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Futures Broker Due Diligence Notes post PFG
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Futures Broker Due Diligence Notes post PFG

  #11 (permalink)
Trading Apprentice
Albuquerque, NM, USA
 
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Atlas Ratings

I would also like to know more about the people behind Atlas Ratings. However, given the current fraud issues with FCMs, I will take what I can get in the way of information. Especially true now, since I am looking for a futures broker. Appreciate the link to the Atlas Ratings.

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  #12 (permalink)
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ondafringe View Post
I would also like to know more about the people behind Atlas Ratings. However, given the current fraud issues with FCMs, I will take what I can get in the way of information. Especially true now, since I am looking for a futures broker. Appreciate the link to the Atlas Ratings.

Now with their own thread...

https://futures.io/brokers-data-feeds/21685-atlas-ratings-fcms.html

Mike

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  #13 (permalink)
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Atlas & own research


The quality of the Atlas rating or better, its usefulness to detect fraud, can be questioned, especially as only public info seems to be used (how should they get other info?) and the evaluation and weighting is not transparent. However, I think the structured approach and the criteria mentioned could be a good starting point for ones own research process.

It's like with reading trading books. You don't have to like or believe everything the authors writes, but take the parts which make the most sense to you and integrate these into your own style

I personally don't put much emphasize on the capital figures as these can be manipulated pretty easily.

What I look at is the number of penalties and actions by regulators over a fixed time span (e.g. 5 years or whatever number of years makes you feel comfortable). And if you use the same duration for all brokers you don't have a problem with some 90 year old brokerages. The problem arises only if you look at brokers who are in the industry for fewer years than the time span you want to look at.

The other thing which is relevant for me is whether they do prop trading or not. That would at least exclude the MF Global problem (but not the PFG problem, of course).

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  #14 (permalink)
Fortitudo et Honor
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Couple of ???'s.

Firstly, if cash is not transferred to an SIPC insured account, or if you're not using T-Bills.....what is the risk associated with Futures transactions?

The broker themselves? The exchange?

I'm assuming if you have to operate with a broker (Like Tradestation for example) where it's either not an option or not realisticly feasible to transfer under the umbrella everyday, other considerations become risk management priorities (i.e. capital ratios, whether or not the broker has a prop desk, etc).

For someone trading with a combination broker (who offers all class instruments, like Tradestation) but uses inter-day and overnight futures transactions....can someone paint me the worst case scenario and what we can do to manage against it?

I guess the only REAL safe thing you could do is to stick with supposedly "safe" rated firms, and then spread your assets among a group of them.

"A dumb man never learns. A smart man learns from his own failure and success. But a wise man learns from the failure and success of others."
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  #15 (permalink)
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RM99 View Post
Couple of ???'s.

Firstly, if cash is not transferred to an SIPC insured account, or if you're not using T-Bills.....what is the risk associated with Futures transactions?

The broker themselves? The exchange?

I'm assuming if you have to operate with a broker (Like Tradestation for example) where it's either not an option or not realisticly feasible to transfer under the umbrella everyday, other considerations become risk management priorities (i.e. capital ratios, whether or not the broker has a prop desk, etc).

For someone trading with a combination broker (who offers all class instruments, like Tradestation) but uses inter-day and overnight futures transactions....can someone paint me the worst case scenario and what we can do to manage against it?

I guess the only REAL safe thing you could do is to stick with supposedly "safe" rated firms, and then spread your assets among a group of them.

The risk lies with the FCM that holds your money. Your broker could be as honest as the day is long, but if the FCM steals your money you're still screwed.

The SIPC only covers securities, not futures or forex.

Be careful with the concept of opening multiple accounts to reduce risk. If you had an account with Crossland, who is a smaller Clearing FCM and you decided to reduce risk by opening an account with larger brokers like MF Global and PFG .....

I'm just a simple man trading a simple plan.

