Sentinel ruling may hurt MF Global clients

This is a dangerous precedent, because if the financial institution collapses, clients with segregated deposit accounts will have difficulty recouping their funds, as they are last in line as an unsecured creditor.  What was once considered sacred is no longer safe.

http://www.reuters.com/article/2012/08/10/us-sentinel-appeals-decision-idUSBRE87900T20120810

 "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.

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.

"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.

Sentinel allegedly pledged hundreds of millions of dollars in customer assets to secure an overnight loan at Bank of New York Mellon, leaving the bank in a secured position but Sentinel's customers out millions.

Customer funds were allegedly moved from the protected accounts to other accounts so they could be used as collateral for loans to Sentinel's own trading operations.

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.

In other words, if the brokerage uses investor funds as collateral to gamble with its own funds, loses it all, and collapses, the client is ass'ed out.  And it's all legal.  This will not only happen.  It has already happened, with the collapse of Sentinel, MF Global, and Peregrine.  And economists and government officials don't understand why retail investors are exiting these already rigged markets.