Is U.S. Forex Trading Safe?

Is forex trading safe in the U.S. even with RFED or FCM duly registered brokers with the NFA/CFTC? U.S. forex brokers don’t have “segregation of asset” money protection rules, whereas futures brokers are subject to those rules. The new CFTC forex rules call for higher minimum net capital requirements for RFED forex brokers vs. futures brokers, so that helps cushion the concern about money protection issues. 

For warnings about hidden problems with forex brokers, see Erskine vs. CFTC 06-3896. The CEO of Rockwell Trading brought up this court case and discussed his concerns about forex brokers and their platform markets on our Oct. 27 Webinar. The CEO focused in on this quote in the case: This forex market, which is central to this case, is not a public market, but is instead a “negotiated market,” in which–according to the parties–foreign currency prices (the prices used for the trades in this case) are “constructed” by the FCMs using “software to process and distill currency prices offered by numerous banks and come up with an indicative market price.”

As I said on that Webinar, keep in mind that this court case occurred before the new CFTC forex brokerage rules went into effect on Oct. 18, 2010. The retail forex industry should be run better with the new rules. Later in the call, we circle back on the “segregation of asset” rules; we will try to do more research on it for next week. 

We noticed a troubling NFA news release dated Oct. 28, 2010 “NFA orders $459,000 monetary sanction against New Jersey forex firm Gain Capital Group LLC.” Read the text of the entire Complaint included in the release. 

Here’s another similar NFA fine of $320,000 against New York forex firm IKON Global Markets. Per the NFA release, “The Complaint alleged that IKON engaged in certain price slippage practices on the MetaTrader platform that were favorable to IKON and caused disadvantageous trading conditions for certain customers. The Complaint also charged that IKON failed to supervise the MetaTrader platform used for their forex business, and failed to supervise the firm’s operations.” I wonder if “slippage practices” are what Rockwell Trading CEO is warning us about?

The CFTC and NFA are scrutinizing forex brokers more now after their Oct. 18, 2010 effective date for RFED registrations in accordance with their new CFTC rules for forex transactions, sanctioned by Dodd-Frank Fin Reg too. The NFA website has several good new guides including Forex Transactions: A Regulatory Guide.

American forex traders are being forced to trade with no more than 50:1 leverage on the major currencies (20:1 on minors), FIFO (no hedging rule) and without any form of money protection. Because leverage with currency futures is not far off 50:1 (30:1 on the CME, for example), hedging may be easier with futures, and futures brokers must segregate assets for some protection. We will compare tax treatment between forex and futures next week. More forex traders may want to consider trading currency futures too. 

Offshore Forex Trading Is Heading Back To U.S. Shores

New CFTC retail forex rules are going into effect exactly as we thought they would. Although we’re still waiting for more formal guidance from the CFTC and NFA, they both have improved their Web site sections on the subject. 

Foreign accounts transferred back to the U.S.
Most U.S.-based retail forex brokers (not banks) are registering with the NFA as RFEDs. If they don’t register their foreign affiliates as RFEDs too, they’re automatically transferring all U.S. resident retail forex trading accounts back to their U.S. RFED firms, by the CFTC’s Oct. 18 deadline. The trader has no choice in the matter.

Remember, the new retail forex rules do not apply to “eligible contract participants,” which are large non-retail accounts defined in prior blogs and in the rules. We’re noticing that more and more offshore brokers who first thumbed their noses at the new rules are falling into line and respecting the rules. 

Foreign commercial banks unaffiliated with any U.S.-based FCM or RFED may have a 360-day extension from registering as a U.S. financial institution. We heard they may have 360 days from the date Dodd Frank Fin Reg was enacted (July 21). We have not confirmed this yet, though. 

Dummy offshore corporations: Not a good idea
Even if you hear from some that the CFTC may focus its enforcement efforts against foreign unregistered intermediaries rather than on individual traders, it’s important to understand the CFTC considers evasion a “prohibited transaction.” Forming a dummy offshore corporation to open a retail off-exchange forex trading account with an unregistered offshore bank or broker is considered evasion, according to the CFTC. Attorneys, CPAs and financial advisors who suggest using dummy corporations to evade these CFTC rules may face challenges by their professional license boards and bars on infractions to their ethical codes of conduct. 

