On August 18, 2016, the US Commodity Futures Trading Commission (CFTC) filed its first enforcement action against a registered retail foreign exchange dealer (RFED) for a violation of CFTC regulation 5.16.1 The enforcement action is notable in that it reiterates the CFTC’s expectation that RFEDs and futures commission merchants (FCMs) must comply with the prohibition against guaranteeing customer losses. Market participants that are regulated by other regulators (e.g., banks and financial holding companies regulated by the federal banking agencies) should be aware that an identical prohibition applies to their retail forex dealing activities.2
Section 742 of the Dodd-Frank Wall Street Reform and Consumer Protection Act amended the Commodity Exchange Act such that relevant regulators were required to issue rules authorizing regulated financial institutions to engage in retail forex. Between 2010 and 2013, the CFTC, US Securities and Exchange Commission (SEC) and federal banking agencies adopted retail forex rules for market participants subject to their jurisdiction.3 All of the relevant regulators imposed a prohibition against guaranteeing customer losses on regulated financial institutions that is similar to the longstanding prohibition imposed on FCMs and introducing brokers.4
In its complaint, the CFTC alleged that the RFED committed three violations of law: (i) failing to maintain required adjusted net capital; (ii) failing to notify the CFTC of a capital deficiency; and (iii) guaranteeing customer losses. The two capital-related allegations relate to the Swiss National Bank’s unexpected removal of its currency peg in January 2015, which caused significant market movement that resulted in the RFED being undercapitalized for two days. The third allegation states that until the events of January 2015, the RFED maintained a stated policy of zeroing out negative customer balances. Under this policy, if a customer incurred a negative balance through trading activity, their account would be credited in the amount of the negative balance. The CFTC alleged that by making this representation, the RFED guaranteed or limited those customers’ losses in violation of the CFTC’s retail forex rules. The CFTC did not address whether the existence of actual recourse by a customer was a prerequisite to finding a violation.
While the CFTC has previously taken action against FCMs and an unregistered retail forex dealer for violations of the prohibition against guaranteeing customer losses, this is the first such action against a market participant authorized under post-Dodd-Frank Act rules to engage in retail forex. Because the prohibition against guaranteeing a customer’s losses applies to all regulated financial institutions that are authorized to engage in retail forex, banks and other regulated financial institutions should be aware that regardless of prior market practices, the federal banking agencies may take a similarly assertive enforcement posture.
1 Complaint, CFTC v. Forex Capital Markets, No. 16-cv-06551 (S.D.N.Y. Aug. 18, 2016).
2 Retail forex is a transaction in foreign currency between a retail customer (i.e., anyone who is not an “eligible contract participant” as defined in Section 1a(18) of the Commodity Exchange Act) and a regulated financial institution that is (i) a future or option on such a future, (ii) an option not traded or executed on a registered national securities exchange or (iii) a certain type of leveraged or margined transaction.
3 78 Fed. Reg. 42,439 (July 16, 2013); 78 Fed. Reg. 21,019( Apr. 9, 2013); 76 Fed. Reg. 41,375 (July 14, 2011); 76 Fed. Reg. 40,779 (July 12, 2011); 75 Fed. Reg. 55,410 (Sept. 10, 2010). The SEC’s retail forex rule expired on July 31, 2016, and market participants registered as broker-dealers may no longer engage in retail forex. 81 Fed. Reg. 33,374 (May 26, 2016).
4 Compare 12 C.F.R. §§ 48.11, 240.11, 349.23 and 17 C.F.R. § 5.16, with 17 C.F.R. § 1.56.