"The way I read it was that basically you no longer have property rights. If you have your money in any (US) financial institution, you now have no property rights because in a crisis situation a bankruptcy judge now has the right to say that all of this speculation (by the banks and brokers) takes precedence over your savings."This is an enlightening discussion on the precedent set in the Sentinel ponzi scheme case that places customer money in brokerages at risk by destroying the principle of the primacy of the customer money, customer segregated funds.
W. E. Pollock
There is an Orwellian sounding distinction made by the Courts between 'stolen funds' and 'misappropriated funds' that seems to provide the TBTF banks and their cronies a license to loot the financial system with impunity, although it could have been written with Jon Corzine and JPM in mind.
Unlike some of the commenters I did not get the connection that the ruling provided approval for brokers to pledge customer funds as collateral for their own speculative loans, but rather it indemnified the lending banks from having to question the source of the funds, even when they could be reasonably expected to know the funds were being taken illegally from customers.
But I could be mistaken on this. This seems to speak to the weakening/widening of the rule on the rehypothecation of customer funds by the CFTC. But the 7th court ruling speaks to entire industry in its indemnification of the banks in having to question the sources of large sums of money, even if they are reasonably but not 'egregiously' suspect.
That is still bad enough, because it opens the door to a moral hazard that will eventually destroy any remaining confidence in first the futures and then the equity and bond markets.
Link to the full 7th Circuit Federal Appeals Court of Chicago ruling on Sentinel with the accompanying comment from a reader at Ann Barnhardt's site.
"The entire case reads like an after-the-fact rationalization of a predetermined conclusion. Years ago when I was with a different firm, I worked on numerous major institutional fraud and auditing cases, and I cannot recall a ruling even remotely similar - let alone from a federal court of appeals.
Please pay particular attention to the section on equitable subordination, on pages 6 through 8. Unbelievably, the court acknowledged in that section that even though some of the bankers lied under oath during the trial, that fact did not prove "sufficiently egregious" actions on the part of the bank.
I will quote the opinion: "Instead of finding that their testimony [i.e. their lies] justified a finding of egregious bank behavior, the district court essentially found that the bank officials were such artless liars that they couldn't have been concealing deliberate wrongdoing." See page 7, column 2.
So in other words, a U.S. Court of Appeals has found that if a banker lies under oath during a trial, that fact proves that the bank was innocent of any misconduct with respect to the subject matter of those lies. (e.g. there is no fraud because they lied so brazenly and therefore badly.) Did we get transported to bizarro world without knowing it?"
Here is an in-depth discussion of the Sentinel Case by Pater Tenebrarum (h/t J. Tavakoli). I read it the other day, and was starting to write something about this when I came across Warren's video. Tenebrarum includes this quote from a piece by Reuters:
“A federal appeals court on Thursday upheld a ruling that puts Bank of New York Mellon ahead of former customers of Sentinel in the line of those seeking the return ofmoney lost in the 2007 failure of the suburban Chicago-based futures broker.
The appeals court affirmed an earlier district court ruling that the bank had a "secured position" on a $312 million loan it gave to Sentinel, which turned out to have been secured by customer money.
Futures brokers are required to keep customers' funds in dedicated accounts to protect them from being used for anything other than client business. However, Thursday's ruling suggests that brokerages can use customer funds to pay off other creditors, Sentinel trustee Fred Grede told Reuters.
"I don't think that's what the Commodity Futures Trading Commission had in mind" with its requirement that brokers keep customer money separate from their own, he said. "It does not bode well for the protection of customer funds."
Worse, Grede said, is that the ruling suggests that a brokerage that allows customer money to be mixed with its own is not necessarily committing fraud.
That may raise the bar for proving that MF Global Holdings Ltd, under then-CEO Jon Corzine, misused customer funds as it scrambled to meet margin calls to back bets on European debt in the brokerage's final days. A $1.6 billion customer shortfall remains...
"I'm sure Mr. Corzine's attorneys will get ahold of this ruling and use it for all it's worth," Grede said.
...The appeals court said that "perhaps the bank should have known that Sentinel violated segregation requirements" but agreed with the district court's earlier ruling that "such a lack of care does not rise to the level of the egregious misconduct" needed to reprioritize a claim.
"That Sentinel failed to keep client funds properly segregated is not, on its own, sufficient to rule as a matter of law that Sentinel acted ‘with actual intent to hinder, delay, or defraud' its customers," U.S. Circuit Judge John D. Tinder wrote in the ruling.”
It *could be* that this distorting of property law was written for the convenience of Jon Corzine and his ilk.
But it could also inadvertently pave the way for a major bailing out of an insolvent financial system using customer funds. There is some precedent in this. Even that bastion of the people, FDR, took their gold by force of law and THEN appreciated it substantially by devaluing the dollar against it in order to refund the depleted banking system. Why the Fed's Took the Gold in 1933.