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  #16 (permalink)
Fortitudo et Honor
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ThatManFromTexas View Post
The risk lies with the FCM that holds your money. Your broker could be as honest as the day is long, but if the FCM steals your money you're still screwed.

The SIPC only covers securities, not futures or forex.

Be careful with the concept of opening multiple accounts to reduce risk. If you had an account with Crossland, who is a smaller Clearing FCM and you decided to reduce risk by opening an account with larger brokers like MF Global and PFG .....

Assuming the ratings are valid or useful, what I was saying is that maybe it's worthwile to take the top 5% of firms and spread your capital among a few of them in order to make sure that if any one of them fail, you're not 100% screwed.

And as far as the FCM goes, what exactly is the mechanism for risk? Is it that these fraudulent FCM's are leveraging investor money in other ventures?

When I hold a position overnight, isn't the marginal reserve either transferred or at least verified by the exchange that the funds are "reserved?"

I'm not understanding how these firms could continue to allow traders to execute trades.

From what I'm reading, PFG was reporting $220M in assets and only had less than $6M in reality. Wouldn't you think that before it shrunk to that that alarms would start going off because some traders wouldn't be able to execute trades?

"A dumb man never learns. A smart man learns from his own failure and success. But a wise man learns from the failure and success of others."
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  #17 (permalink)
Identify Evaluate Execute
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Update to Article and Main Conclusions

Given additional information and potential risks derived about IB's prop trading operation this information has been included in the opening post:

OTHER RISKS

Note 10-Further investigation into broker proprietary trading revealed some significant risks to trader account equity. Proprietary trading is the brokerage trading in its on right. The additional risk to customer funds occurs through the brokerage using client assets to collateralize its positions. The is perfectly legal and is sanctioned by the fed as follows:

Under the U.S. Federal Reserve Board's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client's liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.

Of the three brokers mentioned above, only Interactive Brokers operates a prop trading desk and a very active one at that. In fact according to recent filings Interactive Brokers re-pledged or re-sold $7.9 billion of $16.7 billion of available client funds. In addition the customer through the IB Fully disclosed clearing agreement authorizes this. These big bets have helped IB make a staggering $850,000 pre-tax profit per employee. Compare this to Apple $400,000 per employee and Goldman Sachs $75,000.

https://www.interactivebrokers.com/Universal/servlet/Registr...sedClearingAgreement.jsp

Note Section D4 from this agreement which is basically a mirror image of MF Global:

4. To the extent allowed by the Laws and Regulations, Interactive and its affiliated
companies ("Affiliates") may engage in stock lending activity and the lending of
Customer collateral, securities or other property including, but not limited to, using
Customer collateral, securities or other property for their own accounts or for the
accounts of other Customers, and lending, either to themselves, to their Affiliates, or to
others, any Customer collateral, securities and other property held by Interactive in
Customers' Fully-Disclosed Accounts. Pursuant to applicable Laws and Regulations,
Interactive or its Affiliates may deposit collateral, securities and/or other Customer
property with third parties and may pledge, re-pledge, hypothecate or re-hypothecate
Customer collateral, securities and/or other Customer property, either separately or
together with other securities and/or other property of other Customers of Interactive
for any amount due to Interactive in any Interactive Fully-Disclosed Account in which
Customer has an interest. Interactive or its Affiliates, may so pledge, re-pledge,
hypothecate or re-hypothecate Customer collateral, securities and/or other property

without retaining in Interactive's or its Affiliate's possession or under its control for
delivery a like amount of similar collateral, securities and/or other property and
Interactive or its Affiliates may return to Customer collateral, securities and/or other
property other than the original, or original type of, collateral, securities and/or
property that Customer deposited with Interactive. Collateral that is registered with a
third party may not be in Customer's name.

Note: To get around the US Federal Reserve Board's Regulation T IB, Goldman Sachs and other investment banks use their UK affiliates to hypothecate assets. Whay are they using UK affiliates? The UK has no minimum formula for hypothecating assets so they are open to leveraging client funds many times over. MF Global did exactly this with the sovereign debt bet being many times the total of client funds.

