others, 
so it is not so easy for some $85,000-a-year vice president to 
say I have seen the calculations and, therefore, I will move 
$200 million from one way to the other.
    Senator Johanns. Did you come across any indication that 
the firm was actually using that approach in a way that you 
personally would regard or you would offer an opinion that that 
was deceptive, it was done in a way to deceive people who were 
supposed to be paying attention to this or regulating this?
    Mr. Giddens. I really have no personal opinion about that.
    Senator Johanns. Let me ask a question then about that. You 
are going into this time of a personal investigation, I think 
is what you said, Judge Freeh, and you are going to start 
trying to uncover who did what and when and that sort of thing. 
So what are your options? If you see evidence that that 
practice was done in a deceptive way, just describe for the 
Committee the three or four things that could happen to the 
principals here.
    Mr. Freeh. Yes. In addition to the regulators and the 
criminal investigators conducting simultaneous and in some ways 
very similar investigations and that is why we are cooperating 
with them to the ultimate extent possible, making available 
records, witnesses, waiving privileges where we can do so. But 
in our own investigation and our own mandate, myself as the 
Chapter 11 trustee and Mr. Giddens as the SIPA trustee, is to 
look for causes of action, and at this point nothing is off the 
table. So we not only look at employees and directors of the 
holding company as well as the subsidiary that Mr. Giddens is 
the trustee for, but third parties, including financial 
institutions, who had different collateral requirements, which 
changed particularly in the last several days.
    So at this point, literally everything is on the table, 
both, you know, individual persons as well as institutions, and 
what we will do, maybe separately but maybe simultaneously, is 
make legal determinations with our lawyers about whether a 
viable cause of action exists and whether it is efficient to 
pursue that cause of action.
    In my own case, representing the debtors, we may have a 
cause of action that would cost $10 million, but the 
institution or the individual has no assets, so I would have to 
weigh that in terms of wasting assets in the estate.
    Senator Johanns. Thank you.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Tester.
    Senator Tester. Yes, thank you, Mr. Chairman, and I 
appreciate you holding this hearing. It is not a surprise to 
especially Mr. Giddens. I mean, we saw Montanans' funds used to 
hedge wiped away because of the lack of MF Global's ability to 
segregate funds and keep them segregated. I think this is the 
eighth large bankruptcy in U.S. history, and correct me if I am 
wrong, the first time segregated funds have gone missing, so to 
speak.
    I will probably get back around to Senator Corker's 
question because I think it is a good one, and I am not sure 
there is an answer to it, but we will probably do it anyway.
    First of all, I want to thank all of you for testifying. I 
very, very much appreciate your time here today.
    Mr. Freeh, you have got an incredible resume, one that I am 
sure you are proud of, one that is very, very good. And in 
going back to the question that the Chairman asked, the very 
first question where he did talk about bonuses, I just want to 
clarify because in your statement today you said bonuses are 
not part of consideration now or in the past. I thought you 
told the Chairman nor in the future. Is that correct?
    Mr. Freeh. I did, sir.
    Senator Tester. Well, thank you. And the questions that 
have been asked kind of add some credence to this. You say that 
there are about 15 employees that you have hired--and correct 
me if I am wrong--plus three senior executives. Is that 
correct?
    Mr. Freeh. Yes, sir. The 15 employees remain. They were 
prepetition operators. They run, as I mentioned, tax activities 
and, you know, they are the worker bees so to speak.
    Senator Tester. Not folks, so to speak, who would be part 
of the problem.
    Mr. Freeh. Well, we do not know at this point, but of 
course, we are not considering them insiders. We are 
considering them employees.
    Senator Tester. How about the three senior executives? 
Would they be considered insiders?
    Mr. Freeh. Yes, they are insiders.
    Senator Tester. OK. So in the previous question that 
Senator Johanns asked, you said you are looking about who did 
what when and a potential cause of action. When you negotiate 
their salaries, how are you going to do it when, in fact, you 
are looking at them as being part of the problem, part of the 
so-called crooks?
    Mr. Freeh. Well, we have not made any determinations, of 
course, in that regard. The salaries are set, Senator. We are 
not negotiating salaries.
    Senator Tester. Who sets them?
    Mr. Freeh. Well, they were set at the time of the petition 
reverting back to their base salaries. So each employee, 
including the three insiders, had base salaries which have been 
continued.
    Senator Tester. OK. All right. So the point I am trying to 
get at here--and I think I heard the answer--is, I mean, I do 
not really want to give any benefits whatsoever to anybody who 
caused this debacle, and ``debacle'' is not a tough enough 
word. Are you confident that that is the case?
    Mr. Freeh. I am confident that is the case. What I did say 
to the Chairman with respect to the 15 noninsiders--for 
instance, the group that is working now to get a very important 
and valuable tax refund back to the estate--you know, I need to 
maintain them or else the alternative would be to go out and 
hire, you know, an accounting firm at three or four times the 
cost. So that is the balance that I am conducting, but it is on 
that noninsider level, and there are only, as I said, 15 
critical people that I have to balance a fair and competitive 
salary for.
    Senator Tester. OK. Mr. Duffy, in your testimony you 
described the futures market as mostly professional, and yet 
Mr. Giddens suggests in his testimony that 78 percent of MF 
Global's claimants--I suspect some farmers and ranchers--would 
be seeking a return of less than $100,000. And this really is 
the question: Why should farmers and ranchers trust CME in the 
future to regulate and be able to protect their money?
    Mr. Duffy. I think there are several reasons, sir, but 
first and foremost and really important is the $5.5 to $6 
billion, roughly, of segregated funds that MF Global was 
holding, CME Group held $2.5 billion of those segregated funds. 
When MF Global collapsed and filed for bankruptcy, CME still 
held $2.5 billion of those customer funds. Our customers were 
made whole at the clearinghouse level. There were monies that 
were transferred out at the firm level, not the clearinghouse 
level.
    With respect to what Mr. Giddens said about the $100,000 
clients, there are many clients that have significantly higher 
balances than that. But one of the reasons why we came up with 
the Farmer & Rancher Protection program is there is roughly 
36,000 accounts at MF Global of which 20,000-some-odd have 
$25,000 or $50,000 or less. So it goes a lot smaller. A lot of 
those are bona fide hedgers and ranchers. If, in fact, MF 
Global happened today, under our program every farmer and 
rancher would have been made 100 percent whole.
    Senator Tester. But it was not, and so what about those 
folks who are not made whole now, the little guys?
    Mr. Duffy. Again, we cannot do things--looking back, it 
would be considered a moral hazard. There was $158 billion of 
segregated funds in the futures industry, and that would be a 
detriment to CME or anybody else to try to guarantee that type 
of number.
    Senator Tester. OK. Mr. Giddens--it might just be for a 
second, Mr. Chairman. Mr. Giddens, there have been a lot of 
questions here today about a half a dozen regulators and maybe 
more, about what happened, what transpired, things have been 
talked about, poorly capitalized, liquidity problems when Mr. 
Corzine came on board. And we see something happen in the 
eighth largest bankruptcy that has ever happened where 
segregated funds were compromised.
    Does this kind of stuff just happen or--as a policy maker, 
you always look to say what went wrong, what could we have done 
better, who screwed up. Are you to a point where you can say 
that? And I do not want you throwing anybody under the bus, 
just be honest. Are you at a point where you can say this is 
where the system failed, this was a regulator that either did 
not do their job or did do their job, or if you have got a 
cagey enough accountant and you can juggle the books good 
enough, you can get away with just about anything? Because it 
appears to me that--unless there is something else out there, 
and tell me what it is.
    Mr. Giddens. I think that the evidence indicates that in 
most of the cases the individuals complied with--speaking of 
FCMs generally, complied with the regulations. The regulators 
looked at the materials. The materials were filed. But all of 
the failures of either broker-dealers or FCMs are for the most 
part caused either by fraud or by financial mismanagement. And 
in those percentages where this occurs, as I think was the case 
here, you can by hindsight look at it and say there are some 
things that could have been done--more frequent reporting, also 
I think the imposition on seniors in the firm, such as the CEO 
and the CFO, to say if there is a shortfall in customer funds, 
you may be liable, personally liable, and, therefore, that 
should incentive you to have internal systems which assure you 
that you have enough funds. And perhaps one of the ways to do 
that, as is done with any kind of a normal repo or so is have 
excess collateral, so why not have a requirement that there be 
excess segregation?
    So I think there are specific things that can be done to 
ameliorate the situation. I do not think it was just a 
happenstance circumstance. I think there is often a case in 
many bankruptcies from Enron on out where a firm is in 
financial trouble, and the normal controls are ignored, and 
people act in desperation to try to avoid these kind of 
problems.
    I think the regulators and the reports and things required 
do serve a valuable purpose, but I think they can be improved.
    Senator Tester. Thank you. Thank you all for your 
testimony.
    Chairman Johnson. Senator Moran.
    Senator Moran. Chairman, thank you.
    Commissioner Sommers, I want to focus on CFTC. What was the 
conflict of interest that Chairman Gensler caused to recuse 
himself 5 days after the filing of the bankruptcy?
    Ms. Sommers. I am not familiar with the specifics or what 
he was thinking when he decided to recuse himself.
    Senator Moran. There was not a discussion among the 
Commissioners?
    Ms. Sommers. There was not a discussion.
    Senator Moran. But then there was a vote, I assume, that 
selected you to be the lead on MF Global?
    Ms. Sommers. Yes, sir. The other three Commissioners voted.
    Senator Moran. But no discussion about why Chairman Gensler 
was no longer going to act in that capacity?
    Ms. Sommers. No, sir.
    Senator Moran. Prior to the bankruptcy of MF Global, 
looking back it seems clear that MF Global was under financial 
stress. You can look at stock prices, the New York Fed 
reaction. Did the CFTC take any action to enhance its 
surveillance or to encourage others to enhance its surveillance 
prior to the filing of bankruptcy?
    Ms. Sommers. In the week leading up to the bankruptcy 
filing, we had people on the ground at MF Global. Our staff in 
Chicago was there on the ground. But the numbers and what we 
look at are whether or not the firm is capitalized and whether 
they have the money to meet their segregated obligations to 
their customers. And the data that was provided to us from MF 
Global showed that they were in compliance up until the very 
last few days.
    Senator Moran. When you say you had CFTC personnel on the 
ground, was that an increase in personnel on the ground? Did 
you detect that there might be something wrong and reacted or 
not?
    Ms. Sommers. We actually had people at MF Global's offices 
in Chicago and New York, and that is not typical.
    Senator Moran. And when did that occur?
    Ms. Sommers. The week prior.
    Senator Moran. The week prior.
    Ms. Sommers. Yes.
    Senator Moran. When over 99 percent of MF Global's accounts 
were commodity accounts, did CFTC have an opportunity to 
prevent SIPA from taking over the bankruptcy? And why was MF 
Global Holding, the holding company, why was it allowed to file 
Chapter 11? Both of those instances seem to have preferred the 
general creditors over the segregated account holders. Did CFTC 
have a role in altering the decisions that were made that 
allowed those two things to happen, the kind of--SIPA's 
involvement, in my view to the detriment of the segregated 
account holders, and the holding company-wide bankruptcy 
filing. Both those worked to the detriment, it seems to me, to 
the segregated account holders. Did the CFTC have a role to 
play in those decisions?
    Ms. Sommers. Although I was not privy to the conversations 
that led up to MF Global being placed into a SIPC bankruptcy 
proceeding, it is my understanding that when that is done and 
the SEC has the ability to place an entity that they believe is 
either in financial distress or is approaching financial 
distress, they have the ability to refer them to SIPC.
    We do not have that same authority if an entity is a stand-
alone FCM versus a broker-dealer FCM. But it is my 
understanding that even though the entity was a joint broker-
dealer FCM and placed into a SIPA proceeding, that all of the 
Commission's regulations, Part 190, bankruptcy rules and 
regulations, those all apply, just as they would if it were 
just a stand-alone FCM and those, you know, were not in----
    Senator Moran. Commissioner, is what you are telling me 
then that my understanding that--or my suggestion that those 
segregated account holders were harmed by that decision is not 
true?
    Ms. Sommers. My understanding is that it is not true.
    Senator Moran. Did that discussion occur prior to the 
filing of bankruptcy? Was CFTC engaged in this conversation 
about how this bankruptcy was going to occur?
    Ms. Sommers. The Commission was informed that MF Global was 
going to be placed into a SIPA liquidation. We were not 
involved in whether or not that decision should be made.
    Senator Moran. Who at CFTC was handling the decisions 
related to enhanced supervision and the kind of bankruptcy or 
the bankruptcy proceedings--who at CFTC was handling those 
decisions prior to the bankruptcy?
    Ms. Sommers. Up until November 3rd, Chairman Gensler was 
directing those decisions.
    Senator Moran. And since you have told me you do not know 
what his conflict of interest was that caused him to recuse 
himself 5 days after the bankruptcy, you do not have an opinion 
as to whether that same conflict of interest would have accrued 
prior to the filing of bankruptcy. Do you know if something 
happened between the filing of bankruptcy and the 5 days later 
when he recused himself that created a conflict of interest? Or 
is it the same conflict of interest that was there prior to 
bankruptcy and subsequent to bankruptcy?
    Ms. Sommers. I do not know.
    Senator Moran. Thank you.
    Mr. Chairman, thank you.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you. I apologize for missing part of 
your testimony, but I have a conflict, as others do. We had a 
markup in the Appropriations Committee, and you should not be 
absent from that, as you can recall. I hope some of these 
questions have not been asked, but if they have, I was not here 
to hear them.
    I will first go to you, Commissioner Sommers. During the 
week leading up to the bankruptcy--picking up on some of 
Senator Moran's questions, during the week leading up to the 
bankruptcy of MF Global, did Chairman Gensler ever, ever 
indicate to you that he was concerned about customer assets at 
MF Global?
    Ms. Sommers. My recollection, Senator, is that Chairman 
Gensler had concerns regarding the financial condition of the 
company, and that is why staff were sent.
    Senator Shelby. How many times do you recall--or do you 
have a record of it that you could furnish to the Committee if 
you do not recall yourself right at the moment--did Chairman 
Gensler brief you and other Commissioners at the CFTC's 
meetings on the management of the crisis? Because that had to 
be a concern for the CFTC, because this was not business as 
usual.
    Ms. Sommers. Right. Over the weekend prior to the filing of 
the bankruptcy, I recall receiving two emails from the 
Chairman, and then we held a closed meeting----
    Senator Shelby. And what was the substance of those emails?
    Ms. Sommers. Just informing us that he was on----
    Senator Shelby. That there was a problem?
    Ms. Sommers. No. Informing us that he had been on 
conference calls with domestic and foreign regulators regarding 
the potential sale of MF Global to another financial 
institution.
    Senator Shelby. Did he indicate great concern at that time?
    Ms. Sommers. Not at that time, no.
    Senator Shelby. OK. Mr. Duffy, I will direct this question 
to you and also to Commissioner Sommers. What authorities does 
the Chicago Mercantile Exchange, CME, have to protect customer 
segregated accounts at a futures commission merchant during an 
emergency situation? And, Commissioner Sommers, following up on 
that question to Mr. Duffy, what authorities does the CFTC have 
to protect customer segregated accounts at a futures commission 
merchant during an emergency situation?
    Mr. Duffy, you first.
    Mr. Duffy. Well, first and foremost, we make sure that they 
are in segregated compliance, and these are reports that we----
    Senator Shelby. That there will be--answer that again, if 
you would, just for the record.
    Mr. Duffy. I am sorry?
    Senator Shelby. What did you say, they will be--there 
should be segregated----
    Mr. Duffy. We get segregated reports.
    Senator Shelby. OK.
    Mr. Duffy. From MF Global, as we were getting them all 
along on a daily basis since they were acquired at Refco. So 
they were on a daily seg report voluntarily anyway. So we were 
getting these reports on a daily basis. There was a day lag and 
then you've got to tie them out over a several-day period. So 
these are some of the things that we do to have authorities to 
make sure they are in compliance. If they go out of compliance 
of segregation, it is a violation of CME's rules and then of 
the CFTC's rules.
    Senator Shelby. Were some of those reports you were 
getting, as you look back, were they misleading or were they a 
little more than that or what?
    Mr. Duffy. The latter, sir. They were a little more than 
that. We were told on one report given to us on a Thursday that 
they had $200 million in excess seg. After they had announced 
that the money was missing on Sunday evening----
    Senator Shelby. Was that true?
    Mr. Duffy. It was then true that they gave us the right 
report saying they were 200 deficit. They gave it to us on the 
following Monday. So they definitely--from the prior Thursday. 
So the reports were definitely inaccurate.
    Senator Shelby. So that is misleading you, right?
    Mr. Duffy. It was very misleading to us, sir. Yes, sir.
    Senator Shelby. OK. Commissioner Sommers, a question to 
you, the same thing.
    Ms. Sommers. We have never had this type of situation in 
the past, but if we were ever in a situation where we believed 
that a company was in a situation where they could not meet 
their obligations, the Commission could seek legal action to 
have a receiver appointed in an emergency situation.
    Senator Shelby. I will direct the same question to both of 
you. In the area of protection of customer segregated accounts, 
Commissioner Sommers and Mr. Duffy, both of your organizations, 
as I understand it, had staff on-site at MF Global's Chicago 
offices the weekend before the firm's bankruptcy filing. What 
steps did your agency--I will start with you, Commissioner 
Sommers--take to protect customer assets prior to learning that 
customer assets were missing? And what date and time did staff 
in your agencies first learn that there was a possible or 
probable shortfall in the customer segregated accounts? And 
after you learned of the missing consumer assets, what specific 
steps did each of your agencies take to ensure that customer 
funds were not improperly transferred over the weekend? That is 
when it seems there was more than a little mischief done.
    Commissioner Sommers, you first.
    Ms. Sommers. So the first question with regard to what our 
staff was doing, although the Commission and the DSRO receive 
daily segregation reports, those reports only list the amount 
of money that the FCM owes to customers, what their obligation 
would be there. Our staff was in the process of trying to get 
supporting documentation from MF Global to be able to make sure 
that they actually had that money in the bank.
    Senator Shelby. You had that conversation you testified to 
earlier, either personally or some communication by email, from 
Chairman Gensler that obviously there was more than a little 
concern at your office regarding MF Global. Is that right?
    Ms. Sommers. Well, I think that----
    Senator Shelby. You did not think everything was OK at MF 
Global after you talked to or you read the emails of Chairman 
Gensler, did you?
    Ms. Sommers. I think in the beginning the reason why he 
sent staff to the offices of MF Global is so that we could 
receive the supporting documentation to make sure, to do the 
tie-back of the segregated accounts and to make sure that that 
money was there.
    Senator Shelby. Because there was concern at your agency 
about MF Global.
    Ms. Sommers. Right.
    Senator Shelby. Where the money was coming from and what 
money they had and so forth.
    Ms. Sommers. Right. So----
    Senator Shelby. Is that correct?
    Ms. Sommers. That is true, and the documentation and the 
data that they provided to us showed us that they were in 
compliance. So over the weekend----
    Senator Shelby. But that was not true, was it?
    Ms. Sommers. That was not true.
    Senator Shelby. Did you have a suspicion at that time it 
was not true?
    Ms. Sommers. I do not believe that staff had suspicion that 
they were not in compliance. Over the weekend, the staff was in 
the process of filing all of the documents that we would need 
to file in order to make a transfer possible, so customers from 
MF Global, if there was a financial institution that would 
purchase the FCM, that those customer accounts could be 
transferred with our approval. So we were drafting those 
documents in order to make that transfer of customer positions 
possible. We were not informed--the Commission was not informed 
until Monday morning of October 31st that there was a shortfall 
in customer segregation----
    Senator Shelby. But were you ever concerned that there 
might be some things wrong at MF Global? Obviously, something 
had to come up on your radar.
    Ms. Sommers. Absolutely. We were concerned but never--I do 
not believe I ever thought that one of the concerns should be 
that there would be a shortfall in customer segregation.
    Senator Shelby. Mr. Duffy, do you have any comments on 
that?
    Mr. Duffy. I will echo Commissioner Sommers for the most 
part, and my recollection of what happened was we also had 
people on the round tying out, validating the reports against 
bank records and everything else, and we got through Friday 
into Saturday, and we still had people on the ground. And then 
we were told that there was an accounting error, as we 
referenced in my earlier testimony last year, of $900 million. 
And so everybody was trying to put the company----
    Senator Shelby. An accounting error of 900----
    Mr. Duffy. Yes, I found that pretty staggering myself.
    Senator Shelby. How much, $900 million?
    Mr. Duffy. $900 million, yes. So some people felt it was 
too big, it had to be an accounting error. There were others of 
us that thought it was too big and it could not be an 
accounting error. So I was in the latter camp.
    Senator Shelby. Well, did that send a lot of anxiety 
through your organization?
    Mr. Duffy. It sent a lot of anxiety, but I think people 
felt fairly confident that there was no way that it was not an 
accounting error, and the company was going to be whole and 
segregation----
    Senator Shelby. Were the people wrong that thought that?
    Mr. Duffy. People were dead wrong, sir.
    Senator Shelby. Dead wrong.
    Mr. Duffy. Dead wrong.
    Senator Shelby. Mr. Giddens, you are the MF Global trustee, 
right?
    Mr. Giddens. Yes, sir.
    Senator Shelby. And as trustee, just for the record, what 
is your portfolio? What are you supposed to do as the trustee 
for MF Global, Inc.?
    Mr. Giddens. Well, I am appointed the equivalent of a 
Chapter 7 liquidating trustee, and I have the same powers as a 
Chapter 7 trustee for the FCM and also for the broker-dealer.
    Senator Shelby. OK.
    Mr. Giddens. My job is to marshal the assets of the broker-
dealer estate and to pay them out as required by law. They are 
a sacrosanct property, which is really not part of the estate, 
which belongs to customers--the commodities customers' funds 
and also the securities customers' funds. And there are very 
detailed provisions of both the CFTC Act and also the SIPA Act 
which governs how you calculate those claims and pay them out.
    The big distinction and the big difference and the reason 
that, as Mr. Cook of the SEC has pointed out, some of the 
securities customers have been paid in full is the existence of 
the resources of the SIPA fund which provides up to an 
additional $500,000 to cover losses in an account.
    Senator Shelby. Is that $500,000 per account?
    Mr. Giddens. Yes, sir.
    Senator Shelby. OK.
    Mr. Giddens. Yes, $250,000----
    Senator Shelby. What is the average account?
    Mr. Giddens. The average securities account----
    Senator Shelby. At MF Global.
    Mr. Giddens. At MF Global, probably--just doing the 
calculation in my head, it was probably $1 million or more.
    Senator Shelby. OK.
    Mr. Giddens. The commodities accounts, I think as we 
indicated, 75 percent were less than $100,000 and probably 93 
percent of the commodities accounts were less than $1 million.
    Now, in both cases there were significant numbers of 
commodities customers and securities customers who in the last 
weeks transferred their accounts from MF Global to other 
solvent firms.
    Senator Shelby. And why did they do this? Was there concern 
in the marketplace about MF Global at that time?
    Mr. Giddens. Absolutely. Its credit had been downgraded 
and----
    Senator Shelby. And do you know of your own account, of 
your own knowledge, that that concern in the marketplace 
extended to Chicago, to the Commodity Futures Trading, or to 
the SEC, or to the CME?
    Mr. Giddens. Certainly it was in the major newspapers 
that----
    Senator Shelby. Yes, everywhere.
    Mr. Giddens. ----the firm was experiencing trouble. Whether 
anyone suspected that there was a shortfall in segregation, I 
do not know that. But I do know that because of downgrading and 
rating and losses, many of the larger accounts left the firm.
    Senator Shelby. People were leaving ship, weren't they?
    Mr. Giddens. Absolutely.
    Senator Shelby. OK. Your written testimony, Mr. Giddens, 
provides an overview of large cash movements at MF Global 
during October 2011. Were there any large transfers--you talked 
about some of the others, alluded to them--from MF Global's 
customer segregated accounts to the firm's own accounts while 
multiple regulators were on-site at MF Global starting on 
October the 27th?
    Mr. Giddens. The answer is yes. There were billions of 
transfers in and out of the firm and from the various accounts.
    Senator Shelby. And the regulators were on-site there.
    Mr. Giddens. Yes, sir.
    Senator Shelby. OK. Were there any subsequent large 
transfers out of MF Global's own accounts to pay 
counterparties?
    Mr. Giddens. Certainly during the period of October 27th 
through October 31st, yes.
    Senator Shelby. OK. Mr. Giddens, you recently announced 
that you would pursue litigation in the United Kingdom to 
recover approximately $700 million of customer funds. What is 
your best guess or your judgment for how long it will take for 
MF Global customers to recover, if they do, the $700 million 
that is trapped in the U.K.? And will it take weeks, months, or 
years and so forth? Just your judgment.
    Mr. Giddens. The petition to commence the case is due to be 
filed shortly. How quickly and how the court determines how the 
litigation is held, what discovery is required and the like, is 
unknown at this time. We will try to expeditiously get a 
decision from the court.
    We had a similar situation in the Lehman case in which our 
position was that funds that were with the Lehman U.K. broker-
dealer were segregated customer funds--these happened to be 
securities funds, and that was opposed by the English 
regulators. And that process, because of appeals to three 
courts, took almost in excess of 2 years until there was a 
final decision. I hope that will not be the case here.
    Senator Shelby. What is your best judgment on how long it 
will take to recover the remaining $900 million in customer 
funds?
    Mr. Giddens. We have recovered through closeouts with some 
parties some portion of that already.
    Senator Shelby. How much have you recovered of the $900 
million, roughly? You can correct the record, but just give 
your judgment.
    Mr. Giddens. I believe about in excess of $500 million. But 
I am not sure.
    Senator Shelby. OK. But you will furnish the correct----
    Mr. Giddens. We will happily supply supplemental 
information on that.
    Senator Shelby. Commissioner Sommers, I would like to come 
back to you. In an attempt to justify his MF Global recusal, 
Mr. Gensler stated that he did not want his relationship with 
the MF Global CEO Jon Corzine to ``be a distraction.'' Did Mr. 
Gensler, Chairman Gensler, ever express any concern that his 
relationship with Mr. Corzine would be a distraction from any 
previous matter involving MF Global, including matters related 
to CFTC Rule 1.25 dealing with investment of customer 
segregated funds?
    Ms. Sommers. Not that I am aware of.
    Senator Shelby. You do not recall?
    Ms. Sommers. No.
    Senator Shelby. Have you searched your records and your 
emails and everything else?
    Ms. Sommers. We have.
    Senator Shelby. OK. Mr. Gensler also stated, and I will 
quote him, that he ``will not participate in any enforcement-
related matters involving MF Global and any matter directly 
related thereto.'' Those are his words. This language appears 
from reading it to prohibit him from participating in any of 
the CFTC's efforts to develop recommendations based on lessons 
learned from the collapse of MF Global. Do you agree or 
disagree?
    Ms. Sommers. Senator, we, my staff----
    Senator Shelby. In other words, he cannot have it both 
ways. He is either in the game or out of the game. He is saying 
here he is out of the game as Chairman. Is that correct? Is 
that the way you read the language?
    Ms. Sommers. We have sought direction from the General 
Counsel of the agency on my delegation, and we are told that my 
delegation does not go toward the policy recommendations, that 
the Chairman would be handling them.
    Senator Shelby. I know my time is moving on, but I have 
another question that I need to ask Mr. Giddens as trustee.
    On April 4th, Mr. Giddens, you provided an update on your 
investigation of JPMorgan Chase, which is MF Global's largest 
creditor, regarding the MF Global funds in its possession. You 
stated that you and JPMorgan--and these are your words--``are 
presently engaged in substantive discussions regarding the 
resolution of claims.''
    Is it your expectation that some of these funds will be 
returned from JPMorgan Chase to MF Global customers? And when 
can MF Global customers expect a resolution of claims against 
JPMorgan, if they can?
    Mr. Giddens. I believe that we have a solid basis for 
seeking a recovery of some of the funds that were transferred 
to JPMorgan. As to how that decision ultimately will be made, 
if we do not reach a consensual conclusion, it will probably 
have to be resolved by bankruptcy Judge John Glenn, and how 
long that will take is difficult to predict. But we would not 
be exchanging information and engaging in really confidential 
discussions about legal arguments unless we thought we had a 
good prospect of recovering something from them.
    Senator Shelby. Mr. Chairman, could I ask Mr. Freeh one 
quick question, if I could?
    Chairman Johnson. Yes.
    Senator Shelby. Mr. Freeh, you are the trustee of MF Global 
Holdings. Is that correct?
    Mr. Freeh. Yes, sir.
    Senator Shelby. So is it your responsibility to protect the 
corpus of assets of what is left of MF Global Holdings?
    Mr. Freeh. Yes, MF Global and the other debtors that are in 
Chapter 11, of which I am the trustee, exactly, to get the 
assets and get them back to the creditors if possible.
    Senator Shelby. OK. Thank you, Mr. Chairman.
    Chairman Johnson. I would like to thank our witnesses for 
their testimony today. It is important that Congress continues 
to evaluate the lessons learned from the collapse of MF Global 
and to discuss the important issues raised at today's hearing. 
I look forward to working with my colleagues to help ensure 
that we can better protect customer accounts and improve future 
regulatory coordination.
    This hearing is adjourned.
    [Whereupon, at 11:51 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
               PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
    Today's hearing will examine the lessons learned from the collapse 
of MF Global. The misuse of customer accounts by one of the world's 
largest commodities and derivatives brokers has shaken confidence in 
our markets and deserves a thoughtful discussion of how to better 
protect farmers, ranchers and investors going forward.
    But before we get to these important issues, I would like to 
express my deep concern that almost 6 months after MF Global's 
bankruptcy, thousands of former customers--including hundreds of South 
Dakotans--still have not recovered the $1.6 billion removed from what 
should have been protected customer accounts. I know that the trustees, 
regulators, as well as the FBI and Justice Department, continue to 
investigate what happened in the final chaotic days of MF Global, but 
these customer funds must be returned without further delay to their 
rightful owners and those individuals and executives responsible for 
transferring these funds must be held accountable to the full extent of 
the law. Lastly, it is not acceptable for MF Global executives to be 
given bonuses when customers have not recovered funds improperly taken 
from them by MF Global--and I thank Senator Tester for his leadership 
on this issue.
    Since the collapse of MF Global in October 2011, my staff has 
worked closely with Senator Shelby's staff in conducting extensive 
interviews and due diligence with the regulators, self-regulatory 
organizations and other parties involved in overseeing MF Global and 
its bankruptcy. We have also coordinated with the Senate Agriculture 
Committee--which has primary jurisdiction over matters involving 
commodities--in holding a series of bipartisan briefings for all Senate 
staff with representatives of many of the organizations before us today 
to help our constituents impacted by the firm's downfall.
    As investigators seek to recover MF Global customer funds and hold 
accountable those responsible for any wrongdoing, this Committee will 
focus our attention on preventing future abuses and the other critical 
public policy issues raised by the collapse of MF Global.
    Today's hearing provides a unique opportunity to ask an important 
set of questions: how can we strengthen protections for customer 
accounts at futures commission merchants or broker dealers, including 
those firms that hold U.S. customer funds abroad? Given the size of the 
shortfall in MF Global's customer accounts, what should Congress 
understand about the idea of extending to commodity accounts similar 
insurance protections that are currently available to securities 
accounts under the Securities Investor Protection Act? And how we can 
continue to improve regulatory oversight and coordination for large, 
complex global financial institutions?
    MF Global may also provide some early lessons about the Wall Street 
Reform Act since it is the first collapse of a major financial 
institution since the law's passage. For example, the story of MF 
Global teaches us that effective customer protection and market 
oversight demands that we fully fund our regulatory cops on the beat. 
In hindsight, there is little doubt that the regulators responsible for 
monitoring MF Global should have taken additional steps. But 
shortchanging the CFTC or SEC of much needed funding will only force 
them to delegate even more authority to self-regulatory organizations 
in a way that could impair effective market surveillance. When funding 
cuts prevent regulators from inspecting firms or assigning necessary 
staff to monitor crises, the American people and market confidence pay 
the price.
    Additionally, a key pillar of the Wall Street reform bill was to 
end ``too big to fail''--and if MF Global demonstrates anything, it is 
that those who take risky bets that bring down their companies are now 
free to fail and will not receive any more taxpayer bailouts.
                                 ______
                                 