If you are foolish enough to use a dummy offshore corporation in this regard, you still need to disclose your American ownership of the corporation to your foreign broker, who may deny the account treating it as an American-owned account. If you don’t make that “know the client” disclosure, the broker may have grounds to take action against you. 

RFED U.S.-based forex accounts lack protection
Commercial banks like Citi FX Pro offer FDIC insurance protection and segregation protection in bankruptcy. Securities brokers offer SIPIC protection. Futures brokers don’t have any quasi-governmental insurance protection, but at least they have a “segregation” of assets regime in a bankruptcy filing, which is a lesser form of protection. 

The problem for RFED forex brokers in the U.S. is they don’t have a quasi-governmental insurance program and they can’t even offer futures segregation protection in a bankruptcy filing either. For this reason, some U.S. forex brokers previously suggested that their clients use their affiliates offshore. We heard that the UK offered some money protection on forex brokerage accounts. 

In a bankruptcy filing in the U.S. (think Refco), segregated futures accounts have seniority over other creditors and equity holders, so futures account holders get paid first. The problem for forex accounts with RFEDs is that futures segregation regimes aren’t respected on forex accounts in bankruptcy filings because the rules refer to futures traded on exchanges and forex is traded off exchange. This is an oversight from Congress. This is not the case for commercial banks; only brokers. 

A CFTC official told me he feels forex is still safer under their new rules with registration of RFEDs, minimum capital requirements, better disclosure and lower leverage. There may be some money protection issues in the UK, but working with an unregistered broker or bank and using unlimited leverage might make it more unsafe overall. Traders may have trouble and higher costs seeking remedies in foreign jurisdictions too. If a retail trader enters a prohibited transaction working with an unregistered RFED offshore, he may not have rights to use U.S. courts either. Some forex brokers in the UK and other jurisdictions may register with the NFA as RFEDs and then continue to offer money protection in the UK, although they will still need to adhere to the new CFTC rules on leverage and more.

Bottom line
If you trade retail forex off exchange, make sure your broker or bank is duly registered in the appropriate manner with the CFTC, as either an RFED with the NFA or a commercial bank (U.S. or foreign) with U.S. bank regulators. Both RFEDs and commercial banks may offer leverage up to 50:1 on the major currencies. Only the commercial bank may offer protection on your money. Skip the idea of setting up a dummy offshore corporation to work with a non-registered foreign broker or bank. 

Questions Linger Regarding New Forex Rules

Congress and regulators have thrown the forex trading industry a huge curve ball and we are all scurrying to get answers to important questions.

Many questions remain regarding trading offshore to evade leverage and other constraints posed by the new CFTC rules. Today we try to answer a few more questions along these lines. The answers are still unclear, and we await new NFA guidance, which was promised to one forex dealer executive. A forex dealer executive told me the NFA may actually be waiting on the CFTC regarding the overseas issue, and he expects it will take more than a few days. The overseas firestorm is probably underway. 

According to one leading forex broker executive, the CFTC author of these new retail forex trading rules said the Dodd-Frank (DF) change classifying financial institutions (FI) as “U.S. only” (see CFTC Q&A “who can offer..” section) won’t be made for 360 days from DF enactment (7/21/10). This gives EU banks offering forex trading to U.S. customers time to register in the U.S. But I think FI refers to banks and not CFTC-registered FCMs, which probably include the FDMs (forex-dealer merchants, the prior designation) too. The DF list has FI, SEC-registered and CFTC-registered companies, plus insurance companies and more. FI and FCM seem to be different categories.

So if this forex broker says its U.S. retail forex traders using offshore platforms from its affiliates have more time to close accounts, that may not be true in my view. If the foreign account is deemed a foreign affiliate of an existing CFTC-registered FDM, then using the 360-day extension seems inappropriate to me for financial institutions. If it’s a foreign institution such as an EU bank with no U.S. CFTC-registered FCM or FDM registrations, then maybe it’s okay to use the 360-day extension. 

Hopefully the NFA and/or CFTC will clarify this important issue soon. There are plenty of people asking these important questions, as thousands of Americans have offshore retail forex trading accounts.

It makes sense to me that DF gives 360 days to foreign institutions to form U.S. affiliates if desired. To spring a prohibition on foreign financial institutions offering forex trading to U.S. customers as of Oct. 18, 2010 (the effective date of the new CFTC rules) would be extremely undiplomatic on a global country-by-country dealing basis. There may be lawsuits and diplomatic requests made and this takes plenty of time to deal with properly.

