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An Insurance Fund for Futures Customers on the Horizon?

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First it was the massive fraud committed at MF Global, where company trading losses were conveniently covered with client money — $1.6 billion to be exact — that will likely never be repaid. Then it was the Peregrine Financial Group debacle, the Madoff-like scandal that resulted in $200 million shortfall in customer accounts.

On the heels of these investment banking scandals, lawmakers are working to create an insurance fund for futures customers. Michael Dawley, chairman of the Futures Industry Association and managing director at Goldman Sachs’, has put his support behind the idea, claiming the Institute for Financial Markets should examine the plausibility of such a fund. Scott O’Malia, a Commodity Futures Trading Commission commissioner and chairman of the advisory committee has called the recent scandals a complete betrayal of public trust and called for “an immediate and comprehensive overhaul of customer protection safeguards.”

Speaking at a U.S. Senate committee hearing on MF Global and Peregrine’s collapse this month, CME Group President Terrence Duffy said raising money for such a fund might be too costly to the industry to be appealing.

And even if futures brokerages were willing to pitch in, customers might still be dissatisfied by the ultimate payback.

“Ask the folks that were investing with Mr. Madoff when he took $50 billion and SIPC gave them $2.5 billion in return,” he said, referring to infamous Ponzi schemer Bernard Madoff.

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“Ask those that lost money on MF Global or Peregrine if they wish they’d have had insurance.

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Of course they would,” he said in an email.

In essence, the futures insurance fund would protect customers’ money in the event of another MF Global or Peregrine event, acting similar to the Securities Investor Protection Corp, which guarantees securities investments up to $500,000 in the event a brokerage firm collapses. Just yesterday, leaders from the futures industry and futures customers gathered again to discuss the feasibility.

With no sign of the slowdown in banking scandals, it would make sense to create a safety net for customers. But it remains to be seen if all parties will agree to the cost of such an endeavor.

What Risk Managers Can Learn About Preventing Fraud from Tom Brady, John Elway and CHiPs

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There are a lot of events and anecdotes that risk managers can draw lessons from. September 11, Hurricane Katrina,  the financial crisis and the Gulf oil spill are the among the most oft-repeated.

But Pat Huddleston, former enforcement branch chief of the SEC’s enforcement division, has written an excellent article that looks to more unique sources, showing how risk managers can prevent fraud by learning from Super Bowl-winning QB Tom Brady, NFL legend John Elway and an actor best known for his role in the TV show CHiPs.

That may sound strange, but here is one of the insights he unveils, detailing how new research into the human brain can help law enforcement authorities — and risk managers — discover scams before damage is done.

Unlike other industries, the fraud business never slumps, and the SEC has already begun enforcement actions against scams that began after the financial crisis of 2008. Fortunately for smart risk managers, new discoveries in how the human brain works have emerged as the post-Madoff wave of scams has been building. Risk managers can use these discoveries to develop a new approach to due diligence that is grounded in new evidence about how humans think.

In his 2009 book, How We Decide, Jonah Lehrer reveals that — contrary to the age-old wisdom — emotions are essential to effective decision-making. Among Lehrer’s examples is Tom Brady, the quarterback of the New England Patriots. When Brady drops back to pass, he has, at most, four seconds to release the ball; not enough time for all the thinking required. Instead, Brady responds to his emotions, according to Lehrer. When he looks at his first option he gets a negative feeling. The same with the second. When he looks at the third, he gets a flood of positive emotion and releases the ball. Touchdown.

Of course, Tom Brady wasn’t born with a brain that could lead him to MVP awards, Super Bowl rings and a Hall of Fame career. Rather, the emotions his brain sends forth are reliable because they are informed by his training and experience; this includes all of his the film study, each practice since Pop Warner and every pass attempt he has every made. While Brady has a great arm, it’s his brain that makes him so impressive.

Having spent more than 20 years protecting investors, I can tell you that a well-educated and trained human brain is the most effective tool for preventing and detecting investment fraud. The good news is that risk managers can acquire that kind of tool.

And that’s not all. As promised, risk managers can also learn lessons from a fraud carried out CHiPs actor turned con artist Larry Wilcox and another scam scheme that fooled John Elway.

Head over to the website of Risk Management magazine to read the rest.

JPMorgan Chase Reportedly Ignored Its Risk Management Department’s Warnings About Madoff

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Exhibit #8,492,299 why companies should start listening to their risk managers.

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Senior executives at JPMorgan Chase expressed serious doubts about the legitimacy of Bernard L.

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Madoff’s investment business more than 18 months before his Ponzi scheme collapsed but continued to do business with him, according to internal bank documents made public in a lawsuit on Thursday.

On June 15, 2007, an evidently high-level risk management officer for Chase’s investment bank sent a lunchtime e-mail to colleagues to report that another bank executive “just told me that there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a Ponzi scheme.”

Then again, it’s not altogether surprising that a financial firm would bury its head in the sand as long as money was still coming in and the risk ultimately did not fall on its shoulders. I feel like we’ve seen that somewhere else on Wall Street in the past few years.

Despite those suspicions and many more, the bank allowed Mr. Madoff to move billions of dollars of investors’ cash in and out of his Chase bank accounts right until the day of his arrest in December 2008 — although by then, the bank had withdrawn all but $35 million of the $276 million it had invested in Madoff-linked hedge funds, according to the litigation.

The Madoff saga continues to unfold.

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