                 PREPARED STATEMENT OF JAMES W. GIDDENS
 Trustee, Securities Investor Protection Act Liquidation of MF Global 
                                  Inc.
                             April 24, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for inviting me to testify today. My name is James 
Giddens. I am the court-appointed Trustee for the Securities Investor 
Protection Act (SIPA) liquidation of the failed broker-dealer, MF 
Global Inc. I am also the Trustee for the liquidation of the failed 
broker-dealer, Lehman Brothers Inc., and have extensive experience in 
broker-dealer liquidations. As a SIPA Trustee, I have all the powers 
and duties of a trustee liquidating a futures commission merchant under 
Chapter 7 of the Bankruptcy Code.
Considerations
    I would like to provide to this Committee some considerations on 
topics that may merit further study and input from regulators, industry 
experts, and members of the public. My comments are based on my 
experiences as Trustee generally, as well as my discussions with former 
MF Global customers, a group that includes thousands of America's 
farmers and ranchers, many of whom are undoubtedly your constituents. I 
understand the frustrations of the many former MF Global customers. My 
goal is to return as much money to customers as possible, as quickly as 
possible. All of us hope to avert a repeat of the MF Global 
catastrophe, or, at a minimum, alleviate its consequences, and with 
this goal in mind, I offer the following topics for consideration:

    Strict liability for the senior officers and directors of a 
        commodities broker.

    Establishment of a commodities customer protection fund.

    Suitability requirements for commodities customers.

    Segregation requirements in excess of 100 percent of 
        customer funds; notice requirements for the withdrawal of 
        ``excess'' segregated funds.

    Complete segregation of 30.7 ``secured'' funds and 
        elimination of alternative calculation.

