This article originally appeared in the February 1, 2013 edition of Crain’s Chicago.  To view the original, click here.

By Lynne Marek

Some members of the futures industry backed the National Futures Association’s decision to revamp auditing practices following an independent report this week on the $200 million Peregrine Financial Group Inc. fraud, but said that’s just the start of changing course.

“There are very serious flaws revealed in the report, not to mention an admission that the PFG fraud should have been uncovered in May of 2011 but was not,” said John Roe, who co-heads Chicago-based futures broker BTR Trading Group and is an incoming member of NFA’s board.

The report, presented this week by Berkeley Research Group LLC to a special committee of the NFA board, recommended that the organization revamp its auditor training and hiring practices; update its auditing policies and procedures; and better incorporate information from its own disciplinary reviews and auditing by the industry’s government regulator, the Commodity Futures Trading Commission.

While Berkeley said in the report that NFA auditors followed standard auditing procedures, it nonetheless delivered a laundry list of ways in which they could do a better job.

Cedar Falls, Iowa-based Peregrine, also known as PFGBest, collapsed into bankruptcy in July after the fraud was discovered at the same time the firm’s CEO and founder, Russell Wasendorf Sr., tried to commit suicide.

“My initial impressions are that these are all good and much-needed changes,” said James Koutoulas, who is CEO of the Chicago-based commodity trading adviser Typhon Capital Management LLC and an incoming NFA board member.

“The spirit of the report that cultural changes are needed, as opposed to more forms and red tape, is a great step forward and I think the vast majority of NFA members would gladly comply with requests that make sense,” Mr. Koutoulas said.

Mr. Roe and Mr. Koutoulas formed the Commodity Customer Coalition and pushed for changes in how futures industry customers’ funds are handled in the wake of the October 2010 collapse of MF Global Inc., which resulted in initial losses of hundreds of millions of dollars for customers. The demise of Peregrine in July, and the loss of more than $100 million in customer funds, increased their desire for change. They were elected to the NFA board last month.

The debacle was the most serious loss of customer funds that has happened under NFA’s watch. (CME Group Inc. was the primary overseer in the MF Global case.) Both CME and NFA supplement the Commodity Futures Trading Commission’s government oversight.

“The investigation found that, overall, NFA audits were conducted in a competent and proper fashion and the auditors dutifully implemented the appropriate modules that were required in the annual audits,” the report said. “However, we did find that some NFA auditors did not always exhibit sufficient professional skepticism in assessing and evaluating fraud risks. We also found that some of the members of the NFA audit teams were relatively inexperienced and unfamiliar with the futures industry, and in a few instances, additional support from senior members of the auditing team was warranted.”

For instance, the auditors should have questioned the losses that Peregrine was incurring in the years before it collapsed and the qualifications of its chief financial officer as well as its outside auditing firm, the report said.

“Their mission is to be able to say I verified this and you can rely on this, not that you’re dotting I’s and crossing T’s, and that theirs is a culture that promotes that,” said Harry Cendrowski, who leads the Chicago auditing and consulting firm Cendrowski Corporate Advisors. “The bottom line is they didn’t do their job. They should have seen these signs a long time ago.”

Still, at least one NFA board member supported the Chicago-based self-regulatory organization’s past work.

“My personal opinion is that even though the NFA did everything right, we still need to assure the public any recommendations made are going to be implemented,” said Paul Georgy, an NFA board member who is president of McHenry-based introducing broker Allendale Inc. “I’m not happy about the losses that were incurred, but the fraud aspect is very difficult to control.”