securities the broker dealer can pledge to finance that credit it extended to customers. the rules also protect cash held for customers or derived from customer securities requiring the broker dealer to maintain a bank account, in an amount that exceeds net amounts owed customers. these funds cannot be invested in any instrument not guaranteed by full faith and credit of the u.s. government. together with applicable sec capital requirements, and protections under the securities investor protection act this is to ensure if a broker dealer fails, customer securities and funds will be available to be returned to the customers. the preferred, preferred method of returning securities customer assets in a cipa liquidation is to transfer the assets to a broker dealer. on december 9, the bankruptcy court approved the initial sale and transfer of all customer

accounts. it applied to approximately 318 accounts held for nonaffiliated securities customers. the trustee, since the transfer, nearly all former mf global customers have received 60% or more of their account value. 194 customers have received the entirety of their account balances. we understand the 194 customers include any one entitled to an advance with the claim, net equity up to $1.25 million. generally the rules governing protection of customer funds and securities have worked reasonably well over time. but we are considering whether there are ways they can be strengthened. the clarification and strengthened its of broker dealers including an auditor's examination of effectiveness of broker dealer controls relating to assets.

continuing to work with self regulatory organizations where sros strengthen broker dealer financial responsibility requirements. for example in june of last year, the sec approved a rule requiring the establishment of registration, qualification and examination and continuing education requirements for certain operations or back office personnel. including those who handle customer assets. this rule should help ensure that those responsible for these operations are fully versed in their legal on li investigations including those relating to segregation and protect, of customer assets. in february of this year, modernization task forcing, issued 15 recommendations including statutory changes. the sec staff is evaluating these wreck men recommendations as well. the sec is also engaged in a number of efforts both domestic

and international to share more and better data, qualitative assessments of firms and markets. some efforts include improved coordination with sros more frequent meetings with certain sros with financial oversight responsibilities. thank you again for the opportunity to testify on this important subject. i look forward to answering any questions you may have. >> thank you. mr. ketchum, please proceed. >> chairman johnson, ranking member shelby, and members of the committee, thank you for the opportunity to testify today. >> members of the committee, my name is richard ketchum, chairman, ceo of the finra. when a firm like mf global fails there is always value in reviewing the events leading to the failure and examining where rules and processes might be improved. clearly, continued impact of mf global's failure on customers who cannot access their fund is of great concern. and every possible step should be taken to restore the accounts as quickly as possible.

with respect to oversight of mf globals, financial and operational, finra shared oversight, and the chicago board operations exchange the designated examining authority. when finra its not for a broker dealer we work closely and routinely analyze the focused report filings and annual audited financial statements as part of our ongoing oversight of the firm. while that monitoring focuses on a broad range of issues it is particularly relevant to note our surveillance team, placed heightened focus on exposure to european sovereign debt. during april and may, we began surveying firms their positions in the instruments. in a review of mf global audited financial statements, filed on may 31st of last year, our staff raised question as but a footnote disclosure, regarding

portfolio. during discussions with the firm, finra learned a significant portion of the portfolio was clat rise collateralized by $7.6 billion. they're afforded sale treatment and therefore not recognized on the balance sheet. notwithstanding that accounting position, the firm remains subject to credit risk throughout the life of the repo. beginning in mid june, finra had discussions with the firm regarding the proper treatment of the rtm portfolio. our view was that while recording the repos as sales consistent with gap should not be treated as such for purpose of the capital ruled and market and credit risk those positions carried. as such we asserted capital needed to be reserved against the position. finra and cboe, had discussions with the sec about our concerns. the sec agreed that the firm should hold capital against positions. the firm fought this interpretation throughout the

summer appealing to the sec before conceding in late august. mf global infused capital and made filings. on august 31st and september 1st that notified regulators of the identified capital deficiency and the change in that capital treatment of the rtm portfolio. following this, finra added mf global to alert reporting, heightened monitoring process whereby we require firms to provide weekly information including net capital and reserve formula computations. during the week of october 24th, as mf global's credit rating declined and the credit rating was cut, finra increased the rating at the firm. at the end of the week, finra was on site at the firm with the sec as the it became clear, mf global was unlikely to continue to be a viable stand alone business. our primary goal was to gain an understanding of the custodial locations for customer securities, and to work closely with potential acquirers in