    Improved international cooperation.
Strict Liability for Senior Officers and Directors
    The failure of MF Global Inc. was in part due to a failure to 
maintain integrated systems for tracking liquidity and the movement of 
funds, a lack of supervision of key treasury functions, fragmentation 
of responsibility, and inattention to the details of maintaining the 
segregation of customer funds at senior levels of the company. Because 
regulations require futures commission merchants (FCMs) to segregate 
customer funds at all times, it may be appropriate to impose civil 
fines in the event of a regulatory shortfall on the officers and 
directors who are responsible for signing the firm's financial 
statements.
    Consideration should be given to requiring the chief executive 
officer, the chief financial officer, the chief compliance officer, and 
the general counsel of an FCM to certify not only their company's 
financial statements but also their compliance with customer 
segregation requirements on a frequent and continuing basis. 
Consideration should also be given to making the officers responsible 
for establishing and overseeing a company's internal controls and 
procedures and certifying that they have done so. Where there is a 
shortfall in customer funds, Congress should consider making the 
officers and directors of the company accountable and personally and 
civilly liable for their certifications without any requirement of 
proving intent and without permitting them to defend on the basis that 
they delegated these essential duties and responsibilities to others.
Commodities Customer Protection Fund
    The liquidation of MF Global Inc. would have played out differently 
had there been even a modest protection fund for commodities customers. 
The statistics we have gathered in the claims process demonstrate that 
the accounts of more than two-thirds of the customers who filed claims 
represent only 3 percent of the total amount that MF Global was 
required to segregate for commodities customers, or no more than $200 
million in total. Of the commodities customer claims received by my 
office, 78 percent seek a return of less than $100,000. Thus, a fund 
limited to protecting these smaller accounts--representing many farmers 
and ranchers--could be of relatively modest size but would suffice to 
make these customers whole very quickly even in a case with a shortfall 
the size of MF Global's. With such a fund in existence, three-quarters 
of MF Global's commodities customers would not have been subject to any 
loss and could have been made whole within days of the bankruptcy 
filing.
    A protective fund of this nature could be modestly funded and 
maintained at a minimal cost until such time as necessary to advance 
funds to customers, thereby allowing them to resume trading with little 
or no delay. The fund could be replenished by industry assessments when 
needed to satisfy claims in FCM failures.
Suitability Requirements for Commodities Customers
    MF Global's commodities customers included farmers, ranchers, and 
members of the general public. Commodities trading is clearly an 
important part of the economy that, among other things, assists our 
vital agricultural base in hedging risk and funding itself. However, my 
staff and I have heard from many claimants across the spectrum of day 
traders and others who appear to have invested their retirement 
accounts and life savings in products in the U.S. and abroad that they 
may not have fully understood. We have heard from some former MF Global 
customers who have said they did not understand the account statements 
they received from MF Global even when it was in business.
    Under current regulations, commodities customers are not subject to 
suitability requirements, such as those that the Securities and 
Exchange Commission has approved and are applicable to securities 
customers. Suitability requirements could help ensure that there is 
reasonable basis to believe that a transaction or investment strategy 
is suitable for a commodities customer, based on information about that 
customer obtained through reasonable diligence by the FCM.
Segregation Requirements In Excess of 100 percent of Customer Funds; 
        Notice Requirements for Withdrawal of Residual Balances
    Consideration should be given to requiring an FCM to segregate an 
amount in excess of 100 percent of customer funds. Requiring FCMs to 
post proprietary funds beyond the margin provided by customers could 
help ensure that there is a sufficient cushion at all times for 
commodities customers. Consideration should also be given to 
implementing specific review and sign-off requirements by the CFO or 
other senior officers whenever an FCM seeks to withdraw even what are 
believed to be residual or excess segregated funds from a segregated 
(or secured) account when the withdrawal exceeds a certain dollar 
amount or percentage of either the account or the calculated excess.
Complete Segregation of 30.7 Funds
    Under current rules, FCMs are not required to calculate ``secured'' 
amounts for customer funds held for trading on foreign exchanges per 
Commodities Futures Trading Commission Rule 30.7 (30.7 funds) the same 
way that they must calculate ``segregated'' amounts for customer funds 
held for trading on U.S. exchanges per section 4d of the Commodity 
Exchange Act (4d funds). Specifically, the rules allow a FCM to 
calculate the ``secured'' amount according to one of two methods:

  A.  Net Liquidating Equity Method: the net liquidating value of the 
        net equity of all customer accounts plus the market value of 
        any securities held in customer accounts; or

  B.  Alternative Method: a risk-based measurement based on margin 
        required, plus or minus the unrealized gain or loss on futures 
        positions, plus long option value, minus short option value.

    In the case of MF Global, reliance on the Alternative Method in the 
time period leading up to the liquidation resulted in substantially 
fewer funds being segregated than under the Net Liquidating Equity 
Method. This allowed the FCM to believe that it was in regulatory 
compliance, with hundreds of millions of dollars to spare, even when 
the amount in segregation was actually in or perilously close to being 
in deficit. If FCMs were required to compute the secured amount under 
the Net Liquidating Equity Method, it could help ensure that all 
customer funds are properly segregated at all times and eliminate a 
difference in treatment among customers of which most customers are 
unaware.
International Cooperation
    The collapse of MF Global, like the collapse of Lehman Brothers, 
has revealed significant gaps between protections afforded customers in 
U.S. and foreign countries, such as the United Kingdom, arising largely 
from differences in insolvency laws and the absence of clear legal 
precedent. Though there may not be a one-size-fits-all solution for 
these issues, customers would benefit from greater harmonization of 
rules governing the segregation of customer funds and treatment of 
omnibus accounts. A jurisdiction outside the United States should only 
be approved as a location for the deposit of U.S. customer segregated 
funds if there are adequate assurances that other Governments and firms 
themselves are requiring and effecting segregation consistent with the 
representations made by a U.S. broker to its customers.
    When a company like MF Global or Lehman Brothers fails, it is 
important that property segregated in one country for customers in 
another country is returned to the trustee or administrator in the 
country where the customer resides. In my experience, however, these 
tend to be the last issues to be resolved, which often require 
protracted litigation. In the case of MF Global, I have been engaged in 
active discussions since November with the administrators for the 
estate of MF Global U.K. Ltd. concerning the return of approximately 
$700 million of segregated customer property. I have filed a client 
claim in that proceeding seeking the return of all such segregated 
property, and have engaged in an exchange of information with the 
British administrators regarding this claim. That process has shown 
that there is a dispute as to whether the customer property that is the 
subject of my claim was or should have been segregated under English 
law. I believe that is in the best interests of MF Global Inc.'s former 
commodities customers that this dispute be resolved by the court, and 
the British administrators, at my request, have agreed to seek 
direction from the English court on these issues. Though I will press 
to have this litigated as expeditiously as possible, adjudication and 
resolution will likely take significant time and expenditure of 
resources, all the while holding up the possibility of substantial 
distributions to 30.7 customers in the United States.
Update on Trustee's Investigation
    As Trustee, my statutory mandate as the customers' advocate is to 
preserve and recover MF Global Inc. customer assets so that they can be 
returned to the rightful owners and to maximize the estate for all 
stakeholders.
    As part of my statutorily mandated duty, I am investigating the 
extent of and reasons for any shortfall in customer funds. This 
includes a deliberate, thorough, and independent investigation of the 
complex cash movements made by MF Global Inc. prior to its liquidation. 
My investigative team consists of counsel experienced in broker-dealer 
liquidations and expert consultants and forensic accountants from both 
Deloitte & Touche and Ernst & Young. All efforts are conducted under 
the supervision of the Bankruptcy Court and are coordinated with the 
United States Department of Justice, the CFTC, the SEC, and SIPC.
    On February 6, 2011, I issued a preliminary report on the status of 
my investigation, which preliminarily determined that MF Global Inc. 
had a shortfall in commodities customer segregated funds beginning on 
Wednesday, October 26, 2011, and that the shortfall continued to grow 
in size until the bankruptcy filing on Monday, October 31, 2011. As 
detailed in the preliminary report, my office has traced substantially 
all of the cash transactions made in and out of MF Global Inc. in the 
last week before bankruptcy, totaling more than $105 billion. At the 
request of the Committee, I have attached as an appendix a timeline of 
key events leading up to MF Global's bankruptcy filing based on my 
investigation.
    My investigation has included thorough review of the actions of 
JPMorgan Chase, N.A., regarding JPMorgan's activities in connection 
with MF Global. JPMorgan has cooperated with my investigation, which 
has included witness interviews and review of extensive documentation 
by my staff, including attorneys and forensic accountants from Ernst & 
Young. My office and JPMorgan are presently engaged in substantive 
discussions regarding the resolution of claims.
    I also believe, based on my investigation of conduct, allocation of 
responsibilities and reporting with respect to the segregated customer 
accounts, that there may be claims against certain responsible 
individuals at MF Global Inc. and MF Global Holdings Ltd. for, among 
other things, breach of fiduciary duties owed to both MF Global Inc. 
and its customers, and violations of the segregation requirements of 
the Commodity Exchange Act. I may pursue these legal actions separately 
or in conjunction with commodities customers.
    As I move forward with my investigation, I will continue to provide 
updates to the Court and public on my findings and conclusions.
Status of Customer Distributions
    My office has distributed nearly $4 billion to former MF Global 
Inc. retail commodities customers with U.S. futures positions via three 
bulk transfers:

    Within days of the bankruptcy, I received court approval 
        for the transfer of 10,000 commodities customer accounts with 
        three million open positions, along with approximately $1.5 
        billion in collateral associated with those positions at the 
        time of the bankruptcy. These open positions had a notional 
        value of $100 billion. A serious disruption in markets was 
        avoided by the transfer.

    A transfer of 60 percent of the cash attributable to 
        approximately 15,000 customer commodity accounts with cash only 
        in the accounts, totaling approximately $500 million, was 
        completed in November.

    In December and January, a third transfer occurred that 
        moved approximately $2 billion to restore 72 percent of U.S. 
        segregated customer property to all former MF Global Inc. 
        retail commodities customers with U.S. futures positions.

    My office has received 26,778 total commodities claims and has 
received over 4,500 additional general creditor claims that were likely 
misfiled, which will be treated as commodities claims. I expect that 
the total number of unique claims from former commodities customers 
(accounting for duplicates and amendments) will be approximately 
23,000.
    My office has determined and issued letters of determination for 
nearly 22,000 commodities claims, which is over 90 percent of the 
expected total claims.
    In addition to the completed distributions, I have filed a motion 
with the Bankruptcy Court seeking authority for a distribution of up to 
approximately $600 million of customer property held as segregated by 
MF Global Inc. for its former commodities futures customers who traded 
on U.S. exchanges (4d funds); up to approximately $50 million of 
customer property associated with commodity transactions in foreign 
markets (30.7 funds); and up to approximately $35 million of customer 
property to a domestic delivery class, which we have identified as 
consisting of physical customer property that has been or will be 
reduced to cash in any manner.
    I have also received Court approval to sell and transfer 
approximately 318 active retail securities accounts, which is 
substantially all of the securities accounts at MF Global Inc. Nearly 
all securities customers have received 60 percent or more of their 
account value and already 194 of former MF Global Inc. securities 
customers have received the entirety of their account balances because 
of a SIPC guarantee.
Conclusion
    My office has made every effort to communicate directly and 
frequently with customers. Our Web site includes updates, court 
filings, and claims information, including a section addressing the 
common questions being asked by customers in calls or other 
communications to my staff. My staff and I are answering customer calls 
and emails and holding meetings with customer groups and counsel. I 
have established special hotlines for customers to call with questions 
about their claims determinations, the treatment of their physical 
property, or tax issues.
    If your constituents have any questions, I encourage them to visit 
MFGlobalTrustee.com, email my staff at [email protected].
    I fully understand the frustration of many former MF Global Inc. 
customers, some of whom you have heard from directly. When a broker-
dealer fails under the unprecedented circumstances surrounding MF 
Global's demise, the liquidation is necessarily complex. My office has 
been working tirelessly with speed and diligence to identify ways to 
return assets to customers to the full extent of our ability under the 
applicable provisions of SIPA, the Bankruptcy Code, and CFTC 
regulations.
    Thank you Chairman Johnson, Ranking Member Shelby, and other 
Members of the Committee for the opportunity to testify before you and 
to submit this testimony for the full record of the hearing.




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                  PREPARED STATEMENT OF LOUIS J. FREEH
                    Trustee, MF Global Holdings Ltd.
                             April 24, 2012
    Chairman Johnson, Ranking Member Shelby, and distinguished Members 
of the Committee, my name is Louis J. Freeh and I am appearing before 
you today in my capacity as the Chapter 11 Trustee of MF Global 
Holdings Ltd. and five of its subsidiaries.
    On October 31, 2011, MF Global Holdings Ltd. and MF Global Finance 
USA Inc., referred to generally as ``Finco'', filed for bankruptcy 
under Chapter 11 of the Bankruptcy Code. Upon the commencement of the 
bankruptcy cases, the debtors operated as debtors-in-possession. 
Shortly thereafter, on November 7, 2011, the Office of the United 
States Trustee formed a creditors' committee representing the unsecured 
creditor constituency of the Chapter 11 debtor entities. Without any 
possibility of rehabilitation, the debtors and the creditors committee 
jointly filed a motion to appoint a Chapter 11 Trustee. That motion was 
approved by the Court, and I was named as the Chapter 11 Trustee. My 
appointment was approved by the Bankruptcy Court effective as of 
November 28, 2011.
    On December 19, 2011, three additional MF Global entities that are 
each indirect subsidiaries of the Chapter 11 parent filed for 
bankruptcy. I was subsequently appointed the Chapter 11 Trustee of 
those entities as well. In addition, on March 2, 2012, MF Global 
Holdings USA Inc., a direct subsidiary of the parent holding company 
debtor, filed for bankruptcy protection. On March 8, 2012, I was also 
appointed Chapter 11 Trustee of that estate. As is evident from this 
brief timeline, we are in the early stages of this bankruptcy 
proceeding, and there is still much information to be learned about the 
facts and circumstances that led to the collapse of MF Global.
    My duties as a Chapter 11 Trustee are set forth in Section 1106 of 
the Bankruptcy Code and include the obligation to investigate the acts, 
conduct, assets, liabilities and financial condition of the debtor, 
among other things. Unlike the SIPA Trustee, who is charged primarily 
with the return to customers of their investment property, the 
responsibility of the Chapter 11 Trustee is to maximize the value of 
the estate for the benefit of its creditors.
    Upon my appointment on November 28, 2011, I began to assemble a 
team of legal advisors and financial consultants with extensive 
experience in bankruptcy matters, as it was widely believed that these 
proceedings were likely to be among the most complex bankruptcy matters 
in recent memory. We immediately began to assess the Debtors' state of 
affairs. Investigations into the collapse of MF Global were already 
being conducted by the CME, the SEC, the CFTC, and the SIPA Trustee, 
and at least two Federal prosecutors' offices.. Customers of MF Global 
Inc., the U.S. broker dealer, had already commenced litigation against 
certain officers and directors of the broker dealer as well as those of 
the parent holding company debtor.
    Even before the commencement of my appointment, the Debtors were 
faced with a number of expansive requests for documents and information 
and my team immediately immersed itself in a process that had already 
been unfolding for several weeks, in an effort to learn what documents 
were in my possession, how records were maintained, and where files 
were kept. All of this was critical to our ability to fulfill our 
obligations as Chapter 11 Trustee.
    These difficulties were exacerbated by the fact that what had once 
been operated as one large MF Global worldwide organization suddenly 
became fragmented, virtually overnight. Separate proceedings were 
commenced for individual MF Global entities, most notably the SIPA 
proceeding here in the U.S. and the U.K. administration (the U.K. 
equivalent of a U.S. bankruptcy proceeding) of the U.K. broker dealer, 
which proceed independently from one another. The MF Global entities 
suddenly found themselves without access to global systems previously 
utilized by the entire group of companies, because certain entity-wide 
systems such as accounting and email systems were owned and controlled 
by individual MF Global companies.
    With these difficulties, the Chapter 11 debtors had been able to 
assemble some materials before my appointment. I needed, however, to 
ascertain what documents, files, information, and materials were the 
property of the Chapter 11 parent, versus property of the SIPA estate, 
the U.K. broker dealer estate, or perhaps jointly owned by a Chapter 11 
debtor and another estate. My advisory team was required to review 
thousands of pages of emails, documents and other files to determine 
(1) what those materials said, (2) whether the materials were 
responsive to any request by any governmental agency or the SIPA 
Trustee, and (3) whether any protectable corporate privilege existed. I 
then needed to implement a process to produce as quickly as we could 
documents requested as part of the investigations, but also in a manner 
that did not unnecessarily result in a broad waiver of any existing 
privilege. To do otherwise at this very early stage potentially could 
have been contrary to my obligations as Chapter 11 Trustee. Ultimately, 
these issues were resolved and the process moved forward expeditiously.
    Although none of the entities for which I serve as Chapter 11 
Trustee are regulated entities, the concerns of customers are 
nonetheless important to me and my advisors. With a backdrop of 
allegations of missing customer funds, the Bankruptcy Judge, the 
Honorable Martin Glenn, directed that my team perform an analysis of 
the approximately $25 million held in a cash collateral account owned 
by Finco to determine whether that cash included misappropriated MF 
Global Inc. customer property. Thereafter, my advisors poured through 
account data and transaction documents covering more than $3.5 billion 
in cash transfers, including transfers from accounts held by MF Global 
Inc. My advisors interviewed and met with employees of MF Global Inc. 
and advisors retained by the SIPA Trustee in order to ensure that an 
appropriate investigation had been conducted in preparing the report. 
Upon completing the analysis, which was shared with the SIPA Trustee, 
we concluded with no disagreement from the opinion of the SIPA Trustee 
that the cash collateral account did not include misappropriated or 
misdirected customer funds.
    There has been a great deal of publicity regarding the shortfall in 
customer property. Without in any way diminishing the importance of the 
SIPA Trustee's obligation to locate and recover customer property, the 
Bankruptcy Code requires me to attempt to recover for the benefit of 
the creditors of the Chapter 11 estates monies that were obtained by 
the parent from third party lenders and investors and routed to the 
U.S. broker dealer or elsewhere. In particular, and by way of example, 
during the month of October, 2011, in excess of $1 billion in cash was 
transferred from MF Global Holdings Ltd. and Finco to MF Global Inc. In 
addition, a substantial portion of the net proceeds from the $650 
million of MF Global bonds sold in 2011 to investors by MF Global 
Holdings Ltd. had been transferred to MF Global Inc. Just as the SIPA 
Trustee is analyzing and investigating the whereabouts of funds and 
property entrusted by customers to the U.S. broker dealer, so too my 
team must investigate the whereabouts of funds loaned to the U.S. 
broker dealer for which the Chapter 11 estates remain liable to 
creditors and investors.
    In furtherance of my duty to investigate the affairs of the Chapter 
11 debtors for which I serve as Trustee, my advisors and I meet 
regularly with our creditors committee as well as with representatives 
of the SIPA Trustee and the representatives of the foreign affiliates. 
These meetings are important for each of the estates to gather and 
share information with one another to facilitate a timely investigation 
of the facts and circumstances leading up to the bankruptcy and to 
determine where the assets of the various estates may be located.
    The representatives of the SIPA Trustee and my advisors often speak 
daily, have engaged in information sharing calls at least weekly, and 
are currently discussing coordinated efforts to assist one another in 
the administration of our respective estates. I have found this 
cooperation to be invaluable, if not essential, to my ability to 
satisfy my fiduciary obligations as a Chapter 11 Trustee. I strongly 
believe that the interests of all of the various estates are best 
served by cooperating and sharing information to uncover precisely what 
led to the collapse of MF Global. No one estate has all of the 
information, but together, the puzzle pieces can be put together.
    To be clear, the trustees and foreign administrators can and likely 
will assert different legal arguments to support their claims to 
property located throughout the world. The bankruptcy court and perhaps 
other courts will make those legal determinations. But the ultimate 
legal disputes that may arise should not serve as a barrier to sharing 
the critical facts to tell the world what led to the collapse. 
Notwithstanding that we are operating under the supervision of the 
court, however, it is clear even at this early stage that the 
competing, and perhaps at times conflicting, obligations and duties of 
the two Trustees and various foreign administrators has and will 
continue to have the effect of extending the length of time necessary 
for all of the estates to conduct their investigations; to determine 
the value and location of assets; and ultimately to make distributions 
to customers and/or creditors.
    At the present time, the Chapter 11 debtors employ approximately 15 
nonexecutive individuals, most of whom had been employed by one of the 
debtors prior to the commencement of the bankruptcy cases. They, along 
with the remaining senior executives, continue to provide invaluable 
support in reconciling the debtors' books and records, closing open 
trades at the unregulated entities, the preparation of tax returns, and 
assisting in understanding the many complex prepetition transactions 
between and among the various MF Global entities.
    In conversations about retaining these individuals and the 
knowledge they possess, I've discussed at various times the possibility 
of establishing a retention program. To be clear, no formal program was 
ever created for senior executives, nor was any motion ever filed with 
the court for approval in connection with any retention program for 
senior executives.
    As we continue our investigation, we will be filing a report with 
the Bankruptcy Court on or before June 4, 2012. Mindful of this 
impending deadline, we have filed with the Bankruptcy Court a motion 
seeking authority to issue subpoenas for the production of documents 
and examination of witnesses on a shortened timetable. That motion will 
be heard on April 25, 2012. We remain hopeful that parties will be 
cooperative during this investigation, but a formal process will be 
utilized as necessary.
    It is important to note that the transparency of the bankruptcy 
process mandates that the work performed by the Chapter 11 Trustee is 
closely monitored by the Office of the United States Trustee and 
supervised by the United States Bankruptcy Court.
    I fully intend to fulfill my legal obligations as Chapter 11 
Trustee as timely and transparently as I can responsibly do so, 
recognizing that all of my, and my professionals, actions must be 
consistent with the duties and obligations set forth in the Bankruptcy 
Code.
                                 ______
                                 