This type of financial transaction/trading protectionism is rearing its ugly head on several international stages already. The U.S. is upset about EU rules and proposed rules requiring U.S.-based investment advisers to register in the EU for a required “passport” to raise money from EU investors. This is a huge problem for the U.S.-based investment-management industry. EU banks are upset about new U.S. “FATCA” tax rules requiring EU banks to report to the IRS U.S. customers in their ranks. FATCA ties in with this FI U.S.-only forex trading rule too, as it can help enforce it. 

According to the forex dealer executive I spoke with, the NFA plans to issue a notice to members perhaps today or in a few days to clarify DF and the new CFTC retail forex trading rules, mostly for implementation issues. This expected notice may not speak to the foreign trading issues, although hopefully it will. 

One big implementation issue is how currently CFTC-registered FDMs (under CRA) go about converting their registrations to the new DF-category of RFED. Will this be automatic? How can FDMs make many changes in their registration by Oct. 18, the implementation date for the new CFTC rules? 

This executive said many U.S. forex dealers currently use offshore platforms and affiliates for segregation of funds in the UK for asset protection purposes. He said if a person files for bankruptcy in the U.S., their UK forex trading account capital and rights are protected from U.S. bankruptcy courts. Leverage is unlimited in the UK, but usually 100:1. U.S. customers avoid the NFA’s controversial hedging rule when trading in the UK. He said capital isn’t a big issue because many U.S. forex dealers can absorb more U.S. customers to repatriate from the UK and other international affiliates. I presume leading forex dealers can move UK capital back to U.S. too as needed. This executive says non-residents (international business) may want to stay in the UK since the U.S. leverage is lowered to 50:1. He said U.S. platforms can handle things. The biggest concern is upsetting some U.S. clients who already set up foreign-based accounts and now may have to redo all the paper work back into the U.S. 

U.S. FDMs in the forex dealer coalition are fine on these new rules per this executive. Most are already registered as FDMs and compliant with the NFA, and 50:1 leverage is reasonable in their view. They expect the RFED change to be fairly easy to accomplish. 

I see a big problem for foreign forex dealers operating from tax havens. Most don’t have U.S. operations or branches and they won’t want to register in the U.S. Registration for foreign companies probably requires a U.S. operation, subsidiary or branch office designation. Branch office taxes can lead to trouble on Section 482 transfer pricing tax issues (where the profits are booked). If the IRS finds trouble with tax haven cheating, it can pounce on these institutions. Therefore, I presume many tax-haven forex dealers may lose forex trading business to CFTC-registered RFEDs who will be happy to win back this business. 

Forex IB (Introducing Broker) CFTC-registration changes are important too. The final rules are better than expected from the proposed rules. With final rules, a forex IB can simply register with the NFA on its own in the same manner as futures IBs do now. They don’t need that troublesome (proposed rule) guarantee from an FDM, although they have that choice too. Few FDMs want to take that kind of risk or tie up their capital by guaranteeing a forex IB.

There are many characters in the forex industry that inappropriately blur the lines between education, investment advice, money management and other related services. Many of these forex players may be drawn into registration in some capacity with the NFA and CFTC, perhaps as an IB, and many will want to avoid that registration for many different reasons. Some may have trouble passing NFA back ground checks. Others don’t want the NFA oversight over their perhaps fraudulent or inappropriate business models. Many don’t want to be burdened with other rules like disclosure and reporting. Many will surely have trouble with the conflicts of interest rules too.

The attorney and author of this article said to me via email: I spoke with an attorney at the CFTC Monday who is dealing with these rules. His interpretation was that because of the change to the CEA by Dodd-Frank from “financial institution” to “U.S. financial institution”, overseas forex intermediaries that are not registered as FCMs or RFEDs will not be able to serve as counterparty to U.S.-based retail investors with respect to OTC forex transactions. This would apply to futures and options and futures “look alike” contracts. I say that the enforcement issues are unresolved in our article both because of the practical realities involved in enforcing this rule and because this was just an opinion of one regulator, not of the Agency.

