PFGBest: Another Fraud, Another Example Of Weak Auditors and Weak Regulatory Oversight

My latest column @Forbes is about the most recent futures industry fraud case, PFGBest. PFGBest is another reason why the industry’s poor business environment, wracked with a crisis of confidence after MF Global, just got much worse.

All Fall Down; PFGBest and MF Global Frauds Reveal Weak Watchdogs

I have also been extensively quoted in the Chicago Tribune Phil Rosenthal’s column this past weekend on the case.

Sterner penalties required to halt wrongdoing in financial industry

PFGBest has a long story behind it. CEO Russell Wasendorf, who admitted to a twenty year fraud on customers in his suicide attempt note, started the firm in 1980, according to MarketsWiki, an online open source knowledge base for current and historical information about the global exchange traded capital, derivatives, environmental and related OTC markets. The site is run by Chicagoan John Lothian who publishes a subscription-only industry newsletter.

PFGBest (formerly Peregrine Financial Group, Inc. – PFG), founded in 1980, is a privately held non-clearing registered Futures Commission Merchant. PFGBest has branch offices in Chicago; Bloomfield and New York City, NY; Camarillo and Mission Viejo, CA; Cedar Falls, IA; Scottsdale, AZ; Altamonte Springs, FL, and McKinny, TX. It serves Canada through an office in Toronto, and its Asian division offers brokerage and other services to clients who speak various Chinese dialects. The company also has a network of brokers spanning the globe.

Peregrine Financial Group hit the big time in the mid 1990s when a firm named First Commercial Financial Group was forced by regulators to move its customer business after regulators found financial irregularities. First Commercial’s business was moved to Peregrine and to RB&H, the firm headed by then CME Chairman Jack Sandner. RB&H became a part of MF Global. (Sandner is currently chairman of E-Trade Futures and on the board of the CME Group.)

Lothian writes in his blog on July 12:

Former CME Chairman Larry Rosenberg was CEO of First Commercial.

It is safe to say that Mr. Wasendorf did not get the pick of the litter when the customer business, which cleared at RB&H, was split up between RB&H and Peregrine. First Commercial was a party to 75 CFTC reparation cases and a respondent to 10 NFA arbitrations prior to their registration finally being revoked by the NFA in 1996.

Mr. Wasendorf and his firm Wasendorf & Son was also involved with another CME-related firm that had its own unhappy ending, GNP Commodities, headed by one-time CME Chairman Brian Monieson. GNP was the party to 117 CFTC reparation cases and five NFA arbitration awards. GNP also had two NFA, three CFTC and six exchange regulatory actions against it before its registration was revoked.

Of course Alaron also had its problems.  It was a party to 55 CFTC reparation cases, was a respondent to 12 NFA arbitration cases and two NFA, two CFTC and 15 exchange regulatory actions. By contrast, Peregrine was party to 38 CFTC reparation cases and 31 NFA arbitration awards, as well as four NFA and one CFTC regulatory actions.

Larry Rosenberg went on to head Lake Shore, which was also closed for fraud. First Commercial was also invested in by backers of the LNS Financial Group firm, Glenn Laken and Bob Schillaci. Laken served time while indicted and jailed for securities fraud under NY RICO statutes in 2000. First Commercial owned 49% of  Jack Sandner’s RB & H. Unsubstantiated reports say RB & H was also backed by investors Sheikh Abdulla Backesh who is connected to the BCCI Bank $ 10 Billion fraud and had a minority stake and Talat Othman, of Arlington Heights’ Dearborn Financial.
That’s how the futures business works in Chicago. Firms run into trouble and stronger, better capitalized or sometimes just better connected firms pick over the carcasses for the best meat and take them over for a bargain price at the regulators’ request. Not much different from what the Treasury did to some financial institutions during the 2008 financial crisis.
What’s interesting for me in the PFGBest case is the use of a small, one-woman shop as the auditor. PFG Best has a subsidiary that was registered with the SEC. As such they were required to use an auditor that is registered with the PCAOB. Jeannie Veraja-Snelling registered her firm with the PCAOB and she had no marks on her record with the Illinois professional regulation authority before now.
Her firm also audits another broker-dealer, Corporate Investment Group, Inc, headquarters in Chicago on Argyle Street between the roasted ducks and the Phở.
The SEC and Self-Regulatory Organizations (SROs) like the National Futures Association have been doing fewer and fewer exams of Broker-Dealers during the last five years. This from the SEC’s 2011 annual report:
You might think that a firm with $400 million in customer assets under their control, a one-woman firm as auditor and a history like PFGBest might hit the regulators’  radar. But, as you can see, the goal is only to review 42% of the broker-dealers this year. Let’s hope that includes the rest of the firms with customer assets under their control, potentially weak or vulnerable auditors and a history of fraud embedded in their account and business relationships.
My column at Forbes hits on another regulatory issue that the PCAOB has to deal with. Auditors of SEC-registered broker-dealers may also be putting together the financial statements they are auditing. And they charge many of their customers to help with accounting software issues and other bookkeeping activities. That’s not allowed. Several professionals admitted they were one-stop shops for their broker-dealer clients at a forum put on by the PCAOB and SEC along with FINRA in Chicago in April.

One issue that provoked heated discussion at the Chicago forum was auditor independence. It seems many of these Certified Public Accountants and broker-dealer auditors were under the mistaken impression that it’s the AICPA’s rules for auditor independence that apply to them, not the SEC’s. SEC rules, post-Sarbanes-Oxley Act of 2002, prohibit an auditor of an SEC-registered firm from performing a list of nine prohibited services including bookkeeping and systems design and implementation for its audit clients.