Perhaps this time instead of the official gold in circulation it will be the savings in 401k's and IRA's, and the foreign assets held in custodial accounts, that are misappropriated by banks and brokers.
It is interesting to hear the reaction from some financial circles that the notion of customer segregated funds was always a thinly disguised farce and so this is nothing new. They will rationalize crimes in a widening circle of corruption. Their malicious greed knows no bounds.
When I read the rationale supporting the 7th Circuit Court Ruling I thought it was a satire of convoluted legalism. It basically destroys the notion of fiduciary responsibility for brokerages and their funding banks and opens the door to moral hazard a mile wide and gives the TBTF banks a license to accept stolen goods without consequence, as long as the customers have signed a document of trust even under false pretenses and perjury.
People say that Franklin Roosevelt saved capitalism from the capitalists. And they are absolutely right. But after all the slayings of the great, outspoken leaders and prophets, there is no one left to save them.
Ann Barnhardt is a fierce advocate for customer rights. I have to say that I find her views on muslims in general to be extreme and misplaced to say the least, and highly offensive. And some of her other views are also extreme. I pray for her and others who fight against corruption that it does not tarnish them. Love is a shield against the excesses of a hardened heart.
This is a portion of her 'fierceness.' As a long time friend and fan of hers noted, I would hate to be married to her, and forget to take out the garbage.
Keep in mind that Ann saw her business destroyed and her customers cheated and robbed by the brazen theft of customer money in MF Global perpetrated by a corrupt US financial system. That is a hard lesson.
She has previously documented her legal dealings with the National Futures Association and their 'arbitrary and incompetent actions.'
This discussion on the place of customers in the US financial system is useful. The risk calculation has definitely changed.
The rational market reaction would be for customers to flee the increased risk presented by Wall Street brokers from this ruling and to seek safety where they might find it. It is shocking that the government does nothing to stop this growing erosion of confidence and loss of credibility in the financial system. I think this might be showing up already in the light volumes consisting primarily of HFT vapours.
What To Do When Every Market Is Manipulated - Chris Martenson
Warren Pollock speaks in passing of financial collapse and black swan events. Coincidentally here is a paper from Nassim Taleb that just caught my eye. Time to Exit the Financial Industry.
"The 'fooled by randomness' effect grows under connectivity where everything on the planet flows to the “top x”, where x is becoming a smaller and smaller share of the top participants. Today, it is vastly more acute than in 2001, at the time of publication of (Taleb 2001). But what makes the problem more severe than anticipated, and causes it to grow even faster, is the effect of fat tails. For a population composed of 1 million track records, fat tails multiply the threshold of spurious returns by between 15 and 30 times.Basically what Taleb is saying is that under the existing financial system construct the size and frequency of 'events' require that there will be fewer and fewer big winners, and many more big losers, with the middle being starved if not impoverished. Given the nature of the game, don't be a player, either a broker or a trader. If you have to be in, just be in for the skim; own a piece of the system without playing. The future volatility of the market will crush or starve all participants except for the top one percent.
Genralization: This condition affects any business in which prevail (1) some degree of fat-tailed randomness, and (2) winner-take-all effects in allocation.
To conclude, if you are starting a career, move away from investment management and performance related lotteries as you will be competing with a swelling future spurious tail. Pick a less commoditized business or a niche where there is a small number of direct competitors. Or, if you stay in trading, become a market-maker.
If the Fed attempts, once again, to provoke a financial assets bubble in stocks and corporate bonds as a solution to their problems, this may not be a prescription for the short term in my own view. But it will lead eventually to a depreciating dollar and another financial crash. So being 'out' does not necessarily imply 'being short.' It is hard to play a manipulated game as an outsider, and is not a matter of 'sophistication' and 'intelligence' although it is often presented as such. It is a con game.
When push comes to shove, these trends suggest that might will make right, and possession will be nine tenths of the law. Or as Glenn Greenwald puts it, there will be no rule of law, just liberty and justice for some, the powerful few.
And in case you were wondering, No Criminal Charges Expected at MF Global - NYT, 15 Aug 2012
"Oh, you didn't know that those assets pledged by that fund or broker, the customer money, gold and silver, belonged to someone else when you took it and sold it? Ah, well that is all right then. That is just a misappropriation. And the CEO could not have known about the hijinks going on in their back offices."I wonder if, in their attempts to save their financial friends from the embarrassment of prosecution, the crony capitalists do not bring down the very system that has brought them their unjustifiable riches.
"A public man has no right to let his actions be determined by particular interests. He does the same thing as a judge who accepts a bribe. Like a judge he must consider what is right, not what is advantageous to a party or class...There is not a more perilous or immoral habit of mind than the sanctifying of success.”
John Dalberg Lord Acton