                 PREPARED STATEMENT OF JILL E. SOMMERS
           Commissioner, Commodity Futures Trading Commission
                             April 24, 2012
    Good morning Chairman Johnson, Ranking Member Shelby, and Members 
of the Committee. Thank you for inviting me today to discuss the 
collapse of MF Global, lessons learned, and policy implications. Over 
the past 5\1/2\ months the Commodity Futures Trading Commission has 
conducted a thorough analysis of the books and records of MF Global and 
continues to work closely with the Trustee in the SIPA bankruptcy 
proceeding to recover customer funds. We are also engaging in a 
comprehensive and ongoing enforcement investigation. It is imperative 
that the Commission, the industry, and the Congress identify and assess 
the causes for the collapse and shortfall in customer funds and to take 
corrective action where possible. Chairman Gensler has directed 
Commission staff to develop recommendations for enhancing Commission 
and designated self-regulatory organization (DSRO) programs related to 
the protection of customer funds, which could include changes to 
Commission rules governing futures commission merchants (FCMs), 
enhanced Commission oversight of DSROs, and possible statutory changes, 
among other things. We must do everything in our power to restore 
confidence in the futures markets so that producers, processors and 
other end users of commodities can once again hedge their price risks 
without fear of their funds being frozen or lost.
    On November 9, 2011, the Commission voted to make me the Senior 
Commissioner with respect to MF Global Matters. This authorizes me to 
exercise the executive and administrative functions of the Commission 
solely with respect to the pending enforcement investigation, the 
bankruptcy proceedings, and other actions to locate or recover customer 
funds or determine the reasons for shortfalls in the customer accounts. 
While Mr. Giddens and Mr. Freeh are here to discuss the bankruptcy 
proceedings, I would like to provide some background on why the claims 
of MF Global's commodity customers are in a Securities Investment 
Protection Act proceeding.
SIPA Proceedings
    Under the Securities Investors Protection Act of 1970 (SIPA), the 
Securities and Exchange Commission (SEC) has the authority to refer an 
entity registered as a broker-dealer (BD) to the Securities Investors 
Protection Corporation (SIPC) if there is reason to believe that the BD 
is in or is approaching financial difficulty. SIPC may initiate a 
liquidation proceeding to protect customers of an insolvent BD when 
certain statutory criteria are met. When a BD is also a registered FCM, 
as MF Global was, there is one dually registered entity and the entire 
entity gets placed into liquidation. Because there is one entity, it is 
not possible to initiate a SIPA liquidation for the BD and a separate 
bankruptcy proceeding for the FCM. It is important to note, however, 
that when a dually registered BD-FCM is placed into a SIPA liquidation 
proceeding, the relevant provisions and protections of the Bankruptcy 
Code, the Commodity Exchange Act (CEA or Act) and the Commission's 
regulations apply to the claims of commodity customers just as they 
would if the entity were solely an FCM and in a non-SIPA bankruptcy 
Proceeding.
Current Protections for Customer Funds
    Section 4d of the CEA and Commission regulations require an FCM 
holding customer funds to treat such funds as belonging to the customer 
at all times and to segregate from its own funds any money, securities 
or property deposited by its customers to margin, guarantee, or secure 
futures or options positions entered into on Commission designated 
contract markets (Section 4d funds). FCMs are prohibited from using a 
customer's funds to margin or guarantee the trades or contracts of 
another customer, or of the FCM. The FCM may, however, commingle the 
funds of one futures customer with funds belonging to other futures 
customers in a single account or accounts. The FCM is required to 
maintain sufficient funds in segregated accounts to cover the net 
liquidating equity (i.e., total account balances due) of each of its 
customers at any given point in time.
    The Act and regulations also require an FCM to hold in separate 
accounts (designated as ``Part 30 secured accounts'') customer funds 
deposited for trading futures and options listed on foreign boards of 
trade. The FCM may commingle the foreign futures funds deposited by one 
customer with the funds deposited by other foreign futures customers. 
An FCM may not, however, commingle Section 4d funds with Part 30 
secured account funds. Under Part 30, an FCM must hold funds sufficient 
to meet the margin required on open futures and option positions, plus 
any unrealized gains, or minus any unrealized losses, on the open 
positions. The FCM is not required to hold in Part 30 secured accounts 
funds sufficient to cover the net liquidating equity of each foreign 
futures customer as it must for Section 4d accounts.
    When a customer opens a trading account with an FCM, Commission 
regulations require the FCM to provide the customer with a risk 
disclosure statement that generally centers on market risk, market 
volatility, and leverage. Disclosures concerning how customer funds can 
be invested by an FCM are not currently mandated, but Commission 
Regulation 1.25 lists permitted investments and establishes a general 
prudential standard that requires that any investment of customer funds 
be ``consistent with the objectives of preserving principal and 
maintaining liquidity.'' Section 4d and Commission Regulation 1.25 
require that the value of customer segregated accounts remain intact at 
all times.
    Commission Regulation 1.20 requires that accounts holding 
segregated funds be titled specifically to identify the contents of the 
account as separate from the ownership of the FCM. In addition, FCMs 
must obtain letters from their depositories acknowledging that the 
depositories cannot exercise any right of offset to such accounts for 
obligations of the FCM. Regulation 1.20 depositories cannot hold, 
dispose of, or use customer funds for anyone other than the customer 
who deposited such funds.
    Commission Regulation 1.12 requires FCMS to notify the Commission 
immediately of any deficiency in segregated and secured customer 
accounts. FCMs must also notify the Commission of instances of 
significant margin calls (such as a margin call to a customer, which if 
not satisfied, would put fellow customers at risk if an adequate buffer 
or ``excess segregation'' was not in segregated accounts).
    Customers are required to post margin to support their futures and 
option positions. Generally, a customer deposits more than the minimum 
initial margin required for the positions established. The additional 
funds provide a buffer so a customer can place trades without positing 
additional margin and lessen the likelihood of repeated margin calls or 
having positions liquidated if margin calls are not met on a timely 
basis. In addition to customers depositing additional margin, in 
practice, FCMs typically maintain significant amounts of their own 
capital as ``excess segregated funds.'' By doing this, one customer's 
deficit due to market moves or unmet margin calls is covered by the 
FCM's buffer and does not result in one customer's funds being exposed 
to the credit risk of another customer. FCMs are not obligated to 
provide excess segregated funds, but given the legal obligation to have 
sufficient funds in segregated accounts at all times to cover all 
liabilities to customers, FCMs generally find it wise to have a buffer.
    A customer may withdraw excess margin funds or use such funds as 
the customer deems appropriate. This would include using the funds for 
nonfutures related transactions with the FCM. If the excess funds held 
by the FCM are used in a manner directed by the customer such that the 
funds are not maintained in a segregated or secured account, the funds 
would not have the protections afforded customer funds under the 
Bankruptcy Code and Part 190 of the Commission's regulations.
    FCMs are also free to withdraw excess funds in Section 4d accounts 
deposited by and belonging to the FCM. At no time, however, may an FCM 
withdraw funds belonging to customers from a Section 4d account, use 
those funds for its own purposes, and replace them at a later date.
Oversight of FCMs
    FCMs are subject to CFTC-approved minimum financial and reporting 
requirements that are enforced in the first instance by a DSRO, for 
example, the Chicago Mercantile Exchange (CME), or the National Futures 
Association (NFA). DSROs also conduct periodic compliance examinations 
on a risk-based cycle every 9 to 15 months. The requirements of DSRO 
examinations are contained in Financial and Segregation Interpretations 
4-1 and 4-2, which are specified as application guidance to Core 
Principle 11 (Financial Integrity) for designated contract markets. The 
Commission has proposed codifying the essential components of these 
interpretations into an amended Commission Regulation 1.52.
    An examination of segregation compliance is mandatory in each 
examination (certain other components need not be included in every 
examination). This examination includes a review of the depository 
acknowledgement letters and the account titles of segregated accounts 
(unless unchanged from the prior examination), verifying account 
balances, and ensuring that investment of customers funds is done in 
accordance with Commission Regulation 1.25.
    Commission Regulation 1.10 requires FCMs to file monthly unaudited 
financial reports with the Commission and the DSRO. These reports 
include the FCM's segregation, secured and net capital schedules, and 
any ``further material information as may be necessary to make the 
required statements and schedules not misleading.'' Each financial 
report must be filed with an oath or attestation, and for a 
corporation, the oath must be by the Chief Executive Officer or the 
Chief Financial Officer.
    Commission Regulation 1.16 requires FCMs to file annual certified 
financial reports with the Commission and the DSRO. The audits require, 
among other things, that if a new auditor is hired, the new auditor is 
required to notify the Commission of certain disagreements with 
statements made in reports prepared by prior auditors. Auditors also 
must test internal controls to identify, and report to the Commission, 
any ``material inadequacy'' that could reasonably be expected to: 
inhibit a registrant from completing transactions or promptly 
discharging responsibilities to customers or other creditors; result in 
material financial loss; result in material misstatement of financial 
statements or schedules; or result in violation of the Commission's 
segregation, secured amount, record keeping or financial reporting 
requirements.
Coordination Among Regulators for Dually Registered BD-FCMs
    The Act and Commission regulations establish a regulatory structure 
where frontline financial regulation is performed by the DSROs. As 
mentioned, the CME and the NFA are the two primary futures market 
DSROs. Generally speaking, the CME has primary financial surveillance 
responsibilities over FCMs that are clearing members of the CME, and 
NFA has primary financial surveillance responsibilities over other 
FCMS, including nonclearing FCMs and retail foreign exchange dealers.
    Many FCMs are also registered with the SEC as BDs. These dually 
registered BD-FCMs are subject to the jurisdiction of both the CFTC and 
the SEC. The CFTC focuses primarily on the futures activities of dual-
registrants, while the SEC focuses primarily on their securities 
activities.
    To better ensure that all activities of a BD-FCM are properly 
reviewed, futures and securities regulators, including self-regulatory 
organizations (SROs), coordinate their oversight efforts. This 
coordination includes periodic meetings of the Inter-Market Financial 
Surveillance Group (IFSG), which is comprised of the CFTC, the SEC, and 
futures and securities markets SROs. The IFSG generally meets two to 
three times each year to discuss emerging regulatory issues, including 
rule amendments that impact financial or operational requirements for 
FCMs and BDs, and changes to business operations. The IFSG meetings 
also provide a platform for securities and futures regulators to 
discuss upcoming examination priorities.
    Futures and securities SROs also share information regarding dual-
registrants as part of the examination program. For example, prior to 
conducting an examination of a dually registered BD-FCM, the futures 
market DSRO will contact the securities market SRO for the purpose of 
obtaining an understanding of any issues or concerns that the 
securities SRO may have with the firm, either as a result of a current 
event or as part of the securities SRO's previous examination. The 
information obtained by the futures market DSRO would be used in 
setting the scope of its examination of the FCM. The futures and 
securities SROs also share their examination reports of dually 
registered entities.
    MF Global was a dually registered BD-FCM, and therefore was subject 
to the jurisdiction of both the CFTC and the SEC. The CME was the DSRO 
for MF Global's futures market activities, and had primary 
responsibility for overseeing the FCM's compliance with the capital, 
segregation and financial reporting obligations required by the CFTC. 
The Chicago Board Options Exchange (CBOE) and the Financial Industry 
Regulatory Authority (FINRA) were the SROs for MF Global's securities 
market activities, and had primary responsibility for overseeing the 
BD's compliance with securities regulations.
    Prior to the bankruptcy, the futures and securities regulators 
shared information and examination results as described above. In 
August 2011, MF Global filed revised financial statements and 
regulatory notices with the CFTC as a result of additional capital 
charges that FINRA and the SEC required the BD to take on certain repo 
to maturity transactions on foreign sovereign debt, which was activity 
overseen by the SEC and FINRA. At approximately the same time, SEC 
staff contacted CFTC staff to inform them of the capital charges. CFTC 
staff also consulted with the CME, FINRA, and the CBOE regarding the 
imposition and rationale for the additional securities capital charges. 
The additional capital charges caused MF Global to fall below CFTC 
minimum capital requirements, which the firm immediately addressed by 
contributing additional capital to the FCM.
    Commission staff also consulted with FINRA and the CME during the 
period of October 24 through October 31, 2011. During these calls 
futures regulators and securities regulators provided information on 
the status of MF Global from their regulatory perspectives. These 
discussions focused on various issues, including the impact of the 
credit rating downgrades and reported losses of $186 million for the 
quarter ending September 30, 2011. The purpose of these discussions 
included sharing information regarding the firm's financial condition 
and potential liquidity issues and sources of funding, and the fact 
that the reported earnings and credit rating downgrade did not appear 
to cause a significant number of futures customers to seek to transfer 
their accounts during the early part of the week of October 24, 2011. 
Commission staff also participated on calls with the Joint Audit 
Committee, a committee comprised of futures exchanges and clearing 
organizations, commencing on October 27, 2011. The exchanges informed 
Commission staff that MF Global was meeting all of its financial 
obligations to the respective clearing organizations and that the 
futures markets had not imposed additional margin or capital 
requirements on MF Global. The exchanges indicated that some customers 
were now transferring their accounts out of MF Global.
    Commission staff also consulted with the SEC and FINRA in the hours 
leading up to the bankruptcy filing on October 31, 2011, when, as it 
acknowledged, MF Global was in violation of Section 4d of the Act and 
Commission regulations for failing to maintain sufficient funds in 
segregation to cover the account equities of each customer.
Strengthening Protections for Segregated Customer Assets
    In the aftermath of MF Global, Commission staff is reviewing the 
customer funds protection provisions of the CEA and Commission 
regulations to identify possible improvements to the protection of 
customer funds. As part of this process, staff held a 2-day public 
roundtable on February 29 and March 1, 2012, to solicit input on 
potential areas of regulatory reform and to identify possible 
enhancements to FCM internal controls surrounding the handling of 
customer funds. Panelists at the roundtable represented a broad and 
diverse cross-section of the futures industry, including academics, 
consumer groups, agricultural and energy interests, managed funds and 
pension plans, FCMs, derivatives clearing organizations, securities 
regulators, futures and securities SROs, and industry trade 
associations.
    The roundtable provided a forum for Commission staff to obtain 
information and views on a range of issues. Day one of the roundtable 
focused on the advisability and practicality of implementing the legal 
segregation with operational commingling model as the segregation model 
for collateral posted by futures customers (the Commission has already 
approved this model for swaps); alternative models for the custody of 
customer collateral; FCM controls over the disbursement of customer 
funds deposited for trading on U.S. futures markets; increasing 
transparency surrounding an FCM's holding and investment of customer 
funds; and lessons learned from commodity brokerage bankruptcy 
proceedings. Day two of the roundtable focused primarily on the 
protection of customer funds deposited with FCMs for trading on foreign 
futures markets; particular issues associated with dually registered 
BD-FCMs; and enhancing the self-regulatory structure.
    Commission staff has also held discussions on enhancing customer 
protections with representatives of the Futures Industry Association 
(FIA) and the two primary futures market DSROs, the NFA and the CME. 
Staff is taking into consideration the recommendations that FIA issued 
in its document titled, ``Initial Recommendations for Customer Funds 
Protection,'' and in its publication of frequently asked questions 
regarding the protection of customer funds. The CME and the NFA have 
also implemented certain improvements in their capacity as DSROs and 
are considering others.
    While Commission staff has not yet proposed amendments to 
Commission regulations, it is expected that staff will make 
recommendations in several areas, including rules requiring FCMs to 
establish certain internal controls and other requirements related to 
their handling of customer funds, rules requiring greater transparency 
and reporting regarding the investment and holding of customer funds, 
and amending the requirements governing Part 30 secured accounts.
Regulatory Coordination for Complex Global Financial Institutions
    Many FCMs intermediate futures transactions for customers trading 
on both U.S. and foreign markets, and also provide services as 
securities BDs. The Commission and futures SROs have historically 
focused their resources and oversight efforts on such FCMs' futures 
activities, including the firms' compliance with minimum capital 
requirements and the requirements to segregate customer funds for 
trading on U.S. and non-U.S. futures markets.
    The recent bankruptcies of Refco, Lehman Brothers, and MF Global 
highlight the challenges presented by large FCMs that operate with 
affiliated entities in multiple jurisdictions. Many of these entities 
have lines of business that are subject to multiple U.S. and non-U.S. 
regulatory authorities, which requires coordination among regulators to 
ensure effective and complete financial oversight.
    Staff currently is reviewing and revising its oversight programs to 
better address the risks presented by large, complex financial 
institutions. Staff plans to focus greater attention on assessing such 
entities' liquidity and operational risks. Staff also plans to increase 
its review of such firms' internal controls over the handling of 
customer funds. Staff is also reviewing Commission regulations to 
assess whether to require firms to provide notice of, or seek approval 
for, new lines of business or operations prior to implementation. 
Furthermore, any efforts by regulators to effectively oversee the 
unwinding of a dually regulated BD-FCM require significant coordination 
between futures regulators and securities regulators, including SROs. 
It is imperative that regulators coordinate their efforts and take 
steps to ensure that the actions taken by one regulator do not 
materially impact the ability of other regulators to effectively wind 
down the business of a firm and minimize the impact on the regulated 
financial markets.
SIPC Insurance
    SIPC insurance provides financial assistance to securities 
customers in the event that a failed BD owes customers cash or 
securities that are missing from customer accounts. SIPC coverage is 
limited to $500,000 per customer, including up to $250,000 for cash.
    The use of an insurance-type fund comparable to SIPC coverage has 
been debated in the futures industry for many years. Issues that have 
been identified include the significant costs of establishing and 
maintaining such a fund for commodity customers. Unlike the securities 
markets, which have a significant amount of retail participation, 
futures customers are predominantly institutional in nature. Such 
institutional customers often have substantial account balances with 
FCMs that would require significant insurance pay-outs in the event of 
an FCM failure. Commission staff is considering the feasibility of 
establishing insurance-type protection, however, or other comparable 
protections, for futures customers as it conducts a broader assessment 
of the enhancement of protections afforded customer funds.
Ongoing Investigations
    Commission staff has cooperated with, and shared information with, 
the SIPA Trustee since MF Global filed for bankruptcy. One of the areas 
where Commission staff has shared information with the Trustee is the 
analysis of the movement of customer funds out of segregated accounts 
during the period prior to the bankruptcy filing to identify potential 
improper withdrawals or distributions. Staff continues to provide 
assistance to the Trustee in his efforts to recover customer funds, 
including funds held for customers trading on foreign markets.
    The Commission's Division of Enforcement is also actively engaged 
in the investigation concerning the shortfall of customer funds. Staff 
is speaking with witnesses and reviewing documents and other 
information. They are proceeding as expeditiously as they can. As the 
Committee will understand, I cannot disclose any specific details of 
the investigation because they are nonpublic, and because I do not want 
to prejudice any potential enforcement action. In general, however, 
depending on the specific facts and circumstances, a shortfall in 
customer segregated funds could amount to a violation of the CEA and 
Commission regulations including those that: (1) govern segregated 
funds; (2) prevent theft of customer money; (3) require our registrants 
to properly supervise accounts; (4) prevent making false statements; 
and (5) prohibit deceptive schemes. Depending on the specific facts and 
circumstances, the Commission could file an enforcement action against 
corporate entities and/or individuals who have violated the CEA or 
regulations. In addition, depending on the specific facts and 
circumstances, individuals could also be liable if they are ``control 
persons'' of a company that violated the law. A ``control person'' 
generally refers to management. Depending on the specific facts and 
circumstances, an enforcement action could be filed against individuals 
who ``aid and abet'' violations by companies. Finally, Commission 
regulations impose obligations on accountants who audit FCMs and on the 
banks that hold customer segregated funds for FCMs. My mention of these 
particular provisions does not in any way limit the Division's 
investigation or the relief we can seek, nor does it indicate that the 
Division has reached any conclusions.
    Generally, the Commission has the authority to, among other things, 
seek and impose civil monetary penalties, require a defendant to 
disgorge ill-gotten gains, obtain restitution for customers and obtain 
other injunctive relief. In terms of civil monetary penalties, the 
Commission can seek the greater of three times the defendant's gain, or 
a set amount, which is currently $140,000 per violation. Civil monetary 
penalties are paid to the U.S. Treasury, while restitution is paid to 
victims who suffered losses.
    The Commission is a civil enforcement agency, so we cannot seek 
imprisonment as a sanction in an enforcement action. However, a willful 
violation of the CEA, or our regulations, is a Federal crime, which can 
be prosecuted by a United States Attorney. We do not have any say in 
whether or not the criminal authorities prosecute, and I understand 
that they have a higher burden of proof than we have.
Conclusion
    I understand the severe hardship that MF Global's bankruptcy has 
caused for thousands of customers who have not yet been made whole. 
These customers may have correctly understood the risks associated with 
trading futures and options, but never anticipated that their 
segregated accounts were at risk of suffering losses not associated 
with trading. The shortfall in customer funds was a shock to the 
markets from which we have not yet recovered.
    I believe the Commission can make improvements to our regulatory 
oversight of FCMs and DSROs to help restore confidence in the futures 
markets, and I will work with the Commission and Congress to implement 
the rules necessary to enhance our ability to protect market users and 
to foster open, competitive, and financially sound markets.
                                 ______
                                 
