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NFA submits proposed forex rules to CFTC

On June 2, NFA submitted proposed rules to the CFTC regarding NFA Forex Dealer Members. The proposed rules will impose additional regulatory obligations on Forex Dealer Members in an effort to provide increased customer protection to retail forex investors. NFA's Board of Directors approved the proposed rules at its quarterly meeting in May.

"This proposal has gone through a number of drafts, and the industry has had significant input throughout the process," said NFA President Dan Roth. "We discussed this proposal with NFA's Board of Directors, Executive Committee and our FCM and IB Advisory Committees, as well as our Forex Dealer Members and the Futures Industry Association."

The Commodity Futures Modernization Act of 2000 (CFMA) provides that firms can offer off-exchange foreign currency (forex) transactions to retail customers if they qualify as "otherwise regulated entities", such as FCMs, broker-dealers and insurance companies. Two related issues have resulted from this provision.

"A number of firms that have never done any futures trades and never intend to do any futures trades have recently registered as FCMs and become NFA Members," said Roth. "They have done this for the sole purpose of qualifying as 'otherwise regulated entities' so they can do retail forex trades outside of the Commodity Exchange Act. From NFA's perspective, these firms are not really otherwise regulated because all of our rules apply to exchange-traded futures and options transactions and do not generally apply to off-exchange forex transactions."

To address this problem, NFA created a sub-category of membership for forex firms. NFA Compliance Rule 2-36 prohibits these Forex Dealer Members from engaging in fraud in connection with these transactions.

Another issue related to the language in the CFMA is that, although the "counter party" to the forex trade must be an "otherwise regulated entity", the person actually working the phones selling the product can be completely unregulated. Hundreds of unregulated entities currently solicit business on behalf of Forex Dealer Members.

In fact, NFA has received information that several individuals either disciplined or expelled from the futures industry have been linked to these soliciting firms. During the last two years, NFA has reviewed more than 100 customer complaints relating to forex activities and has taken three Member Responsibility Actions, including two against Forex Dealer Members, for forex activities.

"Compliance Rule 2-36's anti-fraud provisions provide a starting point for protecting customers of Forex Dealer Members," said Roth. "We believe, however, that additional regulatory requirements are needed to protect those customers against unethical business practices and loss of funds due to insolvency or related problems."

The proposed rules would:

  • Change the definition of Forex Dealer Member from a quantitative to a regulatory test that generally follows the provisions of the CFMA;
  • Extend the anti-fraud provisions to Associates and to certain Members who introduce retail business to or manage retail customer accounts with Forex Dealer Members;
  • Require Forex Dealer Members, their Associates, and certain other Members to observe high standards of commercial honor and just and equitable principles of trade in connection with their forex business and to supervise their employees and agents;
  • Subject Forex Dealer Members to discipline for the activities of unregulated entities soliciting or managing customer accounts;
  • Require Forex Dealer Members to supervise affiliates that act as counterparties to retail forex customers and subject them to discipline for the activities of those affiliates;
  • Impose an alternative minimum net capital requirement on Forex Dealer Members based on the notional value of open positions with retail customers;
  • Require Forex Dealer Members to collect security deposits from retail customers;
  • Impose annual dues on Forex Dealer Members based on their gross annual revenue from their retail forex business; and
  • Require Forex Dealer Members and Members doing business with them to submit to arbitration at the request of a retail forex customer.

"Our primary objective has always been to safeguard the integrity of the markets and protect the investing public," said Roth. "We believe that these new rules will maximize customer protection without imposing undue burdens on our Members."

The full text of the rule proposal is available on NFA's Web site (www.nfa.futures.org). NFA is preparing educational materials to help Forex Dealer Members understand their regulatory responsibilities and will make them available on its Web site shortly after the CFTC approves the rules.

NFA is the premier independent provider of efficient and innovative regulatory programs that safeguard the integrity of the derivatives markets.
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