Conclusions

Based on the information above the following conclusions can be drawn:

1. In the event of broker fraud/theft IB, TD and Tradestation appear to be a safer alternative to Futures only broker's because they are covered by SIPC insurance as opposed to futures brokers that have no coverage.
2. Although IB, TD and Tradestation are covered by the SIPC there may not be sufficient solvency to cover claims as the SIPC only has a net $200 million in assets due to the Madoff fraud (present and future claims) exhausting most of its funds. Furthermore the SIPC may simply deny payouts to futures only traders as SIPC is primarily intended to protect securities traders.
3. IB exposes the trader to additional business risks through its ability to hypothecate client assets to collateralize its positions. This is primarily what happened to MF Global. MF Global used client assets to collateralize its European sovereign debt bet that went wrong. IB has the legal right to do the same but in the event of failure could be more catastrophic as it can pledge equities portfolios as well.
4. The risks of futures only brokers have been clearly exposed with the recent demise of PFG due to officer theft. This exhibited significant control issues with the regulator over monitoring segregated funds. The public perception is the regulator does not have sufficient expertise to protect client accounts from dishonest FCMs.
5. If the regulator is able to exhibit in the future that its ability to monitor and control these segregated funds is flawless then FCMs without prop business could be deemed a relatively safe second alternative to SIPC firms such as TD Ameritrade/Think or Swim or Tradestation (provided equities account in place as well).

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Last edited by djkiwi; July 20th, 2012 at 06:17 PM.
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  #18 (permalink)
Elite Member
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Thanks again for all of that detail ,djkiwi. You've articulated in a way I haven't been able to, one of the reasons that I recently switched the brunt of my trading funds from IB > TD/TOS. Will most likely never be an issue for IB account holders but still .....

TD/TOS also provides FDIC insured accounts for the futures cash sweeps, which I like.

"The Future Ain't what it used to be"
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  #19 (permalink)
Identify Evaluate Execute
Mercer Island WA
 
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Hi,


Quoting 
Firstly, if cash is not transferred to an SIPC insured account, or if you're not using T-Bills.....what is the risk associated with Futures transactions?

Total loss because you have no coverage


Quoting 
I'm assuming if you have to operate with a broker (Like Tradestation for example) where it's either not an option or not realisticly feasible to transfer under the umbrella everyday, other considerations become risk management priorities (i.e. capital ratios, whether or not the broker has a prop desk, etc).

Why isn't it feasible to transfer every one or 2 days? It's just an online transfer from one account to the other plus tradestation have ACH. You are lucky you have this option. Most FCMs payment systems are so backward you have to use and pay wire fees getting cash in and out of the account or of course get a check. Who wants to be getting $50k checks in the mail, it could get lost and then you have to mess around going to the bank...


Quoting 
For someone trading with a combination broker (who offers all class instruments, like Tradestation) but uses inter-day and overnight futures transactions....can someone paint me the worst case scenario and what we can do to manage against it?

See note 3 on tradestation which shows what to do. My understanding is that once the cash goes to clearing then the risks are passed to the clearing firm for overnight margin. In the case of PFG it appears the bulk of the funds available for distribution back to customers is from Jeffries the clearing firm from day and overnight margins.


Quoting 
I guess the only REAL safe thing you could do is to stick with supposedly "safe" rated firms, and then spread your assets among a group of them.

They all have risk in one form or another. Even SIPC insurance is dicey as the fund is nearly exhausted and they haven't changed the premium formula since the beginning of man.

Cheers
DJ

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  #20 (permalink)
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Has anyone looked into what it would take to get private insurance from Lloyd's of London and what the minimums might be? Assuming that the minimums are out of reach for most individuals would it be possible to do a risk pool for a number of traders? This could be a very smart business for a savvy entrepreneur who knows insurance.

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