UPDATE 5-Burned by MF Global, futures watchdogs eye Knight

Fri Aug 3, 2012 4:14am IST

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* CFTC has dispatched team to monitor Knight's futures brokerage

* CME, which was MF Global's regulator, 'monitoring' Knight

* Knight bought Penson's FCM, with $411 mln in client funds, in May

* CFTC's Sommers: no parallels with MF Global, Peregrine

By Ann Saphir and Alexandra Alper

CHICAGO/WASHINGTON, Aug 2 (Reuters) - Knight Capital Group Inc's newly acquired futures brokerage came under stepped up regulatory scrutiny on Thursday after a $440 million trading loss wiped out much of the firm's capital, raising concern over the safety of its customer funds.

Confidence in the futures industry's ability to safeguard customer funds has been shaken after two financially pressed futures brokers in less than a year have been accused of improperly raiding customer accounts for as much as a combined$1.8 billion, despite regulatory oversight.

Commodity Futures Trading Commission staff is monitoring Knight's futures brokerage, with special attention to its capital and segregated funds, a person familiar with the matter told Reuters.

CFTC and Securities and Exchange Commission staff also participated in a phone call on Wednesday to discuss the situation at Knight, according to another person familiar with the matter.

CME Group Inc, the future's brokerage's first-line regulator, is also "monitoring" the embattled trading firm, a spokeswoman said, without providing any details.

Misfiring technology at Knight, a large New York Stock Exchange market maker, caused a rush of orders on Wednesday for dozens of stocks, roiling prices and spooking investors.

While the glitch did not impact futures markets, regulators want to make sure the estimated $411 million in customer funds, that were part of Knight's purchase in May of floundering futures brokerage Penson Financial Services, remain unscathed.

That amount is slightly more than Peregrine Financial Group reported having when its chief executive last month confessed to stealing from customer accounts for years, in part to keep his company afloat.

Knight said on Thursday it is "actively pursuing its strategic and financing alternatives to strengthen its capital base."

Regulators say Peregrine's CEO misappropriated more than $200 million of customer money. The October failure of much larger MF Global resulted in a customer asset shortfall of $1.6 billion, the bankruptcy trustee has said.

Jill Sommers, a Republican commissioner at the CFTC, said she did not see any parallels between MF Global, Peregrine and the situation at Knight.

"It isn't like we found out that Knight was stealing money," Sommers said. "This isn't a ratings downgrade, this isn't a liquidity crisis. This was just a trading loss."

Not all observers were equally sanguine.

"Those at Penson should be a little worried," said James Koutoulas, the lead lawyer for Commodity Customer Coalition, an advocacy group for former customers of MF Global and Peregrine Financial. "We would hope at the very least that the customer funds would be intact. If we saw a shortfall, it would be very damaging to the industry."

Spokesmen for Knight Capital did not immediately respond to requests for comment.

Sommers noted that the CFTC has access to an electronic system with futures brokers' customer segregation and capital information, which allows the agency to keep tabs on firms like Knight. But she said she favors commission plans to allow regulators direct electronic access to customer segregation balances from the bank itself.

CFTC Commissioner O'Malia agreed, saying that regulators must be more proactive in tackling fraud with better technology.

"Since money can move at the speed of the click of a mouse, so must surveillance," he said.

FROM MF GLOBAL TO KNIGHT

Knight bought Penson's accounts on May 31 for $5 million, plus a cut of future revenue, according to an SEC filing. Penson had $411 million in customer funds as of that day, according to the most recent report from the CFTC.

It was one of a dozen or so independent future brokers that are only a fraction the size of the Wall street broker-dealers that dominate the industry.

Customers of the ailing Penson brokerage, some of whom came to Penson after MF Global's collapse, had welcomed the Knight deal, but are once again anxious.

"They thought Knight bought them out and they were all going to be fine," said a former Penson employee who left the company before the takeover. She said five former clients had called her on Thursday, and one of them is moving their business elsewhere.

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