coach of avoiding liquidation. as has been widely reported, while finra believes financial securities rules of the sec combined with cipa provide a good structure for protecting customer funds. firm failures provide an important opportunity for review and analysis of where improvements may be warranted. finra's identified changes to better protect customers and their funds. through the process and in terms of coordination with regulatory counter parts. most recently finra and chicago mercantile exchange established calls so our respective staff can share information about the approximately 50 firms that are broker dealers and fcms. we've initiated a series of briefings for domestic and international regulators and securities and futures. our next briefing will be in june and we've expanded a list of regulators and sros included in the event. we have also continued our work

on room making efforts enhancing surveillance. finra firms must capture more granular detail about a firm's revenues and expenses. and last week, finra's board approved a report that would affirm the firm's net capital, leverage, and liquidity. finra shares your commitment to reviewing mf global's collapse. we will continue to review our own rules and procedures and reach out to our federal regulators to identify areas where current processes may be enhanced. again, thank you for the opportunity to share our views. i'd be happy to answer any questions you may have. >> thank you. mr. duffy, please proceed. >> chairman, members of the committee, thank you for the opportunity to testify respecting the collapse of mf global. i have previously testified respecting mf global's misuse of segregated customer funds and cme's efforts on behalf of customers. today i will summarize our

efforts and the industry to restore customer confidence. the shortfall in customer segregated funds was limited to the funds under mf global's control. the customer funds held in segregation by cme's clearinghouse to cover futures positions were complete. our ability to transfer the positions and the collateral of our customers was undone by a provision in the bankruptcy code requiring prorata loss sharing among all customers. we believe that congress can help protect customers whose collateral is safeguarded at a clearinghouse. it can do that by changing the bankruptcy code to permit clearinghouses to transfer fully collateralized customers to other clearing members despite a failure of their clearing member. the industry is united in its search for solutions that will restore confidence in regulated futures and derivatives markets. obviously changes in the bankruptcy code are not easy or quick. and it is constructive to look at a wide range of actions that can be implemented without legislation.

cme group along with other exchanges and the national futures association has proposed four forms of intensified reporting to prevent misuse of customer funds. the futures industry association on behalf of its members also proposed enhanced reporting and greater transparency. cme group is already implementing proposals which will include one mandatory daily reporting of segregation statements by all fcms. two additional surprise reviews of segregated accounts. three, a requirement that the fcm's ceo or cfo sign all payouts exceeding 25% of excess segregated funds amounts. plus, immediate notification to cme and four, a bimonthly report how segregated funds are invested and where they are held. cme has also challenged the industry and the commission to consider whether other solutions will better serve the interests of customers and the industry. in addition to the proposed amendment of the bankruptcy

code, cme working with the clearing members to find a structure that will protect their collateral against fellow customer and fraud risks. we are committed to finding a solution that will provide strong protection for the segregated funds from a legal, operational, and cost benefit perspective. without destroying the industry's business model. in addition to these regulatory initiatives, we also recently launched the cme group family farmer and rancher protection fund. this fund is designed to protect family farmers, ranchers, and the cooperatives in the event of shortfalls and segregated funds. we hope these steps will give additional confidence to u.s. futures markets after the actions and failure of mf global. the misconduct of mf global, however, should not serve as a reason to undermine the current system of front line auditing and regulating by clearinghouses and exchanges. some critics subject that the current regulatory system is compromised by conflicts of interest. there is no conflicts of

interest in cme's duties to the cftc, the customers, and the shareholders. cme's duty to a shareholder requires that it diligently keep its markets fair and open by vigorously regulating all market participants. federal law mandates an organizational structure that eliminates conflicts of interest. the current regulatory model has served the futures industry, its customers, and the public very well. we look forward to working with the congress and the regulators to enhance customer protections and foster confidence in our markets. thank you for your time this afternoon. >> thank you. i would like to thank all of our witnesses for their testimony. as we begin questions, i will ask the clerk to put five minutes on the clock for each member. judge, just to be clear, given that $1.6 billion of customer funds has yet to be recovered due to mismanagement or possible

illegal transfers by mf global, can you commit to us today that your office will not be seeking bonuses for any former or current mf global employee? >> as some type like insurance coverage had been in place for a commodities accounts, how would that have impacted the transfer of client positions? other fcms as well as the claims distribution process for former customers of mf global? do you believe that congress should study the idea of extending to commodities accounts and insurance coverage similar to that provided for