                   PREPARED STATEMENT OF ROBERT COOK
  Director, Division of Trading and Markets, Securities and Exchange 
                               Commission
                             April 24, 2012
    Chairman Johnson, Ranking Member Shelby, Members of the Committee, 
my name is Robert Cook, and I am the Director of the Division of 
Trading and Markets at the Securities and Exchange Commission (SEC). 
Thank you for the opportunity to testify on behalf of the SEC 
concerning the collapse of MF Global.
    The bankruptcy of MF Global has resulted in serious hardship for 
many of its customers, who have experienced significant delays and 
uncertainty with respect to their ability to access their own assets. 
More broadly, the firm's collapse and the apparent shortfall in 
customer assets highlight the need for financial firms and regulators 
to remain vigilant in ensuring that customer assets are appropriately 
protected and made readily available to customers whenever they may be 
needed.
    To that end, the SEC and its staff are working with the trustee, 
our fellow financial regulators, and other authorities to facilitate 
the orderly liquidation of MF Global and the return of MF Global 
customer assets. While the examination and review of the causes and 
implications of the collapse of MF Global are ongoing, my testimony 
provides an overview of the regulation of MF Global's SEC-registered 
broker-dealer subsidiary prior to the bankruptcy, the key events 
leading up to the bankruptcy, the status of approximately 318 
securities accounts in the liquidation proceedings, and the securities 
customer protection regime. My testimony also describes some 
implications of MF Global's bankruptcy for market oversight, as well as 
a summary of recent efforts by the SEC to promote sharing of 
information among regulators, a proposal by the SEC to further 
strengthen the rules that affect the protection of customer assets, and 
self-regulatory organization (SRO) initiatives to enhance the financial 
responsibility regime for broker-dealers.
Regulation of MF Global Prior to Its Bankruptcy
    MF Global Holdings Ltd. (together with its subsidiaries, ``MF 
Global'') was a publicly traded holding company that conducted 
financial activities through a number of subsidiaries located in 
various countries. MF Global Inc. (MFGI), an indirect subsidiary of the 
holding company, was dually registered with the Commodity Futures 
Trading Commission (CFTC) as a futures commission merchant (FCM) and 
with the SEC as a broker-dealer. As of October 31, 2011, MFGI had 
approximately 36,000 futures customers \1\ and approximately 318 
custodial accounts for nonaffiliated securities customers. \2\ MFGI 
also was authorized by the Federal Reserve Bank of New York to act as a 
primary dealer in the U.S. Treasury markets. Another affiliate, MF 
Global U.K. Limited, was regulated by the U.K. Financial Services 
Authority (FSA). There was no consolidated supervisor of MF Global at 
the holding company level.
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     \1\ See, ``Expedited Motion to Approve Further Transactions and 
Distributions for MF Global Inc. United States Commodity Futures 
Customers'' (Nov. 29, 2011).
     \2\ In his motion seeking authorization to sell and transfer 
substantially all customer securities accounts held by MFGI, the 
trustee identified approximately 330 securities accounts that were 
custodial accounts that had positive net equity on October 31, 2011, 
excluding accounts of affiliates and firm insiders. See, Motion of 
James W. Giddens, Trustee for the Liquidation of MF Global Inc., for an 
Order Authorizing the Sale, Transfer, and Assignment of Certain 
Customer Securities Accounts (Nov. 30, 2011) (Trustee Securities 
Account Transfer Motion). A subsequent status update filed by the 
trustee with the U.S. Bankruptcy Court for the Southern District of New 
York indicated that the court's order applied to the sale and transfer 
of ``approximately 318 active retail securities accounts.'' See, 
Trustee's Preliminary Report on Status of his Investigation and Interim 
Status Report on Claims Process and Account Transfers (Feb. 6, 2012) 
(Trustee Interim Status Report).
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    The ``frontline'' supervisory function for the securities 
activities of broker-dealers is performed by the SROs, including the 
Financial Industry Regulatory Authority (FINRA) and the various 
securities exchanges. When a broker-dealer is a member of multiple 
SROs, one SRO functions as the ``designated examining authority'' (DEA) 
responsible in the first instance for examining the securities 
component of the firm's financial and operational programs, including 
its compliance with the SEC's capital and customer protection 
requirements. In the case of MFGI, the DEA was the Chicago Board 
Options Exchange (CBOE), although FINRA was also closely involved in 
the oversight of MFGI's broker-dealer activities. The futures 
activities of financial firms, including related segregation 
requirements, are overseen by the CFTC and the futures SROs, including 
the National Futures Association and the Chicago Mercantile Exchange.
    The SEC oversees the regulatory functions of securities SROs and 
regularly communicates and coordinates with them on examinations and 
other matters. In its SRO role, CBOE conducted examinations of MFGI for 
compliance with financial responsibility rules. FINRA conducted 
examinations for compliance with other rules, such as sales practice 
requirements. In addition, the SEC's national examination program 
conducts its own risk-based examinations of SEC-registered broker-
dealers. Unlike some other regulators of financial firms, the SEC does 
not have an ``on site'' presence at any broker-dealer and generally 
does not have examination staff dedicated solely to particular broker-
dealers.
Key Events Leading up to the Bankruptcy
    Although the investigation of the causes of MFGI's collapse is 
ongoing, we can highlight our current understanding of several key 
events leading up to its failure. \3\
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     \3\ The events described in this testimony, other than those that 
are a matter of public record, are based on SEC staff's current 
recollection and information, including information from third parties 
that is currently unconfirmed. SEC staff's knowledge of the facts 
surrounding the bankruptcy of MF Global continues to develop, and 
accordingly the description of events herein is subject to change.
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Capital Treatment of Repo-to-Maturity Transactions
    During 2010, MFGI started acquiring significant proprietary 
positions in European sovereign debt, which were financed using an 
instrument called a ``repo-to-maturity'' (RTM). \4\ As of March 31, 
2011, MFGI had accumulated several billion dollars of European 
sovereign debt positions using RTM transactions. \5\
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     \4\ An RTM is a form of a repurchase agreement. A repurchase 
agreement generally involves the sale of securities--here, European 
sovereign bonds--coupled with an agreement to repurchase the securities 
at a later date at a fixed price. In an RTM transaction, the repurchase 
date is the same date as the maturity date for the securities that were 
sold.
     \5\ See, MF Global Inc., Financial and Operational Combined 
Uniform Single (FOCUS) Report: Information Required of All Brokers and 
Dealers Pursuant to Rule 17a-5, Part III (Form X-17A-5 Part III) (Mar. 
31, 2011), Statement of Financial Condition, Note 4.
---------------------------------------------------------------------------
    In the summer of 2011, based on an analysis of MFGI's financial 
statements, FINRA and CBOE staffs questioned MFGI about whether the 
firm was properly recognizing its RTM positions for purposes of its 
regulatory net capital computations. The SEC's net capital rules (which 
are similar to those of the CFTC in important respects) require broker-
dealers, including MFGI, to maintain certain minimum amounts of liquid 
capital based on their business activities. After consulting with SEC 
staff, SRO staff informed MFGI that under the SEC's rules it must take 
capital charges for the European sovereign positions as if they were on 
the firm's balance sheet, notwithstanding the fact that the bonds had 
been ``sold'' pursuant to the RTM transactions.
    In August 2011, representatives of MFGI contacted SEC staff in 
Washington, DC, to request a meeting to present the firm's view that 
the RTM positions should be subject to lesser capital charges than 
those determined by staff from the SROs and SEC. On August 15, 2011, 
SEC staff met with representatives of MF Global, including its Chief 
Executive Officer, Jon S. Corzine, to discuss this issue. After further 
consultations among the regulators, FINRA staff informed MFGI on or 
around August 24 that the regulators' collective view that a capital 
charge was required for the RTM positions had not changed.
    Following the resolution of that issue, the regulators also 
discussed with MFGI: (1) whether MFGI needed to provide a formal net 
capital deficiency notice under SEC Rule 17a-11, which generally 
requires broker-dealers to provide a ``hindsight notice'' of any 
deficiency in their compliance with the SEC's financial responsibility 
rules; and (2) whether MFGI needed to restate and refile its monthly 
``FOCUS'' report (containing capital and certain other financial 
information) for July 2011, which could result in the net capital 
deficiency becoming public. \6\ Pursuant to Rule 17a-11, once the 
deficiency was identified, the firm was required to file the 
``hindsight notice'' and, on August 25, it did so. After consulting 
with SEC staff, SRO staff also required the firm to file an amended 
FOCUS report for July 2011. On August 31, MFGI amended its FOCUS report 
for July 2011 to reflect the required capital charges, reporting a 
``hindsight'' capital deficiency of approximately $150 million as of 
July 31, 2011. At the holding company level, MF Global disclosed the 
net capital issue regarding the RTM positions at MFGI in an amendment 
to MF Global's public filings on September 1. \7\
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     \6\ FOCUS reports are filed by broker-dealers with their DEA 
pursuant to SEC Rule 17a-5.
     \7\ See, MF Global Holdings Ltd., Amendment No. 1 to the Quarterly 
Report for the Period Ended June 30, 2011 (Form 10Q/A) (Sept. 1, 2011).
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Bankruptcy of MF Global
    During the week of October 17, 2011, press reports noted that 
regulators had directed MF Global to increase capital at MFGI due to 
concerns about MFGI's capital treatment of its RTM positions. On 
Tuesday, October 25, 2011, MF Global announced quarterly earnings, 
reporting a net loss of $192 million for the three months ending 
September 30, 2011. Its stock price declined almost 50 percent that day 
and continued to decline over the week. During this same week, certain 
credit rating agencies downgraded the firm's credit rating or put it on 
negative watch. MF Global informed SEC staff during this week that 
certain counterparties and customers were reducing their exposures to 
MFGI, and MFGI was undertaking significant efforts to reduce the size 
of its balance sheet.
    SEC staff commenced a continuous on-site presence at MFGI's New 
York office beginning on October 27 to monitor the firm's condition, 
and to engage with senior management regarding the steps that were 
being taken by the firm. On Friday, October 28, MF Global management 
reported on developments to Chairman Mary Schapiro and SEC staff, 
including myself. According to the firm, it was in discussions with 
various parties regarding potential strategic transactions, such as the 
sale of the firm, the sale of the RTM positions, and the sale of the 
firm's customer business. We continued to receive updates from our on-
site staff and from calls with firm management on Saturday and Sunday, 
and we continued to consult closely with other regulators, including 
the CFTC, FINRA and the FSA. By Sunday afternoon, MF Global reported 
that the firm was close to concluding a strategic transaction with a 
potential purchaser of the customer business of MFGI, which could 
provide customers with continued access to their accounts. SEC staff 
worked closely with the CFTC and FSA to review and comment on the key 
transaction terms to determine that they provided adequate customer 
protection. However, MF Global subsequently reported in the early 
morning hours of Monday, October 31, that MFGI had identified a 
significant deficiency in its segregated accounts for futures 
customers, and that the acquisition negotiations had terminated.
    At that point, after considering MFGI's financial condition and 
available alternatives, SEC staff determined, in consultation with the 
CFTC, that the safest and most prudent course of action to protect 
customer accounts and assets was to initiate a liquidation proceeding 
under the Securities Investor Protection Act (SIPA). \8\ A referral was 
made to the Securities Investor Protection Corporation (SIPC) early in 
the morning on Monday, October 31. On that same day, the U.S. District 
Court for the Southern District of New York entered an order granting 
the application of SIPC to commence a liquidation of MFGI under SIPA 
and appointing James W. Giddens as trustee for the liquidation. The 
case was then removed to the U.S. Bankruptcy Court for the Southern 
District of New York (Bankruptcy Court). Also on October 31, MF Global 
Holdings Ltd. separately filed a voluntary bankruptcy petition in the 
Bankruptcy Court, and MF Global U.K. Limited entered administration 
proceedings in the United Kingdom.
---------------------------------------------------------------------------
     \8\ SEC-CFTC Statement on MF Global, Oct. 31, 2011, available at 
http://sec.gov/news/press/2011/2011-230.htm.
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MFGI Liquidation and the Impact on Securities Customers
    The preferred method of returning securities customer assets in a 
SIPA liquidation generally is to transfer those assets in bulk to 
another solvent broker-dealer. This approach typically provides 
customers with access to their securities and funds more quickly than 
the claims process. Accordingly, shortly after the initiation of the 
SIPA proceeding, the trustee solicited from other broker-dealers 
interest in taking over MFGI's securities customer accounts. Based on 
the available expressions of interest, on November 30, 2011, the 
trustee filed an expedited motion seeking authorization to sell and 
transfer substantially all securities custody accounts to another 
broker-dealer. This sale and transfer applied to approximately 318 
accounts held for nonaffiliated securities customers of MFGI. The 
transaction was approved by the Bankruptcy Court on December 9, 2011.
    Securities customers are able to trade their securities and use 
their funds upon completion of the transfer of their accounts. 
Moreover, each customer is given the option of maintaining the 
customer's securities account at the receiving broker-dealer or moving 
the account to a different broker-dealer selected by the customer. 
According to the trustee, of all former MFGI securities customers, 
nearly all have received 60 percent or more of their account value, and 
194 have received the entirety of their account balances, after giving 
effect to the protection afforded by SIPC (up to $500,000). \9\ 
Customers who do not ultimately receive 100 percent of their net equity 
through this initial transfer may be able to receive additional funds, 
up to the aggregate amount of their net equity, if the trustee 
determines that there is customer property available for that purpose. 
Although the claims submission deadline was January 31, 2012, for 
former MFGI commodities customers and former MFGI securities customers 
seeking the maximum protection under SIPA, securities customers and all 
general claimants may still submit claims to the trustee through June 
2, 2012.
---------------------------------------------------------------------------
     \9\ See, Trustee Interim Status Report, supra note 2.
---------------------------------------------------------------------------
    Throughout this process, SEC staff has been working closely with 
the trustee and SIPC, seeking to expedite the return of assets to 
customers of MFGI. To that end, SEC staff has been in frequent 
communication with the trustee with respect to the status of the 
transfers and claims made by securities customers.
Securities Customer Protection Regime
    MFGI acted as a ``carrying'' firm for a small number of securities 
customers, meaning that it held their funds and securities. MFGI also 
had additional securities customers for which it executed purchases and 
sales of securities but did not hold funds and securities--rather, such 
securities were held at other custodians that settled transactions 
executed through MFGI on a ``delivery versus payment'' basis.
    As a broker-dealer registered with the SEC, MFGI was subject to the 
SEC's customer protection rule. This rule requires that each broker-
dealer that holds securities or cash for customers take two primary 
steps to safeguard customer property. These steps are designed to 
protect customer property by prohibiting broker-dealers from using 
customer funds and securities to support their proprietary positions or 
expenses. Together with the applicable SEC capital requirements, this 
regime also is meant to make it more likely that, if the broker-dealer 
fails, segregated securities and funds will be readily available to be 
returned to the customers.
    The first step required under the customer protection rule is that 
the broker-dealer must maintain physical possession or control over 
securities that customers have paid for in full. This means that if a 
customer has fully paid for his or her securities, they cannot be used 
by the broker-dealer in its business--for example, they cannot be 
pledged as collateral to finance the firm's own trades or to raise 
funds for the firm to invest. Further, if a customer has a margin loan, 
the customer protection rule strictly limits the amount of securities 
that can be used by the broker-dealer for financing purposes. The goal 
in both cases is to require broker-dealers to hold customer securities 
in a manner that allows those securities to be readily available to 
customers, either on demand or upon the liquidation of the firm.
    The second step required under the customer protection rule is that 
the broker-dealer must maintain a reserve in an account at a bank for 
the benefit of customers in an amount that exceeds the net funds 
attributable to customer positions. These funds cannot be invested in 
any instrument that is not guaranteed, as to principal and interest, by 
the full faith and credit of the U.S. Government. The amount owed to 
customers must be computed pursuant to a prescribed formula, normally 
on a weekly basis. A broker-dealer cannot make a withdrawal from the 
reserve account until the next computation, and then only if the 
computation indicates that there is an excess amount in reserve--
greater than what is required to be maintained under the rule. In 
essence, this requirement complements the protection afforded to 
securities held at a broker-dealer by requiring the firm to maintain a 
reserve of funds or U.S. Government guaranteed securities equal to its 
net cash obligations attributable to customer positions.
    A broker-dealer that complies with the customer protection rule--
isolating customer funds and securities through these steps and 
separating them from the firm's proprietary business--should be in a 
position to return all the securities and funds it owes to customers if 
it falls into financial difficulty. If a broker-dealer cannot return 
all the securities and funds owed to customers, SIPC has the 
responsibility to institute a proceeding under SIPA to liquidate the 
broker-dealer. Under SIPA, all securities customers share pro rata in 
the available securities customer property before any other types of 
creditors of the broker-dealer. If the available securities customer 
property is insufficient to return 100 percent of the amount owed to 
securities customers, SIPC may advance up to $500,000 per customer (of 
which $250,000 can be used to make up a cash shortfall).
Implications for Market Oversight
    While our near term focus has been on working with SIPC and the 
trustee to facilitate the return of securities and funds to customers 
of MFGI, the SEC will continue to strive to identify further 
enhancements to its customer protection regime that may be appropriate.
    The events leading up to the bankruptcy of MF Global and its 
aftermath reinforce the importance of close and ongoing coordination 
and information sharing among regulators and other interested parties. 
In this case, these parties included not only the SEC and CFTC and 
other Federal regulators, but also the SROs, the FSA, SIPC, and, 
following the bankruptcy filing, the trustee.
Protection of Customer Assets
    While our experience with addressing MF Global's failure highlights 
the importance of domestic and international regulatory coordination, 
it also underscores the paramount importance of the rules governing 
protection of customer assets and the controls that are crucial for 
compliance with those rules. In general, the rules governing protection 
of customer funds and securities that apply to registered broker-
dealers, described above, have worked well over time, but we are 
considering whether there are ways that they could be strengthened. In 
particular, in June 2011, the SEC proposed rule changes that are meant 
to clarify and strengthen the rules governing audits of broker-dealers, 
including an auditor's examination of broker-dealer controls relating 
to the custody of customer assets, as well as to enhance the SEC's 
oversight of broker-dealers that hold customer securities and funds. 
Specifically, the proposal would:

