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The Curious Investor: Fraud puts futures markets to the test

Russ Wasendorf chairman chief executive officer PFGBest. | AP

Russ Wasendorf, chairman and chief executive officer of PFGBest. | AP

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roeder report

David Roeder reports on real estate at 6:22 PM. Every Thursday on News- radio 780 and 105.9 FM WBBM. The reports are repeated at 10:22 p.m. Thursday and 7:22 a.m. Sunday

Updated: July 23, 2012 9:18AM

I’ll let you in on a secret about futures trading in Chicago, something I’ve picked up in 20 years of following this homegrown, colorful and occasionally brilliant industry.

It has a public persona that doesn’t match reality. Think of the sweaty traders, loud, brash and seemingly ready to bust somebody’s nose in the pits. They’re still around, despite a shift to electronic trading, and remain a colorful emblem of Chicago ingenuity.

So it might surprise you that there’s another truth about the futures business: It’s full of wusses on the public dole.

That’s heresy in this town, I know, but leaders in this business aren’t doing much to restore customer faith in futures. They are wusses in a crisis. Scandals are forcing customers to flee, and yet an industry defined by swagger does nothing but play defense.

Peregrine Financial Chairman Russell Wasendorf Sr. tried to kill himself Monday an alleged shortfall of more than $200 million in his firm’s customer accounts was coming to light. Regulators have frozen the accounts and are trying to trace the money. Wasendorf was arrested and charged Friday.

The collapse of the firm followed last year’s debacle over MF Global, a potential $1.6 billion fraud. The circumstances differ, but the impact on customers is alike. Their money gets tied up and some of it may be gone for good.

Futures exchanges and brokerages have for years skirted around the industry’s lack of protection for customers. At the Chicago exchanges owned by CME Group (CME), there’s a clearing guarantee that applies to money tied up in trades. Many people mistook that for blanket protection, like the $500,000 per account guarantee for trading stocks.

The industry needs an insurance program. Retired Chicago Mercantile Exchange Chairman Jack Sandner last week advocated another sensible idea, a central repository for all customer funds. But there’s been more talk than action on these initiatives when reform should have been Job One after MF Global.

CME and brokerage executives always have been afraid of account insurance. It has to be funded by a trading fee that could easily meld into a transaction tax, something they have dreaded for years. Such a tax now looks inevitable, and not just in the United States. Which brings me to the public dole.

Futures traders are mostly good taxpaying citizens, but they don’t pay the cost of regulating themselves. All taxpayers chip in on the roughly $200 million annual budget of the Commodity Futures Trading Commission. In the equities world, the much larger Securities and Exchange Commission is funded by trading fees.

It’s time for industry participants to pay their own way, even as the cost of renegade fraud mounts.

At CME, money is marching out the door in the form of lost business and trust and market oversight costs. Its systems are more subject to manipulation by computer algorithms as individual traders leave, thinking they can’t get a fair shake. It’s as if the business is consuming itself.

And yet, there’s little movement on basic reform. It would be sad if a Chicago mainstay with a history of innovation and boldness shrinks because it lacks courage to change.

BLAIR’S BEST: William Blair & Co. has published its latest “better values” list, a bimonthly set of recommendations for stocks it expects to outperform the broader market over the next two years. Blair has a good record of meeting that objective.

On the new list are: Visa (V), Mead Johnson Nutrition (MJN), Cardinal Health (CAH) and O’Reilly Automotive (ORLY) among companies worth more than $10 billion; Brown & Brown (BRO), MEDNAX (MD), Babcock & Wilcox (BWC) and Watsco (WSO) among companies worth $1.5 billion to $10 billion; and Cavium (CAVM) and Teavana Holdings (TEA) among companies worth less than $1.5 billion.

CAN’T ESCAPE FACEBOOK? Here’s why you shouldn’t trust your fund manager. Morningstar, at the behest of the Wall Street Journal, reviewed the latest filings of U.S. based mutual and exchange-traded funds and found that around 160 of them invested in Facebook’s (FB) IPO in May. Some would not seem to be likely investors in an untested company and probably have customers who expect the fund manager to be playing in less risky territory.

Among the Facebook buyers were Fidelity Dividend Growth (FDGFX) and Fidelity Advisor Dividend Growth (FDGIX). Facebook does not pay a dividend. Others funds with “value” in their names, such as JPMorgan Intrepid Value (JIVMX) jumped on the offering, even though risky tech ventures don’t fit the definition of a value stock.

CLOSING QUOTE: “[T]here is simply not enough money in Europe to save Italy and Spain. The Germans are growing tired of bailing out their broke brethren, and we can expect leaders to delay, defer and demur for as long as they can, which probably won’t be for very much longer. When the piper finally demands to be paid, no central bank on earth will have the firepower to stop the global financial avalanche that this crisis could trigger. — John Nayaradi, publisher of Wall Street Sector Selector, writing at

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