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Spoofing, Surveillance and Supervision

Jay Biondo, Product Manager - Surveillance at Trading Technologies, co-authored an article along with James Lundy and Nicholas Wendland, both of Drinker Biddle & Reath LLP, reviewing the CFTC's regulations and expanding efforts, 21st century surveillance and supervision, as well as strategic recommendations.

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June 13, 2007

Growth Can Mean Toxic Clients: Can the clearing firm solve the ultimate contradiction? Can the fir

By Gregory Bresiger

Atul Kamra, president of First Clearing, says his firms feels pressure to grow but the wrong kind of growth can "actually hurt" a clearer in the long run. A financially disadvantageous relationship happens when a clearer, trying to sell a new a client, offers a rate that is too cheap or makes a promise that he can't deliver on.

"You get overzealous about growth," Kamra says. "And when you have a client that doesn't fit, that is unhappy about unfulfilled promises, the clearer's bad reputation "spreads like wildfire," he says.

Indeed, Ferguson, with some 30 years in the securities industry, asserts that almost every clearer in the business for more than a few years has run into problems with fit. Usually the problem has come from clearers changing their rules for a line of business or a new firm they don't understand, he says.

You're Stuck

"What happens to firms is that they may get stuck and be a victim of a scam," he says.

How does that happen? The clearer examines the U-4 forms of the principals of the firm, but doesn't thoroughly examine the U-4s of all the producers, according to Mumby, the Baltimore consultant.

"Know their history of doing business, including all of the producers," he says.

The clearer, Ferguson notes, is at fault because, in his zeal to obtain new business, he made many exceptions to his own risk standards. Ferguson refuses to give small brokerages extensions in settlement procedures. He closely watches that smaller clients always meet net capital requirements.

And Ferguson cautions colleagues at other firms that, if they feel uncomfortable about any aspect of a client's business, they shouldn't shrug it off as the broker's problem and wait until the regulator starts to do something.

Too Late

Regulators usually won't disclose problems at an introducing broker until sanctions have been imposed, he notes. By then, it will likely disrupt the clearer's business. Clearers should be careful, Ferguson says, if they expect to be able to head off trouble before it happens.

"If one of my small brokers calls up, and has a customer who wants to deposit $20 million, it sounds great. But one has to remember that young brokers are the most likely to be scammed," according to Ferguson.

He always views these kinds of proposed transactions skeptically.

"I look at those kinds of things," he says, "and always ask, Why do they want to deposit a big amount with me?''' Another red flag is if the money is only going to be parked at his firm for a short time, he says.

Sometimes Ferguson turns down a client even though he believes his firm is a good match and could do an effective job. He says the "style" of a broker's business will sometimes bother him. For example, he doesn't like brokerages that cold-call because many of their clients will renege on transactions.

"And when you see a pattern of reneging, you anticipate that there are problems to follow," Ferguson says. Reneging can also mean losses for the clearer when transactions go bad.

Clearers must know themselves very well, industry analysts say. However, they should know their clients even better.