    Enhance the current requirement that a broker-dealer 
        undergo an annual audit by a public accounting firm registered 
        with the Public Company Accounting Oversight Board by 
        strengthening the standards that govern the auditor's 
        examination of the broker-dealer's compliance, and internal 
        controls over compliance, with SEC net capital and custody 
        requirements.

    Require that broker-dealers that maintain custody of 
        customer assets file with the SEC a new ``Form Custody'' every 
        quarter. This form would contain more detailed information 
        about how broker-dealers maintain custody of customer assets in 
        order to further facilitate verification by examiners that 
        customer assets are being properly protected.

    SEC staff has evaluated comments received in response to this 
proposal and is working to finalize a recommendation to the Commission.
    More broadly, the staff is evaluating other possible rule changes 
to the financial responsibility requirements, including some previously 
considered by the Commission that could strengthen customer protection. 
For example, one change under consideration would be to limit, for 
purposes of the customer reserve fund required by Rule 15c3-3, the 
amount of cash a broker-dealer could maintain in any one bank, as a 
percentage of capital of the broker-dealer or the bank.
    The SEC also continues to work with the SROs to help strengthen 
broker-dealer financial responsibility requirements. For example, in 
June 2011, the SEC approved a FINRA rule filing to establish 
registration, qualification, examination, and continuing education 
requirements for certain operations--or ``back office''--personnel, 
including those who handle customer assets. This rule should help to 
better ensure that those responsible for operations functions are fully 
versed in all the relevant rules and their obligations, including those 
relating to the segregation and protection of customer assets. In 
addition, in February 2012, the SEC approved a FINRA proposal to 
require each member firm to file certain additional financial or 
operational schedules or reports to supplement existing requirements to 
file FOCUS reports with FINRA pursuant to SEC Rule 17a-5. This rule 
allows FINRA to receive more granular data pertinent to income and 
expense items, and therefore to better identify firms that warrant 
heightened scrutiny and to evaluate industry-wide trends.
    In February of this year, the SIPC Modernization Task Force, which 
was established by SIPC for the purpose of undertaking a comprehensive 
review of its operations and policies and to propose reforms to 
modernize SIPA and SIPC, issued a number of recommendations, including 
proposed statutory changes. SEC staff is evaluating these 
recommendations, several of which are directed to the scope and dollar 
limit of protection for individual customers in SIPC liquidations. 
Although SIPC has not itself yet responded to the recommendations, we 
look forward to discussing them with SIPC as part of our review.
    Finally, with regard to accounting standards, in March 2012, the 
Chairman of the Financial Accounting Standards Board (FASB) added a 
project to the FASB's agenda to reconsider the accounting and 
disclosure requirements for repurchase agreements and similar 
transactions. The FASB Chairman cited the need to revisit the 
accounting requirements to address application issues as a result of 
changes in the marketplace and to ensure that investors obtain useful 
information about these transactions. As part of the project, the FASB 
is expected to reconsider the accounting and disclosures requirements 
related to RTM transactions. There is ongoing communication between SEC 
staff and the FASB regarding their standard-setting efforts.
Regulatory Cooperation
    Given the pace of developments in the financial markets generally 
and, in particular, how quickly the financial condition of a financial 
firm that is in distress can deteriorate, the SEC is engaged in a 
number of efforts--both domestic and international--to share more and 
better data and qualitative assessments of firms and markets, and to do 
so in a timely way. Some of these efforts involve coordination with the 
SROs, in recognition of their importance as ``frontline'' supervisors.
    For example, examination staff in the SEC's Office of Compliance 
Inspections and Examinations (OCIE) recently initiated quarterly 
meetings with FINRA and CBOE and semi-annual meetings with the Chicago 
Stock Exchange (CHX), in each case in respect of the SRO's capacity as 
a DEA. Further, OCIE recently has sought to enhance its inter-regulator 
Summit of Securities Regulators, increasing the frequency with which it 
convenes and expanding the group of regulators such that it now 
includes FINRA, CBOE, CHX, the Municipal Securities Rulemaking Board, 
the North American Securities Administrators Association, the Federal 
Reserve Board, various Federal Reserve Banks, and the CFTC. The first 
meeting of the expanded group will take place this month and will 
provide an opportunity for this diverse gathering of regulators to 
discuss issues and concerns regarding registrants, current regulatory 
developments, and to identify common risks and collaboration 
opportunities. In addition to these recent initiatives, the Commission 
has been a key participant in the Intermarket Surveillance Group (ISG) 
since its formation in the 1980s. The ISG provides a critical venue for 
sharing investigative information and surveillance data among domestic 
and foreign market centers, market regulators, and exchanges, including 
both securities and futures exchanges.
    For many years, the SEC has been engaged in numerous and ongoing 
efforts to increase cooperation and the flow of information relevant to 
market oversight among international regulators, through various means, 
including cooperative arrangements, such as memoranda of understanding 
(MOU), informal and formal bilateral discussions, and participation in 
multilateral organizations. \10\
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     \10\ A list of supervisory MOUs is available at: http://
www.sec.gov/about/offices/oia/oia_cooparrangements.shtml.
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    In the international sphere, the SEC works closely with both 
banking and securities regulators through various venues, including the 
Financial Stability Board, IOSCO, the Council of Securities Regulators 
of the Americas, the Cross-border Crisis Management Working Group, and 
the Senior Supervisors Group. The SEC also has ongoing bilateral 
dialogues with key international regulatory counterparts, including the 
United Kingdom, India, China, Korea, and Turkey. Furthermore, the SEC 
participates alongside the Department of the Treasury and the Federal 
Reserve Board in the Financial Markets Regulatory Dialogue with the 
European Union.
Conclusion
    The SEC and its staff are working with our fellow financial 
regulators and other authorities to facilitate the identification and 
return of customer assets. We also are engaged in ongoing efforts to 
increase the exchange among regulators of information that is relevant 
to oversight of markets and market intermediaries, and are considering 
measures to further strengthen the existing customer protection regime.
    I would be pleased to answer any questions you may have.
                                 ______
                                 