accounts under the securities investors protection act? yes, cipa proceedings which govern broker dealers contain essential and well-established procedures for contemplating and facilitating transfers of accounts to other solvent broker dealers and provide mechanisms for the prompt payment of customer claims. while all of this is greatly facilitated because there is the financial support of the cipa fund, which has in the case of cipa several billion dollars of assets and the ability to assess the industry for additional funds. those funds would assist if it were necessary to cover shortfalls to enable a trustee

to transfer accounts to other solvent -- by analogy other solvent scms. i think as mr. duffy was alluding to, there are problems here because under the statute you have to to distribute equally on a prorata basis. so i believe, yes, if you had a fund which would give you more flexibility as a trustee, you could more rapidly transfer accounts and at least have that as available in your arsenal of things to move things along. >> commissioner, could you describe any legal actions or other efforts the cftc has taken to recover the margin $700 million of u.s. customer funds being held in the uk? how is the work of the cftc in this area been coordinated with mr. giden's efforts to protect

u.s. customers subject to cftc regulation 30.7? >> thank you, senator. the cftc does not have the authority to bring an action in the uk court proceeding, but we are as we are in the united states working very closely with mr. giden and his staff. the law firm that he has hired to represent the bankruptcy in the uk, in front of the english court, and we will continue to monitor all of the different actions that happened in that proceeding. >> do you have anything to add? >> just to confirm that we do confer frequently with the cftc about the strategy in the uk and the nature of the legal issues.

equally we have to the extent we can have shared information with judge freeh regarding that proceeding. our view, of course, is all of those funds in the uk are segregated assets that belong to the 30.7 customers of the broker dealer. >> mr. duffy, do you have any views on the fia recommendations offered last month to better protect segregated customer accounts? also, would it be valuable for sros in the cftc to receive daily electronic backup documentation on these accounts directly from clearinghouses d custodial banks reported by fcms as accurate?

>> let me take the latter first as far as the daily reporting from the sro and the cftc to the exchanges. i am a big believer, senator, in transparency in realtime reporting. it's hard to argue with that. the reality is, what's the practicalti tity of getting tha done? if people were having multiple books or nefarious activities, it would be very difficult to detect what happened in the mf global situation. so as much as i support realtime tieouts, i think there is a lot of information that still needs to go into that. as far as the fia's recommendations on the sign-offs and some of the things they've proposed, they're supportive of their recommendations. >> i note that senator shelby has temporarily left the committee hearing to attend an

appropriations hearing. and he will be back. senator corker? >> thank you, mr. chairman. and thank all of you for your testimony. and i sit through most of these hearings. i have to say it almost gives you a headache to think about all the various regulators involved in one entity. and we created that, y'all didn't, i'm not saying that. it does seem like there's a lot of silos and various areas that each of you look at that don't overlap properly and what i'd like to do is ask mr. gedings and judge freeh, what happened? and what happened to the -- what happened to the customer accounts? how did the money end up in places that it was not supposed to end up? we've talked about everything but that here today. >> uh -- our analysis of what

happened and where the money went i think is substantially concluded that's the first phase of the think, is substantially concluded. that's the first phase of the process. because of the liquidity crisis in the last week, something like $105 billion in cash went out of the firm to banks, depositories, some to commodities customers, some to securities customers, in what on the surface appear to be ordinary commercial transactions. a great deal of this was caused by customers leaving the firm and asking that their assets be transferred out of the firm. also, the firm had to scurry around to find additional collateral. additional collateral was

required with respect to the repo to market transactions which went from something like $200 million to maybe $900 million additional collateral required. in these firms, cash is moved around from various accounts on a daily basis. and it is possible that if mistakes are made and you say we have excess in one category, you can use it to move to another, and with so much happening in one week and so many volumes of transactions, that's where we think what accounts for the mistakes. so we know -- we can trace where the cash and securities in the firm went. and that we've done. the second, more complex phase, which we're also aggressively

