This post was originally written for The Journal of the National Introducing Brokers Association.

The recent insolvencies of MF Global and PFGBest, along with the near miss of Knight Capital, have sent customers scrambling to confirm the safety of their property and the financial health of their brokers. Prior to October 2011, most futures customers never gave the solvency of their FCM a second thought. Customers now find themselves on the hunt for the canary in the coal mine. In a financial world fraught with rogue traders, Ponzi schemers and high frequency meltdowns, what is the best approach for detecting a Corzine or Wasendorf at your FCM?

The quick answer is: there is no quick answer. You must first consider what type of trader you are and on what exchanges you will be trading. There are a number of additional factors to consider, most of which are changing as regulators react to recent collapses. Many reforms are also in the pipeline which may change the tools with which to assess an FCM. It is possible in the next 12 months that various reform initiatives, from third party custody of segregated funds to a customer protection fund, will change the way the futures industry does business and alter how customers interact with their FCM. While we await these reforms, there are some things to consider in order to minimize your risk.

If you are using a broker whose parent firm is publicly traded, there are some tools at your disposal. Publicly available ratings from independent ratings agencies can give you some metrics on the financial health of the parent firm. However, much like the regulators, the ratings agencies are often too late to be of use. Still, customers should be looking at their FCM’s parent company for signs of distress. These can include hiccups in quarterly earnings, fluctuations in stock prices, fluctuations in corporate bond yields, changes in capital structure, changes in management, high risk proprietary investments, fluctuations in net capital and regulatory issues to name a few.

If you are using a privately-held firm, the alchemy gets a little trickier. Ultimately, one must rely on the stated health of the firm–and Mr. Wasendorf would have told you that his firm was never better on July 9, 2012. Still, you can ask your broker for financial statements and audit reports. In some cases, the balance sheet of privately-held FCMs is not as relevant as the balance sheets of their trading counterparties. As some non-clearing FCMs do not handle customer funds, it is important to know who your FCM is clearing through and what banks they are using to house your assets.

You will also want to consider the corporate structure of your FCM. Generally speaking, it is preferable for a customer to be trading through an FCM which is housed in a legally distinct entity. This ‘ring-fencing’ of the FCM from other business lines, such as a broker-dealer operations, will reduce the probability that customer funds could be used for proprietary purposes by the FCM. It will also help contain insolvencies which arise from externalities from affecting customer property (see Refco).

Regardless of the ownership structure of your FCM, you will want to make sure they have a diverse customer base and adequate capital. A firm with narrow customer base may be more exposed to fellow customer risk than more diverse firms. Though a bit behind, the CFTC’s FCM Financial Data is a good place to watch for net capital fluctuations and changes in segregated balances. These release of these reports is likely to speed up as the industry demands more timely access to them.

If you are trading on foreign boards of trade, you will want to know how your funds are transferred to and from foreign exchanges. If your broker is keeping collateral with unaffiliated foreign brokers and banks, that is advantageous to you in a bankruptcy proceeding. Funds kept with foreign subsidiaries of your FCM will get ensnared in local bankruptcy proceedings in an insolvency. Funds held outside your broker’s control will flow back to customers more quickly.

If you are unlucky enough to choose poorly, you will still end up ‘protected’ by the bankruptcy code–which is to say subject to a drawn out, expensive legal proceeding the outcome of which won’t be clear for years to come. Until the aforementioned reforms are in place, customers may want to protect themselves simply by not trusting any broker. Sweep excess balances to SIPC or FDIC insured accounts at unrelated financial institutions. Many FCMs now offer no-cost ACH transfers which can minimize the expense of actively managing the cash in your account. Larger traders will want to consider maintaining multiple trading accounts with unrelated FCMs. Smaller traders may want to use cash instead of specifically identifiable property to margin positions. Cash is much easier to extract in a bankruptcy and it won’t be subject to the liquidation discretion of a Trustee.

President Reagan’s advice to “trust, but verify” has never been more salient. If Russ Wasendorf had been his broker, he might have truncated that to simply “verify”.