Several audit firm professionals tried to convince the SEC and PCAOB staff that they were mistaken in the belief that broker-dealer auditors could not sign the broker-dealer audit opinion as well as help implement accounting software, prepare period-end journal entries and compile those same financial statements and regulatory reports that they would audit. PCAOB staff told me that this issue has come up at every forum.

Those audit firm professionals were dead wrong. The changes that will have to occur to bring the audit firms, and their clients, in line may mean not only consolidation of audit firms that can not deliver audit-only services cost effectively and per the standards, but also consolidation of broker-dealers who do not want hire competent accounting and systems professionals in-house or pay for it separately from a firm other than their auditor.

How many other broker-dealer frauds will we see because external auditors are not independent, objective and professionally skeptical enough?

Thanks to Lance Goldberg for additional PFGBest history.

8 replies
  1. Conscience of a Conservative
    Conscience of a Conservative says:

    Given how Industry waters down regulation by starving regulators of the necessary funds to enforce regulation via their friends in congress (which we see time and time again) it seems to be a more common senses approach would be to make the system more dependent on outside auditors and to empower those through the courts to sue for both compensatory and punitive damages. The only downside would be that we would need to more accurately define the standard of care and to agree to see the price of audits go up, but I would think this is more than offset by what we see in shareholder, bond holder and customer losses from the pilfering and chicanery that currently goes on in the system. The accounting firms have the expertise, we just need to properly incentive firms to engage properly engage the auditors and to have the auditors take their responsibility more seriously.

  2. Francine
    Francine says:

    @Conscience of a Conservative

    We are on the same page on this. However, I am more stick than carrot at this point. Incentives don;t work with sociopaths. Most corporate fraudsters are just greedy amoral opportunists. So punishment works. Timely, strong, specific, clear punishment. I would add litigation risk to the punishment basket. Right now it is pretty nil for the big audit firms. They pay settlements put they do not pay consequences because transcripts are sealed and the truth about how negligent and amoral they have been never gets out.

    I keep repeating this Martin Luther King Jr. quote: “Morality can’t be legislated but behavior can be regulated. Judicial decrees can not change hearts but they can restrain the heartless.”

    We have stopped restraining the heartless. We expect laws to change hearts. We think we can legislate morality. It’s not working.

  3. George Smithgolf
    George Smithgolf says:

    As much as critics of the Big 4 CPA firms love to find fault with them, it is clearly a red flag for a firm such as PFGBest or Madoff’s funds. My own due diligence of investment firms and non profits includes whether they are audited by a Big 4 or other large reputable CPA firm. Francine, hopefully we can agree on this….

  4. Disgusted
    Disgusted says:

    In the case of regulated entities at least, it’s time to re-think the process. We have the technology to prevent these problems. We do not, apparently, have regulators who understand the implications of the technology or the will to impose change on the firms who will offer former regulators well-paid Board positions upon retirement for looking the other way during their “public service” career.

    The sources of the data for the regulatory reports that PFG was required to prepare consist of 1) Banks 2) Exchanges 3) Other regulated entities 4) Internal General Ledger and 5) Internal Trade accounting (“bookkeeping”) sytem. And that’s not going to be much different for any regulated entity. Assets not held at a regulated entity and illiquid assets should be disallowed in their entirety. Can you hear the screams?

    Historically, efforts to improve the process have been directed at making the regulated entity provide information more quickly and accurately. That model should be turned upside down. Give the regulator online access to each of the inputs and near-real-time reports can be produced. What’s more, the interrelationships between the inputs raise the level of difficulty to begin a fraud because changes in the GL or bookkeeping system that aren’t supported by changes in the other inputs will raise red flags.

    It’s time to start regulating financial services like it was a public trust, and not the privileged playground it has obviously become.

  5. Oversight for the Better
    Oversight for the Better says:

    Yes, I agree, and I can say with some confidence that the “bad auditor” concept is now mainstream. My evidence is a book, “The Road From Empire to Eco-Democracy.” I picked it up while playing bridge with one of the authors, Ben Ball. Here’s their take on “Regulating Wall Street:”

    “Finally, accounting practices need to be rebuilt. The accounting profession has become morally and intellectually bankrupt. Our worst jokes about accountants have come true. What are now “Generally Accepted Accounting Practices” conceal rather than inform, distort rather than reveal. What is perfectly legal and “generally accepted” fails miserably to serve accounting’s primary function: to inform management, investors , government, and the public of the facts, and especially to highlight existing or potential problems. In theory, outside auditors are accountants elected by shareholders to be their watchdogs over management. But in practice they are handpicked by management to be their household pets. This invites corruption that is difficult to locate and correct. We must remove this self-serving power from mangement.”

    Look at that – a long paragraph and no punches pulled. Some of their concepts are a bit distorted and they do not seem to have a full understanding of all the issues, but it’s a public perception.

  6. Francine
    Francine says:

    @George Smithgolf

    I would certainly agree that the auditor and the scope of the audit including fees paid should be aligned with the size of the firm and the risk. To have a firm with $400 million pf customer assets under their control audited by a one-woman shop that had not ever been inspected by the PCAOB since she does not audit public companies is as clearly a mismatch and red flag as Madoff’s firm was. Brighter minds, like NFA and SEC, should have seen this and put a stop to it.

  7. Charlie Quinn
    Charlie Quinn says:


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