pursuing, is to get as much of that back if we have an appropriate legal theory to do that, and we've done that. we've had some success to date and will continue to pursue that with a goal of getting back as much of the property as we can. >> let me ask you this question. we kind of all get the picture of what happened, a lot of money was moving around quickly, the firm was in a desperate state. with all of that occurring, regardless of the umpteen million regulators that look at this, i mean, the fact is how do you keep that from -- how do you keep, at the end, money going out of a customer account inappropriately some other place? how can even a regulator at that instant keep that from happening? >> given the fact that so-called operational personnel can move funds, have the authority to do

it, it's almost not possible to build a foolproof system which would -- the checks that you have were the reporting requirements and also the totaling-up on a daily basis of what the segregation requirements should be. if there are substantial mistakes in that, it permits someone to say, theoretically, i have an excess in the commodities funds, therefore, i can transfer that to the securities accounts, or vice versa. we had an example shortly after i was appointed. i had a call from mf global itself saying, we have wrongly transferred $220 million from the securities accounts to the commodities accounts and we would like to reverse that. how that was done or who authorized it or whatever, we

can't say. but clearly there were mistakes being made. and part of this -- as i say, the processes that most people don't realize is relatively low-level operational people at any given time have the authority to transfer hundreds of millions of dollars -- >> was there an investment committee? i mean, when you -- is there personal recourse to the executives when these kinds of things happen? i mean, is there a way to deal with them on a personal basis against their personal assets? and secondly, was there any kind of investment committee or internal controls that existed there to keep this kind of thing from happening within the firm, and if not, are there other firms to your knowledge that have these same problems? >> on the personal liability, i think there are -- well,

personal view and people working with me view is that there are discrepancies so that seniors and higher-ups who do not directly authorize the young vice president to move money are probably -- very difficult to suggest that they are personally liable. that's one of the reasons i suggested that we look at that and begin to consider saying, it's not enough when you're managing the firm, determining the investments and the overall strategy, if you in effect create the liquidity crisis, that you will bear some responsibility if there are shortfalls in customers' property. i think it's certainly -- >> and just -- i know i'm running out of time. i'm actually over. were there internal controls or investment committee, was there any discipline within the firm that kept one person from making a big bet in the company going haywire?

>> there was -- my understanding was there was a -- an investment committee, there were risk officers at the firm. there were examples of where recommendations were not taken by the risk officer and under perfectly legitimate corporate structures, senior officers could choose to ignore that. and our view at mf global, from our analysis of its operations, was that the firm was poorly capitalized and had liquidity crises, highly leveraged before mr. corzine came to the firm, and, in fact, those problems continued. they certainly went through the motions of having operational

supervision and risk supervision and the like. how effective that was, i think, is demonstrated by the ultimate failure of the firm. >> mr. chairman, thank you for the time. >> senator menendez. >> thank you, mr. chairman. thank you all for your testimony. mr. giddens, mr. freeh, let me ask you, i just heard your response to senator corker's last question, that mf global is poorly capitalized, had a liquidity crisis, that it was highly leveraged. was that in essence the harbinger of its doom? >> that was certainly a large contributing factor, so that if they had a crisis there was not much of a cushion to fall back on. i think also would be the nature of their investments in risky european sovereign debt of

countries such as i believe italy, spain and ireland. with a result that since those were purchased on margin, the margin amounts and the collateral put up had to be continually increased. so that toward the end, as i recall, something in the neighborhood of $200 million to $300 million in margin became closer to $900 million in margin that had to be put up. so all of that created much more severe strains on the firm. >> senator, also in addition to that, a critical factor was the -- really the inability of its i.t. and technology system to just keep pace with the trades and to even to record them . in the last few days there's many nonrecorded trades. record. in the last few days there's many nonrecorded trade record t. in the last few days there's many nonrecorded traderecord th. in the last few days there's many nonrecorded trades. even now to reconstruct what happened there is really difficult. the i.t. system and the technology was not equipped for

the frenetic pace of trading in the last several days. and that combined with the miscalculation, using the most generous term at this point subject to investigation, of what was segregated and what was not segregated and the inability to control and track the trades and the accounts, was just a perfect storm for the disaster that occurred. >> so you clearly had between poor capitalization, liquidity crisis, highly leveraged, and inferior technology ability, a structural problem at mf global. let me ask you this. has it been part of your effort and review to determine what individuals, at what level -- i'm trying to think of here structure more than an individual. but what individuals created the set of decisions that created the challenge that we have? >> yes, senator. i mean, that's the subject both of my investigation and mr. giddens'. we