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February 13, 2013

NFA Promises to Improve Auditing Procedures in View of Peregrine Fraud

By Anne Sherry, J.D.

The National Futures Association (NFA) announced that it will be adopting the audit procedure recommendations of Berkeley Research Group, LLC (BRG). An NFA special committee retained BRG to investigate NFA's audit practices and procedures and the application of those procedures to its audits of Peregrine Financial Group, Inc. (Peregrine). BRG issued findings and 21 recommendations designed to improve auditing operations, in particular to improve training and procedures and to increase professional skepticism among audit staff.

Background. Peregrine's president and chief operating officer, Russell R. Wasendorf Sr., used forged bank records to conceal the misappropriation of over $200 million in customer funds over a period of nearly 20 years. As the designated SRO for futures commission merchants, NFA was responsible for monitoring and auditing Peregrine for compliance with accounting and regulatory requirements. NFA conducted 27 audits of Peregrine between 1995 and 2012 but did not uncover the fraud until the auditors began using an electronic bank confirmation process in 2012. Both NFA and the CFTC were subject to scrutiny from legislators regarding their failure to detect the ongoing fraud.

Key findings and recommendations. BRG released its findings in a 160-page report of investigation. The investigation found that NFA audits were overall conducted competently and properly and that auditors implemented the required modules. BRG specifically investigated whether NFA auditors received a tip or complaint that Wasendorf was conducting a fraud and found none. The investigation also found that Wasendorf was able to conceal his fraud through the meticulous use of convincing forged documents given both to his staff and to NFA auditors. However, BFG found certain areas to be lacking, such as professional skepticism, training and staff support, and the audits' lack of focus on Peregrine's internal controls.

NFA response. BRG identified its key findings and issued 21 recommendations for NFA to improve its audit practices and procedures, particularly relating to training; improving professional skepticism; and testing an FCM's internal controls, outside auditor qualifications, and sources of capital contributions. NFA announced in a press release last month that management will adopt and implement the recommendations. The president of NFA, Dan Roth, said that NFA's "primary goal is to thoroughly review the BRG report and develop a plan to implement its recommendations" and present a plan to the board of directors in the near future.

Mr. Roth continued, "We are confident that the actions already taken by NFA and other regulators, along with the recommendations proposed by BRG, will help us to create a stronger regulatory environment and a better industry."

RegulatoryActivity: AccountingAuditing CommodityFutures

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