                PREPARED STATEMENT OF RICHARD G. KETCHUM
  Chairman and Chief Executive Officer, Financial Industry Regulatory 
                               Authority
                             April 24, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, I am Richard Ketchum, Chairman and CEO of the Financial 
Industry Regulatory Authority, or FINRA. On behalf of FINRA, I would 
like to thank you for the opportunity to testify today.
    When a firm like MF Global fails, there is always value in 
reviewing the events leading to that failure and examining where rules 
and processes might be improved. I commend the Committee for having 
this hearing to do just that. Clearly the continued impact of MF 
Global's failure on customers who cannot access their funds is of great 
concern, and every possible step should be taken to restore those 
accounts as quickly as possible.
    Like many other financial firms today, MF Global's operations 
included multiple business lines, engaging multiple regulatory schemes 
and crossing national boundaries. We and the other regulators here 
today will explain our roles in overseeing the various parts of the 
firm. We all share the goal of restoring funds to customers. While 
FINRA's role in that process is limited at this stage, we are committed 
to continuing to provide assistance wherever we can.
FINRA
    FINRA is the largest independent regulator for all securities firms 
doing business in the United States, and, through its comprehensive 
regulatory oversight programs, regulates both the firms and 
professionals that sell securities in the United States and the U.S. 
securities markets. FINRA oversees approximately 4,500 brokerage firms, 
163,000 branch offices and 630,000 registered securities 
representatives. FINRA touches virtually every aspect of the securities 
business--from registering industry participants to examining 
securities firms; writing rules and enforcing those rules and the 
Federal securities laws; informing and educating the investing public; 
providing trade reporting and other industry utilities and 
administering the largest dispute resolution forum for investors and 
registered firms.
    In 2011, FINRA brought 1,488 disciplinary actions, collected fines 
totaling more than $63 million and ordered the payment of almost $19 
million in restitution to harmed investors. FINRA expelled 21 firms 
from the securities industry, barred 329 individuals and suspended 475 
from association with FINRA-regulated firms. Last year, FINRA conducted 
approximately 2,400 cycle examinations and nearly 6,800 cause 
examinations.
    One of our regulatory programs that is particularly relevant to 
today's hearing is our financial and operational surveillance. Through 
this program, FINRA reviews FOCUS (Financial and Operational Combined 
Uniform Single) reports that broker-dealers file on a monthly basis as 
required by the Securities and Exchange Commission (SEC). These reports 
detail a firm's financial and operational conditions and allow FINRA to 
closely monitor a firm's net capital position and profitability for 
signs of potential problems.
    FINRA's activities are overseen by the SEC, which approves all 
FINRA rules and has oversight authority over FINRA operations.
Oversight of MF Global
    Like many financial firms today that operate simultaneously in 
multiple channels, MF Global was not solely a broker-dealer, but also a 
futures commission merchant or FCM. As such, multiple Government 
regulators and self-regulatory organizations (SROs), including FINRA, 
had a role in overseeing various parts of the firm's operations.
    With respect to oversight of MF Global's financial and operational 
compliance, which is most relevant to today's hearing, FINRA shared 
oversight responsibilities with the Chicago Board Options Exchange 
(CBOE) and the SEC, especially in terms of the firm's compliance with 
the net capital rule. For broker-dealers that are members of multiple 
SROs, the SEC assigns a Designated Examining Authority, or DEA, to 
examine the firm's financial and operational programs, including the 
firm's compliance with the Commission's net capital and customer 
protection rules. For MF Global, that DEA was the CBOE. As such, CBOE 
conducted the regular examinations of the firm for capital compliance.
    There are two primary SEC rules for which financial examinations 
evaluate compliance, the net capital and customer protection rules. The 
primary purpose of the SEC's net capital rule, 15c3-1, is to protect 
customers and creditors of a registered broker-dealer from monetary 
losses and delays that can occur if that broker-dealer fails. It 
requires firms to maintain sufficient liquid assets to satisfy customer 
and creditor claims. It accomplishes this by requiring brokerage firms 
to maintain net capital in excess of certain minimum amounts. A firm's 
net capital takes into account net worth, reduced by illiquid assets 
and various deductions to account for market and credit risk. This 
amount is measured against the minimum amount of net capital a firm is 
required to maintain, which depends on its size and business. The net 
capital rule is intended to provide an extra buffer of protection, 
beyond rules requiring segregation of customer funds, so that if a firm 
cannot continue business and needs to liquidate, resources will be 
available for them to do so.
    The SEC's customer protection rule, 15c3-3, has two components, 
reserve formula computation and possession or control, and was designed 
to ensure the safety of customers' assets. The objective of the reserve 
formula computation is to protect the customer funds in the event the 
broker-dealer becomes financially insolvent. Possession or control 
requires that the broker-dealer obtain prompt possession or control of 
customers' fully paid for and excess margin securities, ensure that 
customers' assets held by a broker-dealer are properly safeguarded 
against unauthorized use and separate firm and customer related 
business.
    Fewer than 20 FINRA-regulated broker-dealers have a DEA other than 
FINRA, but in those cases, we work closely and cooperatively with the 
DEA when questions or issues arise. Even when we are not the DEA for 
one of our regulated broker-dealers, FINRA monitors and analyzes the 
firm's FOCUS report filings and annual audited financial statements as 
part of our ongoing oversight of the firm. That was the case with MF 
Global.
    While that monitoring focuses on a broad range of issues, it is 
particularly relevant to note that our financial surveillance team 
placed a heightened focus on exposure to European sovereign debt 
beginning in spring 2010. During April and May, our staff began 
surveying firms as to their positions in European sovereign debt as 
part of our ongoing monitoring of regulated firms.
    In response to our outreach on this issue, MF Global indicated in 
late September 2010 that the firm did not have any such positions. We 
later learned that the firm began entering into transactions that 
carried European debt exposure prior to that inquiry. While the firm's 
response was consistent with GAAP accounting rules that repo-to-
maturity (RTM) transactions are treated as a sale for accounting 
purposes, the lack of a complete response delayed us in detecting the 
firm's exposure.
MF Global's Exposure to European Sovereign Debt
    In a routine review of MF Global's audited financial statements 
filed with FINRA on May 31, 2011, our staff raised questions about a 
footnote disclosure regarding the firm's RTM portfolio. RTMs are 
essentially transactions whereby the maturity date of a firm's bond 
position held in its inventory matches the maturity date of the repo. 
During the course of discussions with the firm, FINRA learned that a 
significant portion of that portfolio was collateralized by 
approximately $7.6 billion in European sovereign debt. According to 
U.S. GAAP, RTMs are afforded sale treatment and therefore not 
recognized on the balance sheet. Notwithstanding that accounting 
position, the firm remained subject to market and credit risk 
throughout the life of the repo.
    Beginning in mid-June, FINRA had detailed discussions with the 
firm, in which CBOE also participated, regarding the proper treatment 
of the RTM portfolio and we asserted that not enough capital was 
reserved against the RTM. While the SEC has issued guidance clarifying 
that RTMs collateralized by U.S. Treasury debt do not require capital 
to be reserved, there is no such relief for RTMs collateralized by debt 
of non-U.S. Governments. We researched whether the firm retained 
default risk on the positions, and concluded that it did. Our view was 
that while recording the RTMs as sales was consistent with GAAP, they 
should not be treated as such for purposes of the capital rule given 
the market and credit risk those positions carried. As a result, we 
asserted that capital needed to be reserved against the RTM.
    FINRA and CBOE also had discussions with the SEC about our concerns 
that the firm was not holding capital against its RTM portfolio. The 
SEC agreed with our assertion that the firm should be holding capital 
against the positions. The firm fought this interpretation throughout 
the summer, appealing directly to the SEC, before eventually conceding 
in late August 2011.
    The firm infused additional capital and filed an amended July FOCUS 
report on August 31 to report a $150 million capital deficiency in 
July. The firm also provided notification, pursuant to SEC Rule 17a-11, 
of its capital deficiency to the SEC, CBOE and FINRA as well as to the 
Commodity Futures Trading Commission (CFTC), pursuant to CFTC Rule 
1.12. The net capital deficiency in the amended July FOCUS report was 
reported on the CFTC's Web site. In addition, on September 1, the firm 
amended its Form 10-Q filing with the SEC to identify the change in net 
capital treatment of the RTM portfolio.
    In September, FINRA added MF Global to ``alert reporting,'' a 
heightened monitoring process whereby we require firms to provide 
weekly information on net capital, inventory, profit and loss as well 
as reserve formula computations.
    On October 19, the Intermarket Financial Surveillance Group (IFSG), 
which is comprised of securities and futures regulators and self-
regulatory organizations, had its annual meeting. The IFSG was 
established in 1989 in order to enhance the coordination and monitoring 
efforts of both securities and commodities regulators. Through an 
information sharing agreement, SROs provide each other with financial 
surveillance data and related information on an as-needed basis. In 
addition, SRO representatives meet annually to discuss relevant capital 
and customer protection issues. Exposure to European sovereign debt was 
one of the topics at the October meeting and FINRA raised MF Global's 
positions during the discussions.
    During the week of October 24, as MF Global's equity price declined 
and its credit rating was cut, FINRA increased the level of 
surveillance over the firm. We requested detailed information about the 
firm's balance sheet and liquidity; we received updates about the loss 
of lending counterparties and customers; and we spoke to clearing 
organizations about the margin required to settle trades. At the end of 
that week, FINRA was on site at the firm, with the SEC, as it became 
clear that MF Global was unlikely to continue to be a viable standalone 
business. Our primary goal was to gain an understanding of the 
custodial locations for customer securities and to work closely with 
potential acquirers in hopes of avoiding SIPC liquidation. As has been 
widely reported, the discrepancy discovered in the segregated funds on 
the futures side of the firm ended those discussions.
MF Global Bankruptcy and Liquidation Proceeding
    On October 31, 2011, MF Global Holdings, Ltd. and MF Global, Inc. 
filed for bankruptcy and entered into SIPC liquidation. Since that 
time, FINRA has provided assistance as requested by the SEC and the 
trustee.
    On November 4, 2011, FINRA assisted the trustee in alerting broker-
dealer firms via email that the trustee was accepting proposals for the 
transfer of approximately 450 customer securities accounts of MF Global 
to another member of SIPC.
    We have also assisted the trustee by providing information about 
other broker-dealers to which MF Global securities customer accounts 
may be transferred.
Increased Regulatory Coordination and New Rulemaking Efforts to Better 
        Protect Customers and Their Funds
    Both prior to and since the failure of MF Global, FINRA has worked 
to identify changes that can be made to better protect customers and 
their funds, through both our own rulemaking process, and also in terms 
of our coordination with our regulatory counterparts. I will highlight 
a few of the efforts that FINRA has been involved in over the past 
several months.
    First, FINRA and the Chicago Mercantile Exchange have established 
regular coordination calls so that our respective staffs can share 
information about the approximately 50 firms that are both broker-
dealers and futures commission merchants, and therefore are subject to 
the oversight of both entities. Through these calls, our staffs will 
have regular opportunities to discuss routine oversight issues as well 
as to highlight for one another any concerns or situations that warrant 
heightened monitoring. The goal for these calls is to enhance 
coordination between our organizations and ensure that each is aware of 
issues identified by the other, as early as possible. In addition, 
FINRA is currently in discussions with the CFTC regarding possible 
information sharing arrangements that could further enhance oversight 
of dual broker-dealer/futures commission merchant firms.
    Another example of enhanced coordination among regulators is a 
series of ``supervisory colleges'' that we initiated last fall. Based 
on the model that international regulators have used in overseeing 
large global banking institutions, we hosted an in-depth briefing on 
select nonbank investment firms and invited staff from both domestic 
and international regulators of securities and futures to participate. 
During the event, regulators were able to exchange information and 
engage in a dialogue with the firms' senior executive management--and 
each other--to gain a more comprehensive understanding of each 
institution's business strategy, legal and regulatory structure, 
corporate governance, and risk drivers. We plan to host a second such 
event in June and have expanded the list of regulators and SROs 
included in the event.
    In addition to coordinating with other regulators, FINRA has 
continued its work on two rulemaking efforts that are aimed at 
enhancing financial surveillance and expediting the return of customer 
funds and securities in the event of liquidation.
    In late February, FINRA implemented a new rule that requires FINRA-
regulated firms to file additional financial or operational schedules 
or reports as we deem necessary to supplement the FOCUS report. The 
rule provides FINRA with the framework to request more specific 
information that we determine is necessary or appropriate for the 
protection of investors or in the public interest. Under this rule, the 
SEC has approved the adoption of one such report--the Supplemental 
Statement of Income--which enables FINRA to capture more granular 
detail about a firm's revenue and expenses, including a breakdown of 
commission revenues by product, a breakdown of principal trading gains 
and losses by security type as well as detailed components of fee and 
interest revenues among other things.
    Also pursuant to this rule, last week, the FINRA Board approved a 
proposal to adopt a second supplemental FOCUS report to capture 
information that is not otherwise reported on certain firms' balance 
sheets. If approved by the SEC, all carrying and clearing firms would 
be required to file this information with FINRA on a quarterly basis. 
Captured in this report would be, among other data, gross exposures in 
financing transactions, such as reverse repos, repos, repos to maturity 
and other transactions that are otherwise netted under GAAP. This 
additional information will permit FINRA to more effectively assess on 
an ongoing basis the potential impact that off-balance sheet activities 
may have on such firms' net capital, leverage and liquidity, and their 
ability to fulfill their customer protection obligations.
    FINRA has also proposed a new rule that would expedite the 
liquidation of a firm and most importantly, the transfer of customer 
assets, should a firm need to cease operations. FINRA is currently 
reviewing comments submitted on this proposal and will make adjustments 
as warranted before submitting a final proposal to the SEC for review.
Conclusion
    FINRA will continue to work with our fellow regulators and Congress 
as the liquidation process for MF Global proceeds, and as we implement 
the measures identified to date which could improve oversight of 
similar firms and coordination between regulators. We share your 
commitment to reviewing the events involved in the firm's collapse, 
relevant rules and coordination with other regulators to continue to 
identify potential policy or procedural adjustments that may be 
warranted.
    We realize that it is critical to continually evaluate the customer 
protection regime to ensure that it is designed as well as it can be to 
ensure prompt restoration of customer funds in the event of a firm 
collapse. To that end, we would be glad to participate in a broader 
review, in coordination with the SEC, CFTC, self-regulatory 
organizations and others to provide an overall assessment of where 
current rules and processes may need enhancements.
    Again, I appreciate the opportunity to testify today. I would be 
happy to answer any questions you may have.
                                 ______
                                 
                PREPARED STATEMENT OF TERRENCE A. DUFFY
                   Executive Chairman, CME Group Inc.
                             April 24, 2012
    Chairman Johnson, Senator Shelby, Members of the Committee, thank 
you for the opportunity to testify respecting some lessons learned from 
the collapse of futures commission merchant (FCM) and broker-dealer 
(BD) MF Global, Inc. (MFG) and possible policy responses to protect 
customers. I am Terry Duffy, Executive Chairman of CME Group (CME Group 
or CME), which is the world's largest and most diverse derivatives 
marketplace. CME Group includes four separate exchanges--Chicago 
Mercantile Exchange Inc. the Board of Trade of the City of Chicago, 
Inc., the New York Mercantile Exchange, Inc. and the Commodity 
Exchange, Inc. (together ``CME Group Exchanges''). The CME Group 
Exchanges offer the widest range of benchmark products available across 
all major asset classes, including futures and options based on 
interest rates, equity indexes, foreign exchange, energy, metals, 
agricultural commodities, and alternative investment products. CME also 
includes CME Clearing, a derivatives clearing organization and one of 
the largest central counterparty clearing services in the world; it 
provides clearing and settlement services for exchange-traded 
contracts, as well as for over-the-counter (OTC) derivatives 
transactions through CME Clearing and CME ClearPort'.
    I have previously testified respecting MF Global's misuse of 
segregated customer funds and CME Group's efforts on behalf of 
customers. Today, I will summarize CME Group's and the industry's 
efforts to restore customer confidence, and our suggestions for 
strengthening customer protection and confidence going forward. I will 
also explain why the current system of front line auditing and 
regulation by clearing houses and exchanges should not be abandoned as 
a result of the misconduct of MF Global, and why you can be confident 
in the robust regulation that the SRO system provides.
Introduction
    On October 31, the Securities Investor Protection Corporation 
(SIPC) filed a petition with a Federal District Court in New York to 
place MFG into bankruptcy. Unlike in prior bankruptcies of CME member 
firms, our clearing house was unable to transfer all customer positions 
and property to another firm due to missing customer funds in 
segregated customer accounts under the control of the FCM. Indeed, this 
may be the first time in the industry's history that public customer 
will suffer ultimate losses with respect to their accounts for U.S. 
futures exchange trading. \1\
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     \1\ As recent examples, in both Refco and Lehman, which had large 
FCM operations, while nonfutures customers were significantly impacted 
by the bankruptcy proceedings, the regulated commodity customer 
accounts were transferred to new FCMs without any disruption. We had no 
reason to believe this situation would be any different at MFG until 
the segregation shortfall at MFG was discovered.
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    The shortfall in customer segregated funds occurred only in regard 
to funds under MFG's control. The customers' funds held in segregation 
at the clearing level at CME and other U.S. clearinghouses were intact. 
However, the clearinghouses were not able to avoid market disruptions 
by immediately transferring those customer positions and any related 
collateral because of limitations under the Bankruptcy Code. We believe 
that Congress can help protect customers whose collateral is 
safeguarded at clearing houses by changing the bankruptcy code to 
permit a clearing house that holds full collateral for a failed 
clearing member's customers to immediately transfer customer positions, 
along with the required collateral for those positions, to other 
clearing members.
    The industry is united in its search for solutions that will 
restore confidence in the safety of funds invested in regulated futures 
and derivatives markets. Obviously, changes in the Bankruptcy Code are 
not the only answer, and it is constructive to look at a wide range of 
changes that can be implemented without legislation. In order to 
evaluate the proposals, it is necessary to begin with an understanding 
of the current system for protecting customer property and positions. A 
bit of background information regarding the clearing model in the 
futures industry, including the role and obligations of FCMs and 
derivatives clearing houses is my starting point.
The Futures Commission Merchant
    An FCM is an individual or organization that (i) solicits or 
accepts orders to buy or sell futures contracts or options on futures 
contracts and (ii) accepts money or other assets from customers to 
support such orders. As such, FCMs are agents or intermediaries for 
their customers. Among other things, the Commodity Exchange Act (CEA), 
which is the main statute governing the FCM's legal obligations, 
expressly states that all money and other property of any customer 
received to margin or guarantee a derivative contract cleared though a 
derivatives clearing organization belongs to the customer and may not 
be commingled with the FCM's own trading accounts.
    With respect to ensuring that such customer collateral received by 
the FCM is segregated, the CEA, applicable regulations of the Commodity 
Futures Trading Commission (CFTC) and our clearing house rules require 
that money and other customer property must be separately accounted for 
and may not be commingled with the funds of the FCM or be used to 
margin, secure, or guarantee any trades or contracts of any person 
other than the person for whom the same are held. Additionally, CME 
Clearing has rules on its books directly addressing FCMs' obligations 
in this regard.
    In practice, an FCM maintains a number of customer segregated 
accounts at custodians approved by the CFTC. As a customer establishes 
positions, the FCM transfers collateral from one of its customer 
segregated accounts to a customer segregated account maintained and 
controlled by the clearing house. In many cases, the FCM collects 
margin from its customers in excess of what is required by the clearing 
house to support the customer positions cleared through the clearing 
house; this ``excess margin'' is often held in the customer segregated 
accounts controlled by the FCM. The FCM also typically holds some of 
its own funds in the customer segregated accounts, in order to ensure 
that the accounts never fall below the required segregated amount. All 
assets in the customer segregated accounts are subject to various CFTC 
and clearing house rules, including limitations on permissible 
investment of these funds under CFTC Regulation 1.25. Different rules 
apply to the assets of customers who also trade on foreign exchanges.
Derivatives Clearing Houses
    A clearing house acts as the seller to every buyer and buyer to 
every seller of every cleared contract. For futures contracts, it pays 
winners and collects from losers twice each day so that debt is 
eliminated from the system and systemic risk is minimized. When a firm 
fails to pay its losses, the clearing house must still pay the other 
firms that have profitable positions opposite the failed firm's trades. 
The Guaranty Fund is one of the principal means to make such payments 
possible.
    Each clearing member contributes assets and agrees to pay an 
assessment, based on its risk profile, for the sole purpose of covering 
any loss suffered by the clearing house when it makes good on its 
commitment to honor its contracts despite the default of another 
clearing member. This guaranty is designed to protect against the 
systemic risk that could arise if the default of one clearing member 
were to lead to the failure of other clearing members. It is worth 
noting that the assets in and committed to the Guaranty Fund do not 
belong to CME Group, they belong to the clearing members who have 
contributed them.
    Nearly 65 different U.S. FCMs hold approximately $155 billion in 
U.S. customer collateral and nearly $40 billion in collateral held for 
trading on foreign exchanges--much of which is not placed with 
regulated clearing houses. As of March 2011, the total amount of 
customer funds held by the top 30 FCMs was more than $163 billion. No 
clearing house, however large, could effectively or economically 
guarantee all such funds and all such activity. Some have suggested 
that a Government insurance program similar to the equities markets' 
SIPC be established for futures markets. SIPC is designed to protect 
retail brokerage accounts up to $500,000, so even under SIPC, many 
larger securities accounts are not insured. While there are some 
smaller retail futures customers, many futures customers carry tens of 
millions or even more in their FCM accounts. The futures markets are 
mostly professional markets with very different risk profiles from the 
securities markets. Given the size and scope of the majority of the 
accounts in this business, a Government insurance scheme may be a cost 
prohibitive and/or ineffective solution. Nevertheless, an insurance 
scheme is certainly an idea that should be explored, and CME will work 
closely with regulators and industry participants to find solutions 
that can help prevent a repeat episode of such magnitude and retain, or 
in some cases restore, the confidence of market users.
Industry Proposals To Protect Customers
    On March 12th, a special committee composed of representatives from 
the futures industry's regulatory organizations, including CME, offered 
four recommendations to strengthen current safeguards for customer 
segregated funds held at the firm level. CME Group is already 
implementing these proposals, which will include:

    Requiring all Futures Commission Merchants (FCM) to file 
        daily segregation reports.

