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CME Group Continues to Lay Risk on Customer Base

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With confidence replaced by anger, CME is set for long term pressure and lawsuits.

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The notorious MF Global (MFGLQ.PK) case, which continues to stink and sicken more by the day, is a function of decisions not made by the prime beneficiary of a healthy and confident futures market, namely the CME Group (CME). With the CME's decision from day one not to immediately guarantee all client assets held in segregated accounts, they have opened up a Pandora's box.

At this point, the investigators don't even know what is going on, so it is useless for me to try to take a stab at it. I have read everything from client collateral, to their gold and silver, Treasuries, grains, you name it, as being the stolen goods. Investor angst and frustration is at a new maximum. For the CME group, the trouble starts now as the red flags concerning stolen property and clear regulatory ineffectiveness are flashing. How can you run an exchange whose entire concept is to receive, store, and deliver commodities when customers with warehouse receipts and years of storage fees cannot access their goods? They will say that it's not in their hands-the Trustee is calling the shots now. Sorry folks-not good enough. We got here because you did nothing for your customers when the news broke. You took none of the risk and instead lapped it on the backs of your very customers. The biggest ones that actually use the system for which it was designed-to move blocks of unleveraged asset--are hurting the most.

Consider this recent release by the Trustee, whose job is clearly more difficult than can be imagined:

As no customer may obtain more than his proportionate share of the property available to satisfy customer claims, if you instruct the Trustee to return your property to you, you will be required to pay the estate, as a condition to the return of your property, an amount determined by the Trustee. If your property is not margining an open contract, this amount will approximate the difference between the market value of your property and your pro rata share of the estate, as estimated by the Trustee.

Translation: Your personal property is subject to provide for a group loss and in order to get it back, previously fully-paid-for securities must be paid for again to ensure you don't get more than the collective loss permits. This is absolute madness. First off, with cash still frozen and margin accounts unable to support the positions transferred, where is the cash coming from? I can't even buy my property back. While I must note that no official word has been made on actual claims, and this property provision seems to apply to a relatively narrow set of securities and certificates, the tone of a prorated loss applying to properties located and found is utterly egregious. If rumors are true that property was indeed stolen, then the CME Group really needs to drill, dig, mine, plant, and frack to get like assets back to customers or the entire model fails to make any sense on so many levels.

I have to believe that property is still where it should be. Considering MF Global passed a CFTC audit on the Wednesday before its bankruptcy, and the following Monday all assets were frozen, it is almost impossible to believe that hundreds of Brink's trucks were swirling around from one Comex-approved warehouse to another, picking up goods that were somehow illegally transferred from their rightful owners in two days. Even still, one would think the investigators could figure that one out pretty quickly. Where did all the trucks go? Simply match serial numbers of customer assets to those that left the warehouse and the log points you to where the stuff is. If it is that easy for someone to steal your stuff out of what is advertised as the safest warehouse in the world, then the American system is crumbling now at a far accelerated rate. If the theft occurred before the CFTC audit, then how do investors have any confidence whatsoever in the agency's tag line: "Ensuring the Integrity of the Futures and Options Markets."

Indeed, the immediate return of customer property, "like property" if you will, is of paramount importance, where "like" means the same stuff and the same amount. If property goes through a liquidation phase to bolster the assets of a general fund, all hell has broken loose. If property was in fact stolen, then all hell has broken loose. While the Trustee is calling the shots, the CTFC and CME legal team needs to lobby for this harder than ever. Their entire business depends on such return.

The CME Group's stock is a sitting duck. Its customers are fleeing, and deep scars are get deeper every day the uncertainty remains. I find it interesting that so much long term damage was accepted in lieu of simply guaranteeing the $600 million. With roughly 150,000 accounts, that's 400 bucks a customer. This is a company whose revenues depend on volume and storage. Both are in serious jeopardy.

The fact that no statement regarding the soundness of customer property has been made to date is simply unacceptable. The notion that it could have been so easily stolen when customers have physical receipts with serial numbers in hand, storage fees on tax returns, clear debits on accounts for original purchases, is beyond comprehension. Just the lawsuits alone will exhaust the resources to ensure them. More guidance is sorely needed. I have no qualm with the Trustee -- his task is enormous, and enormously complicated to boot. It is encouraging to see the investigation ramping up with Gary Gensler's recusement. The SEC, Department of Justice, FBI and CTFC are all on the case. One would expect a clear result soon. Each day that passes erodes confidence further.

Perhaps it's time for President Obama to break both his silence and job-creation talk since Chicago, his hometown, will bear this fall. Brokers now spend their days playing tic-tac-toe between commiserating with furious and betrayed victims. Further, an American financial system with such flimsy property protection and meaningless words like "Customer Segregated Account" will not attract enough capital to support any new jobs. This Friday is shaping up like each day of the past two weeks, rumors swirling, and a bunch of money-less customers desperately wondering what precedents will be set in this case that CTFC commissioner Bart Chilton described as a "massive hide-and-seek ploy."

I have not lost full faith in the process of recovery quite yet. But we are inching closer.

(See also: MF Global: Is This the Second Coming of Bernie Madoff?, Uncertainty Abounds in Continuing MF Global Saga, and Is the MF Global Saga Finally Winding Down?)

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No positions in stocks mentioned.
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