Excellent comment on our FaceBook page:
Robert: I spoke with both the NFA and the CFTC by phone. The most knowledgeable was a guy in the compliance dept at the CFTC. He says the rules apply to any brokerage, foreign or domestic, that wants to do business with U.S. traders. So, while the regulations are not aimed at traders themselves, they are indeed aimed at any/all brokers that do business with U.S. traders. In other words, if we have accounts at FXCM UK or Dukascopy (Switzerland) or anywhere else in the world, the CFTC will force those brokers to change our leverage to 50:1. The only good news I heard was the definition of what the “major currencies” are. Apparently the NFA has a list of what it considers the major currencies. This is in the Financial Regulations section of the NFA manual. Fortunately this includes (in addition to USD) the EUR, GBP, JPY, CHF, CAD, AUD, NZD and even the Norwegian, Swedish and Danish currencies. In other words, any currency that retail traders are likely to trade will be at 50:1 not 20:1. I can live with that. I’m not happy about the excessive intrusion of our government into our business, but I can live with this.

New CFTC Forex Trading Rules Call For 50:1 Leverage

The CFTC has published its highly anticipated final rules for trading off-exchange retail forex. As discussed on prior blogs, the recently enacted Dodd-Frank Fin Reg bill forced the hand of the CFTC to act by Oct. 19 because it would otherwise bar non-eligible contract participants from off-exchange retail forex trading. The CFTC acted in the nick of time because these new rules are effective on Oct. 18, 2010 — one day before the Dodd-Frank deadline. 

Some of the changes are crystal clear — like new 50:1 leverage limits on major forex currencies — but the equally important rule about allowing or barring offshore trading is not yet clear per documents published to date. One off-exchange retail forex broker concluded Tuesday that offshore trading won’t be allowed after the effective date, implying that offshore forex brokers will have to register with the CFTC as well and will be subject to these same new rules. 

The CFTC’s new leverage rule calling for a minimum 2 percent deposit on trading major forex currencies off exchange (50:1 leverage) seems on par with what commercial banks like Citi FX Pro offer their retail forex trading customers now. 

It’s a wise move by the CFTC to reduce leverage by two times — 100:1 to 50:1 under the new rules — rather than going way over board with its original proposal of 10:1 leverage. Unlike most off-exchange retail forex dealers in the U.S., Citi FX is not regulated by the CFTC; it is subject to bank regulation. 

It’s important to note the CFTC grants the NFA powers to set leverage rules higher than these new minimum percentages. 

Thankfully, the CFTC responded to the pleas from the off-exchange retail forex trading industry saying the CFTC’s proposed 10:1 leverage rule would put the industry at a huge competitive disadvantage to on-exchange currency futures trading (30:1), commercial bank forex trading (50:1) and offshore off-exchange retail forex trading (200:1). The new deposit rule for non-major currencies is 5 percent (20:1).

Regulators and Congress are often sensitive to chasing business (and fraud) abroad with new rules as well as taking business away from small businesses and handing it over to big banks. The CFTC also wants the U.S. to remain competitive for foreign traders, as foreign traders can continue to trade offshore without concern about registration in the U.S. 

It seems these new rules will put a stop to Americans trading retail forex offshore to evade CFTC rules. That trend picked up the pace in recent years and it may need to be reversed quickly. But we aren’t completely certain of this yet. We will study the new rules and see if offshore trading remains feasible for Americans under extraterritorial provisions of the Dodd-Frank Fin Reg bill. (We discussed how offshore trading might be a problem for American’s using offshore forex platforms on our recent blog and podcast.) 

We base our initial thoughts on the first documents released by the CFTC (links below). In the CFTC’s Q&A document, see the “Who can offer off-exchange forex transactions to retail customers” section. It states that Dodd-Frank Fin Reg changed the definition of allowable financial institutions to “only U.S. financial institutions.” The next section, “What is the scope of the CFTC’s jurisdiction,” implies that unless the entity is regulated by the SEC or bank regulators – again for U.S.-only financial institutions – the default catchall regulator is the CFTC. It makes sense that the CFTC would act in this manner, but again, we aren’t certain of these rules yet. Nothing in these CFTC documents specifically exempts offshore forex platforms or brokers from these new rules, either. Stay tuned for further observations.

For more information: 

CFTC releases final rules regarding retail forex transactions: Click here. 

Final rule regarding retail foreign exchange transactions (summary): Click here.

Federal Register: Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries:Click here.

Questions and answers regarding final retail foreign exchange rule: Click here.

CFTC unveils retail currency-trading rules: Click here.