    Performing more frequent periodic spot checks to monitor 
        FCM compliance with segregation requirements.

    Requiring a principal of the FCM to approve any 
        disbursement of customer segregated funds not made for the 
        benefit of customers and that exceeds 25 percent of the firm's 
        excess segregated funds.

    Requiring all FCMs to file bimonthly Segregation Investment 
        Detail Reports, reflecting how customer segregated funds are 
        invested and where those funds are held.

    In addition, in order to enhance intra-regulator coordination, we 
have recently established routine communications with FINRA for all of 
our common firms--the firm coordinators/relationship managers will 
reach out to each other to have these communications. We believe this 
will allow the coordinators on both sides to get to know one another 
better and to increase the sharing of information.
    On February 29th, the Futures Industry Association proposed initial 
recommendations for enhancing the protection of customer funds. http://
www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer
_Funds_Protection.pdf The specific recommendations include:

    Establishing a reporting requirement for the daily 
        computation made by each FCM of customer funds on deposit in 
        segregated accounts;

    Requiring FCMs to file twice-monthly reports on the 
        investment of customer funds;

    Requiring FCMs to assure the appropriate separation of 
        duties among individuals working at FCMs who are responsible 
        for compliance with the rules protecting customer funds; 
        Requiring FCMs to document their policies and procedures in 
        several critical areas, including the valuation of securities 
        held in segregated accounts, the selection of banks, custodians 
        and other depositories for customer funds, and the maintenance 
        and withdrawal of ``residual interest,'' which consists of the 
        excess funds deposited by firms in the customer segregated 
        accounts.

    CME has also challenged the industry and the Commission to consider 
whether other solutions will better serve the interests of customers 
and the industry. In addition to the proposed amendment of the 
Bankruptcy Code, CME is working with its clearing members and certain 
customers to find a structure that will protect their collateral 
against fellow customer and fraud risks. We are committed to finding a 
solution that will provide stronger protection for futures and swaps 
customers' segregated funds, from a legal, operational, and cost-
benefit perspective without destroying the industry's business model.
    In addition to these regulatory initiatives, we also recently 
launched the CME Group Family Farmer and Rancher Protection Fund to 
protect family farmers, family ranchers and their cooperatives against 
losses of up to $25,000 per participant in the event of shortfalls in 
segregated funds. Farming and ranching cooperatives also will be 
eligible for up to $100,000 per cooperative.
    These steps, we hope, will help to rebuild the confidence in U.S. 
futures markets that was so badly shaken by the actions and failure of 
MF Global. While we think these initiatives are important to rebuilding 
that confidence, the misconduct of MF Global should not serve as a 
reason to undermine the current system of front line auditing and 
regulation by clearing houses and exchanges.
``Self-Regulation'' Is a Misnomer: Both the CFTC and Clearing Houses 
        Play Key Regulatory Roles
    Some critics suggest that the current regulatory framework is 
somehow to blame for MF Global's misconduct. As further detailed in the 
discussion below, ``self-regulation'' in the context of futures markets 
regulation is a misnomer, because the regulatory structure of the 
modern U.S. futures industry is in fact a comprehensive network of 
regulatory organizations that work together to ensure the effective 
regulation of all industry participants.
    The CEA establishes the Federal statutory framework that regulates 
the trading and clearing of futures and futures options in the United 
States, and following the recent passage of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, its scope has been expanded to 
include the over-the-counter swaps market as well. The CEA is 
administered by the CFTC, which establishes regulations governing the 
conduct and responsibilities of market participants, exchanges and 
clearing houses.
    CME was the designated self-regulatory organization (DSRO) for MFG. 
As MFG's DSRO, CME was responsible for conducting periodic audits of 
MFG's FCM-arm and worked with the other regulatory bodies of which the 
firm is a member. CME conducted audits of MFG pursuant to standards and 
procedures established by the Joint Audit Committee (JAC) \2\ and 
reported such results to the CFTC.
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     \2\ The JAC is a representative committee of U.S. futures 
exchanges and regulatory organizations which participate in a joint 
audit and financial surveillance program that has been approved and is 
overseen by the CFTC. The purpose of the joint program is to coordinate 
among the participants numerous audit and financial surveillance 
procedures over registered futures industry entities.
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    CME conducted audits of MFG, and all firms for which it was the 
DSRO, at least once every 9-15 months. The last audit of MFG was based 
on the firm's records for the close of business on January 31, 2011. 
This regulatory audit began subsequent to this audit date, and the 
audit was completed with a report date of August 4, 2011.
    Some critics have suggested that the failure of MFG demonstrates 
that the current system of front line auditing and regulation by 
clearing houses and exchanges is deficient because of conflicts of 
interest. However, there is no conflict of interest between the CME 
Group's duties as a DRSO and its duties to its shareholders--both 
require that it diligently keep its markets fair and open by vigorously 
regulating all market participants.
    Federal law mandates an organizational structure that eliminates 
conflicts of interest. In addition, we have very compelling incentives 
to ensure that our regulatory programs operate effectively. We have 
established a robust set of safeguards designed to ensure these 
functions operate free from conflicts of interest or inappropriate 
influence. The CFTC conducts its own surveillance of the markets and 
market participants and actively enforces compliance with the CEA and 
Commission regulations. In addition to the CFTC's oversight of the 
markets, exchanges separately establish and enforce rules governing the 
activity of all market participants in their markets. Further, the 
National Futures Association (NFA), the registered futures association 
for the industry, establishes rules and has regulatory authority with 
respect to every firm and individual who conducts futures trading 
business with public customers. The CFTC, in turn, oversees the 
effectiveness of the exchanges, clearing houses and the NFA in 
fulfilling their respective regulatory responsibilities.
    The futures industry is a very highly regulated industry with 
several layers of oversight. The industry's current regulatory 
structure is not that of a single entity governed by its members 
regulating its members, but rather a structure in which exchanges, most 
of which are public companies, regulate the activity of all 
participants in their markets--members as well as nonmembers--
complemented with further oversight by the NFA and CFTC.
CME Group Regulation
    As discussed above, no one has a greater interest than CME Group in 
ensuring that its industry-leading markets are perceived as--and in 
fact are--safe, open and fair. CME Group does so by vigorously 
regulating the users of our markets. There is substantial evidence that 
such private regulation has served the markets and market participants 
very well. We have established a robust set of safeguards designed to 
ensure these functions operate free from conflicts of interest or 
inappropriate influence:

    Our ability to attract and retain business fundamentally 
        depends on our customers' confidence in the integrity of our 
        markets, and exceeding our customers' expectations in that 
        regard is one of the cornerstones of our business model. 
        Ensuring that our markets are defined by effective and 
        appropriately balanced regulation is a competitive advantage 
        that draws institutional, commercial and individual customers 
        to CME Group.

    As a public company, it is only by performing our 
        regulatory functions well that we avoid the severe reputational 
        repercussions and associated impacts to shareholder value that 
        would arise if lax regulation or improper conflicts were to 
        compromise our commitment to fair, transparent and financially 
        sound markets.

    CME Group's own capital is first at risk if a failed 
        clearing firm's capital and collateral posted to CME is 
        insufficient to cover a default at the clearing house, giving 
        us the strongest possible economic incentive to ensure robust 
        oversight of our clearing firms' compliance with our rules and 
        CFTC regulations.

    In addition to strong economic and reputational self-
        interest, CME Group is subject to robust regulatory oversight, 
        as further detailed in the next section, creating powerful 
        regulatory incentives for CME Group to effectively regulate its 
        markets.
The MF Global Bankruptcy
    The MF Global bankruptcy was not a failure of exchange or 
Government-sponsored regulation. Our Audit and other regulatory teams 
performed their responsibilities in regard to MF Global consistent with 
the highest professional standards. One hundred percent of the customer 
segregated collateral posted to CME and held at the clearing level, 
amounting to $2.5 billion, was fully accounted for. The well-publicized 
shortfall in U.S. customer segregated funds came from funds held at the 
FCM level, not funds held at the clearing level.
    MF Global's unlawful transfers of customer segregated funds were a 
very serious violation of the CEA and exchange rules. Unfortunately, no 
regulator, whether an exchange sponsored regulator or otherwise, can 
always detect and stop an individual who is intent on breaking the law. 
Regulators can seek to establish appropriate rules, monitor compliance 
with the rules to deter misconduct and correct infractions, and in 
cases where a rule is broken, deter future misconduct by taking 
vigorous action against persons liable for breaches of the rules.
    Nor were there was no conflict of interest with respect to CME 
Group's regulation of MF Global. Indeed, in 2008 and 2009, CME Group 
fined MF Global $400,000 and $495,000, respectively, for supervision 
failures and other violations of trading practices rules, clearly 
indicating that CME Group's regulators actively monitored and enforced 
compliance with the rules by MF Global, just as we do with every other 
market participant.
    Notwithstanding the fact that MF Global's misconduct was the cause 
of the shortfall in customer segregated funds, CME Group's efforts in 
the wake of these events speak to the level of our commitment to 
ensuring our customers' confidence in our markets:

    We made an unprecedented guarantee of $550 million to the 
        SIPC Trustee in order to accelerate the distribution of funds 
        to customers.

    CME Trust pledged virtually all of its capital--$50 
        million--to cover CME Group customer losses due to MF Global's 
        misuse of customer funds.

    And, as noted above, CME Group recently launched the CME 
        Group Family Farmer and Rancher Protection Fund to protect 
        family farmers, family ranchers and their cooperatives against 
        losses of up to $25,000 per participant in the event of 
        shortfalls in segregated funds. Farming and ranching 
        cooperatives also will be eligible for up to $100,000 per 
        cooperative.

    No other exchange or clearing house has taken such actions.
Government Oversight
    Regulation at CME Group is subject to active Government oversight, 
primarily by the CFTC.

    CME Group's exchanges are registered as designated contract 
        markets (DCMs) with the CFTC, and our clearing house is 
        likewise registered as a derivatives clearing organization 
        (DCO).

    In order to achieve registered status, we are required to 
        fulfill substantial regulatory obligations codified in the 
        CEA's 23 core principles for DCMs and 18 core principles for 
        DCOs. These include core principles requiring that we establish 
        structures and enforce rules to minimize conflicts of interest 
        in our decision making processes and that we have appropriate 
        procedures for resolving potential conflicts.

    The CFTC's Division of Market Oversight actively oversees 
        DCM compliance with core principles and its Division of 
        Clearing and Risk oversees DCO compliance. Exchanges and 
        clearing houses are continually subject to both formal and 
        informal reviews of how effectively we fulfill our regulatory 
        mandates. In the event CME Group's exchanges or clearing house 
        were to fail to comply with the core principles, the company 
        could face significant sanctions, reputational exposure and 
        even compromise the registration status which allows us to 
        operate our markets.

    With respect to regulatory coordination, the CFTC and SEC 
        allow the SROs on the futures side and securities side to 
        coordinate their financial surveillance. We are signors to an 
        agreement under the Intermarket Financial Surveillance Group 
        (IFSG). This agreement allows the ``experts'' to focus on their 
        piece of the puzzle, as well as to share information on common 
        firms where we have concerns. The IFSG also meets once or twice 
        per year to share information on regulatory developments and 
        common firms. As noted above, we have recently established 
        routine communications with FINRA for all of our common firms--
        the firm coordinators/relationship managers will reach out to 
        each other to have these communications. We believe this will 
        allow the coordinators on both sides to get to know one another 
        better and to increase the sharing of information.
Enforcement
    CME Group's effectiveness and assertiveness in regulating its 
markets is also reflected in the results of our surveillance and 
enforcement programs.

    In 2011, CME Group's exchanges opened approximately 700 
        regulatory inquiries, in addition to conducting proactive 
        regular surveillance, and took 138 formal disciplinary actions 
        against market participants.

    Two of those recent actions, resulting in $850,000 in fines 
        and remedial actions, were taken against one of our most active 
        proprietary trading firms for failing to properly supervise and 
        test its deployment of automated trading systems. In another 
        recently resolved matter, 18 brokers and locals in a particular 
        market on the trading floor were fined more than $600,000 and 
        subject to trading suspensions for engaging in noncompetitive 
        trades that disadvantaged other market participants.

    Direct regulation by the exchange offers our regulators unique 
proximity to the markets, market participants and the broader resources 
of the exchange. This fosters the development of expertise that not 
only makes our regulatory staff more effective, but also assists 
Federal regulators in our common objective of preserving the integrity 
of the markets.

    Most of our interaction with Federal agencies occurs with 
        the CFTC, and its Division of Enforcement publishes a report of 
        its activity for each fiscal year. Its most recent full report, 
        for FY2010, noted that it took 57 enforcement actions. \3\ In 
        30 percent of those actions, CME Group either referred the 
        matter to the CFTC or provided assistance to the CFTC.
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     \3\ The CFTC recently released statistics for FY2011, which noted 
the filing of 99 enforcement actions and the opening of more than 450 
investigations, but the full report is not yet available.

    Excluding enforcement actions outside of CME Group's 
        regulatory purview, such as fraud in the FX cash markets, the 
        percentage of CFTC actions in which CME Group referred the 
        matter to the CFTC and/or provided assistance to the CFTC was 
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        68 percent.

    Another example of how exchange-sponsored regulation and 
        Federal regulation work together is a 2011 matter in which CME 
        Group regulators initially acted to bar a party engaged in 
        illegal practices from our markets and then referred the matter 
        to the CFTC and Department of Justice. Both the CFTC and DOJ 
        took enforcement action, and in December 2011, he was convicted 
        in criminal court and sentenced to 44 months in prison and 
        ordered to pay restitution of approximately $369,000 after 
        having pled guilty to wire fraud.

    Last week, the CFTC acknowledged and thanked the NYMEX for 
        its assistance in the recent Optiver market manipulation 
        matter. ``NYMEX's proactive surveillance program detected the 
        subject trading by Optiver in the Crude Oil, New York Harbor 
        Gasoline, and Heating Oil contracts and contributed to the 
        cessation of the activity alleged in the complaint. NYMEX also 
        provided the CFTC with important information from the NYMEX's 
        own investigation of this matter, as well as other 
        assistance.'' \4\
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     \4\ http://www.cftc.gov/PressRoom/PressReleases/pr6239-12

    Exchange-sponsored regulation often allows for more expedient 
identification of potential issues given our knowledge of and proximity 
to the markets, as well as the ability to react more quickly and 
flexibly to potential market and regulatory issues; in certain matters, 
that speed can make all the difference between having the ability to 
freeze or recoup misappropriated money and losing it forever to 
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wrongdoers.

    For example, in a series of three separate recent cases 
        resolved in 2011, the CME Group exchanges were able to quickly 
        identify suspicious activity in our markets involving off-shore 
        parties seeking to misappropriate money from other unwitting 
        market participants. We promptly referred those matters to the 
        CFTC which subsequently filed suit against the parties in 
        Federal court. Our ability to quickly detect this activity and 
        assist the CFTC in its subsequent investigatory efforts 
        resulted in fines and restitution of more than $3.5 million 
        and, by quickly freezing funds, prevented $7.2 million more 
        from being stolen.
Conclusion
    The protection of the interests of customers and restoration of 
public confidence following the failure and unlawful actions by MF 
Global continue to be CME Group's highest priority. We look forward to 
working with Congress and the regulators to enhance customer 
protections and foster confidence in our markets.
