As we search for solutions to the Peregrine Financial Group crime spree and the MF Global non-criminal (so far) implosion, answers to questions about another criminal brokerage firm blow-up go unanswered.

The industry has come forward with after-the-fact solutions to the MF Global issues. The regulators have quickly put in place electronic confirmation of bank statements to address the PFGBEST mess. But despite all of the concern over inexperienced or captured regulators in each of those cases, the the fact is a well-known private equity investor and a robust public accounting IPO process failed to find the ongoing fraud at Refco. One estimate is that Thomas H. Lee and the public accounting firms doing the IPO due diligence spent over $10 million in investigating Refco and did not find their more than decade long fraud.You might say, well, in the Refco case there was no problem with their futures commission merchant business and that it seamlessly moved to Man Financial. But you would be wrong. You see Refco’s now in jail CEO was also stealing money from clients, but the clients would change often. The Friday before the Monday Columbus Day banking holiday when the news first broke, Refco stole over $300 million of customer segregated funds from a single customer account while directing a transfer of collateral intended for its FCM to its off-shore broker-dealer.

The big difference between the hole in segregated funds in the Refco case compared to the PFGBEST case is that the theft did not take place over the last 20 years, but rather on the last business day.

Somehow, because of the bank holiday on Monday, the freezing of customer accounts by Refco on Tuesday and the subsequent bankruptcy, those stolen segregated accounts were not returned prior to the balance of Refco’s FCM segregated funds moving over to Man Financial. No pro-rata distribution took place. Instead, it took extraordinary legal efforts on the part of my former employer Tom Price to get all those funds returned to the account they were stolen from. It took about 2 ½ years to get all the money back.

So the question is, how was Refco different from PFG and how the customer claims are being handled there? Is it because is was just one institutional customer that it was treated differently?

But more importantly, the question is, if a profit motivated private equity investor and a big public accounting firm doing pre-IPO due diligence can’t find the Refco fraud, why would we expect the regulators to be able to find this kind of fraud?

When I asked this question at the CFTC’s Technology Advisory Committee meeting in July, no one had an answer. When I asked this question again at a meeting in Chicago of a number of industry executives, they had no answer.

The question goes unanswered. But I can tell you this, if we are going to truly restore customer confidence in our markets, this question must be answered. Until then, a big cloud remains over the industry and our markets.

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