Peregrine Financial Collapse Cost Farhan Khan His Life Savings | Huffington Post
This article originally appeared on HuffingtonPost.com.
On a Tuesday morning earlier this month, Farhan Khan sat down for his milk and toast at his home in the Dallas suburbs. The 32-year-old engineer opened an app on his smartphone, expecting to see $380,000 in his brokerage account, nearly all his life savings. Instead his account was frozen; his Iowa-based brokerage, PFGBest, was out of business.
He started to cry after reading the news: The company’s CEO had admitted to embezzling more than $200 million in customer funds as part of a 20-year fraud scheme. “My heart sank,” Khan said during a recent call with The Huffington Post. “All my fears were realized.”
While Khan’s probable loss has proved devastating for him, financial advisers say experiences like his point to some key lessons for managing personal investments: Be very careful when placing all your life savings in one type of account. Read the fine print about how that money is protected. Otherwise, there’s a risk of possibly losing everything — whether from market volatility or crooked players.
Meir Statman, a finance professor at Santa Clara University who has written extensively about behavioral finance, said that many individual investors possess a deeply held belief that they can beat the market. That often leads them to take risky positions, like going all in on a certain kind of investment, whether tech stocks or commodity futures, or to using a flashy broker.
“They are trying to get an angle and be sophisticated and get a [higher return] or a discount on a trade,” Statman said, adding that investors can also lured by the cachet of working with a boutique firm, rather than keeping their money with a stodgier mainstream institution.
PFGBest is the most recent high-profile case but it’s certainly not the only example of customers getting burned by their investments. Wendy Cross of Atlanta, who is out $360,000, is just one of dozens of investors who lost their life savings to a fraudster investment banker, Aubrey Lee Price, in July. Price allegedly disappeared last week after he confessed to stealing more than $40 million from customers. “Not just my money, it was my dreams, my future, my freedom, gone,” Cross told a local television channel.
No matter how unsexy diversifying or investing in index funds might seem, the importance of these practices is stressed by financial planners. “Going into any one investment has mistakes,” said Dan Keady, director of financial planning for TIAA-CREF.
Putting all one’s eggs in a single basket can present a problem for investors who are overly cautious as well. Placing all your life savings in safer but lower-yield Treasuries, for example, could result in a person missing financial goals for retirement, Keady said. He extolled the strategy of “having strategic diversified portfolio,” saying the key is rebalancing one’s accounts.
Even Statman, a professor of finance who has studied markets for years, said that he keeps all his investments diversified by using index funds. “People find it hard to believe that simpler might well be better,” he said.
But Khan was not worried about risk or diversification when he moved his money to PFGBest, he said. He had been aggressively saving for years and wanted to venture into commodities, which can produce high returns though with increased risk, to further grow his $380,000 nest egg.
In December, Khan transferred all his money from a Charles Schwab account to PFGBest, attracted by low fees that were half the cost of Schwab’s and the faster trading platform.
But then he experienced some stage fright. After a few early trades in crude oil, he retreated, moving all his money to a cash account by June. “I was a little nervous about making transactions and I just held off,” he said.
That haven ended up offering no safety as it turned out that PFG’s CEO and founder Russell Wasendorf Sr. had pilfered more than $200 million from customer accounts, including cash from customer segregated accounts. The company filed for Chapter 7 bankruptcy on July 10 following an unsuccessful suicide attempt by Wasendorf. On July 13, he was arrested and charged with making false statements to regulators.
“If you’re happy, what’s the point of diversification?” Khan said. “I didn’t think there was a risk when money is in a [customer segregated] account.” He also believed that his account had been insured through Securities Investor Protection Corporation or SIPC.
But customer segregated accounts earmarked for futures trading are not insured — by SIPC or any other regulator because it’s illegal for the brokerage firm to touch that cash. That has led to investors’ assuming that they are somewhat safer than bank accounts. Customer funds at a bank are comingled and can be leveraged by the institution; the Federal Deposit Insurance Corporation provides as much as $250,000 in insurance per account. Commodity brokerages’ segregated customer accounts cannot be touched — at least in theory.
But in the last year, there have two spectacular examples of criminal activity in the world of commodity trading. PFGBest’s implosion follows more than a billion in losses by customers of MF Global, which used client funds from the commodity side to cover trades elsewhere.
“When you put [money into a customer segregated account], they cannot take it and use it as their own,” said John Roe, a commodity trader and spokesman for the Commodity Customer Coalition, a nonprofit formed by commodity brokerages following the MF Global disaster last fall. “That protection held fast for 75 years and in the last nine months it has been challenged twice.”
“Zero interest rates pushed [MF Global] to take risk,” he added.
Even as the commodity industry is likely to undergo new scrutiny to ensure that customers are not put at more risk, the coalition is lobbying for stronger protections.
But, of course, no law can require consumers to be smarter with their life savings, only advice.
“The rule applies that if it sounds too good to be true, then it’s not true,” Statman said.