The Dodd-Frank Fin Reg bill may extend the CFTC’s rules for retail forex trading to foreign trading platforms that are also marketed to Americans. This might mean U.S. resident traders won’t be able to evade CFTC rules for the proposed 10:1 leverage and the recent LIFO trading NFA rule change by using a foreign trading platform. Some foreign forex trading platforms offer 200:1 leverage and spread betting (no requirement for LIFO accounting).
The CFTC hasn’t finalized its January 2010 proposed rule changes for “Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries”, including a proposed reduction of leverage from 100:1 to 10:1.
A tax and regulatory attorney colleague replied to my questions on these issues: “Our Congress takes a very broad reach of the extraterritorial reach of our securities and commodities regulatory laws. Solicitation of customers who are U.S. persons — even though the solicitation is made outside the U.S. by a non-U.S. person — is covered. That is why, for example, foreign futures exchanges that want to offer their products to U.S. customers must obtain a 30.10 order from the CFTC qualifying them to solicit U.S. customers. As a practical matter, of course, enforcing that extraterritorial jurisdiction can be difficult (is the U.S. going to invade the Cayman Islands?)”
If 10:1 retail forex trading leverage is enacted by the CFTC/NFA, can U.S.-based retail spot forex brokers easily move their U.S. trading customers to their UK affiliates? It seems like the U.S. broker would be switching them to a foreign affiliate to evade U.S. regulations, and based on my colleague’s statement, I think it could be a problem.
U.S. forex traders may be left with two unfortunate choices. Trade on CFTC-sanctioned foreign OTC platforms respecting CFTC rules on LIFO and perhaps 10:1 leverage or take their chances in offshore tax havens (reportable on tax returns). Why go to foreign platforms if the rules are the same and perhaps invite more IRS questions? Why go to offshore havens if it’s potentially illegal and a tax problem – with the IRS scrutinizing offshore accounts?
Tax-haven platforms may never get CFTC sanction, so will they be illegal under Dodd-Frank, or, will it be a viable way to navigate around the U.S. forex trading leverage constraints?
Many comments published on the CFTC site say it’s a bad idea to chase U.S. forex trading business to tax and regulatory havens where there’s much more fraud. The way Congress wrote Dodd-Frank, it seems like it’s either going to be sanctioned by U.S. regulators or prohibited entirely. Can a U.S. person report forex transactions on their tax return from counterparties that are not sanctioned?
My colleague said Dodd-Frank Section 929Y has one reference to “extraterritorial” (which means ”foreign”) saying the SEC has jurisdiction to regulate extraterritorial swap contracts. We think this same extraterritorial concept may apply to retail forex trading too. The CFTC regulates retail forex, whereas the SEC has authority over swaps. The Dodd-Frank bill couldn’t possibly mention every point, leaving much to interpretation by regulators. We think the CFTC may interpret the legislative text to mean the CFTC has extraterritorial control over retail forex too. It would be too simple for Americans to avoid the new rules with foreign brokers otherwise. If the CFTC has extraterritorial powers on retail forex, then foreign-based brokers will probably not do business with non-eligible contract participants. Good size hedge funds and proprietary trading firms may be qualified participants. Foreign banks and brokers with U.S. affiliates will fear the U.S. regulators attacking their U.S. operations.
Might there be an opening for retail forex trading to move into prop trading firms — with traders joining these firms as partners — inside and outside the U.S.? By combining trading capital with other traders, a group of individuals may achieve eligible contract participant status. There are regulatory problems with prop trading firms too, as covered on this blog.
We’re working on these very important issues for U.S. forex traders. We hope to have more information on our conference call Thursday at 4:15pm ET. We discussed it on last week’s podcast too.
Excerpts from the Dodd-Frank bill:
Dodd-Frank SEC. 742. RETAIL COMMODITY TRANSACTIONS.
PROHIBITION-‘(I) IN GENERAL- Except as provided in subclause (II), a person described in subparagraph (B)(i)(II) for which there is a Federal regulatory agency shall not offer to, or enter into with, a person that is not an eligible contract participant, any agreement, contract, or transaction in foreign currency described in subparagraph (B)(i)(I) except pursuant to a rule or regulation of a Federal regulatory agency allowing the agreement, contract, or transaction under such terms and conditions as the Federal regulatory agency shall prescribe.
Dodd-Frank SEC. 929Y. STUDY ON EXTRATERRITORIAL PRIVATE RIGHTS OF ACTION.
(a) In General- The Securities and Exchange Commission of the United States shall solicit public comment and thereafter conduct a study to determine the extent to which private rights of action under the antifraud provisions of the Securities and Exchange Act of 1934 (15 U.S.C. 78u-4) should be extended to cover-
(1) conduct within the United States that constitutes a significant step in the furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors;
(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.
(b) Contents- The study shall consider and analyze, among other things–
(1) the scope of such a private right of action, including whether it should extend to all private actors or whether it should be more limited to extend just to institutional investors or otherwise;
(2) what implications such a private right of action would have on international comity;
(3) the economic costs and benefits of extending a private right of action for transnational securities frauds; and
(4) whether a narrower extraterritorial standard should be adopted.
(c) Report- A report of the study shall be submitted and recommendations made to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House not later than 18 months after the date of enactment of this Act.