As the MF Global Holdings (MFGLQ) Inc. bankruptcy proceedings drag on, some customers who had brokerage accounts at the firm are becoming increasingly doubtful that they will get all of their money back.
Tom Forester, who manages the $232 million Forester Value fund, says his wife, who was an MF Global customer, has yet to see all of her funds returned.
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Mr. Forester's fund, which uses options to hedge market risk, isn't an MF Global customer, but Mr. Forester says he plans to open a second brokerage account for the fund to spread his bets in case his primary broker faced a similar failure.
"God forbid something happens to them, but we want to have a back-up quickly," he says.
The question many investors are asking is whether they could be next.
The good news is that people who merely hold a stockbrokerage account are probably protected. But for those who trade options and futures or use leverage, the answer is more complicated, say lawyers, investment advisers and former regulators.
"You have to examine the fine print," says David Kotok, chairman of Sarasota, Fla., investment advisory firm Cumberland Advisors. "Anybody who ignores it does so at their peril."
Commodities broker MF Global filed for bankruptcy protection at the end of October, after $6 billion worth of bets on troubled European sovereign bonds frightened customers away and caused the company to run out of cash. A last-minute sale of the firm fell through when accountants discovered a shortfall in customer funds, now estimated to be $1.2 billion or more.
An MF Global spokeswoman declined to comment.
The shortfall wasn't supposed to be possible. Brokerages are required to segregate customer assets from the firm's assets.
In the past, that has meant that even if a firm ran out of its own money, the customer accounts could easily be transferred to a new broker, says Michael Greenberger, a law professor at the University of Maryland and former director of trading and markets at the Commodity Futures Trading Commission, which regulates the industry.
"The system has held up until now," he says. "This is a black eye. People are going to be less likely to use futures trading than they were."
In the event a broker fails and customer funds are missing, the Securities Investor Protection Corp. will replace for each customer up to $500,000 worth of missing securities, including up to $250,000 in cash. SIPC doesn't replace futures contracts, and, so far, a similar system hasn't been set up for accounts regulated by the CFTC.
Many securities firms also buy insurance to supplement SIPC. Scottrade, for example, says it buys coverage through Lloyd's of London that brings customer protections up to $25 million, including up to $1,150,000 in cash.
You'll still be subject to problems if the insurer can't make good on claims, notes Mr. Kotok. If you're willing to put up with the hassle of managing multiple accounts, or if your brokerage doesn't offer supplemental SIPC coverage, make sure to get an account for each $500,000 chunk of assets you hold, he says. Also, open "cash" accounts that opt out of margin agreements, he says, because such accounts restrict what brokers can do with the money.
Commodities accounts face another complication: Even though brokers are supposed to segregate client funds, the CFTC permits them to use the funds to make ultrasafe investments and keep whatever gains come as a result, says a former CFTC official who now represents some firms affected by the MF Global collapse.
The problem: Until recently, the CFTC included foreign sovereign bonds in its universe of safe investments.
Earlier this month, CFTC commissioners passed a rule that would restrict brokers from investing in foreign sovereign bonds with customer funds. Brokerages have until next summer to comply.
Some lawyers have theorized that MF Global might have used customer funds as collateral to back its own trades, a process called "rehypothecation." Most commodities brokerages agreements include clauses that allow the practice. In the event of a default, that could mean customers with missing funds could be considered unsecured creditors and be forced to wait in line with other creditors to get their money back, says Bruce Krasting, an independent analyst and former hedge fund manager.
"It's standard language. I don't think you could even be a big shot and get a carve out to disallow it," he says. "Every agreement I've seen permits rehypothecation."
Some lawmakers and regulators have called for commodities brokers to create and fund an insurance program, similar to SIPC, to protect customer assets. But until they do, there aren't many options for small investors who trade futures to protect themselves.
"The ultimate safety here is reform," says Mr. Greenberger. "There isn't a whole lot small traders can practically do to protect themselves."
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