For years traders, brokers, and money managers have been able to operate within the over-the-counter retail foreign currency markets (“forex”) with very little regulation. As a result, trillions of dollars and millions of clients have traded within the industry with little standardization or legal oversight; that is until now. As of the date of this article the industry is mere inches away from being entirely revamped and standardized through regulation. The passage of the Farm Bill in May of 2008 eventually will mean mandatory registration with the Commodity Futures Trading Commission (“CFTC”) and membership with the National Futures Association (“NFA”) for nearly all forex professionals. Have you and your firm considered what are you going to do about this? Determining what steps you should take today may in fact determine whether or not you will still have a business tomorrow.
To Register or Not to Register
In order to gain knowledge of where the current forex regulatory environment is heading one has to understand where it has been. Prior to May of 2008 forex solicitors and money managers were not required to be registered. As a bit of a history lesson, in what is now an infamous 7th Circuit Court of Appeals decision, the CFTC lost a forex fraud case commonly referred to as “Zelener.” To be incredibly brief, the court ruled in this case that over the counter retail transactions were not futures, and thus could not be regulated by the CFTC. To learn more on the history of this event a nice summary is available at the National Futures Association’s website from June of 2009.
Since this landmark forex court decision, many in the regulatory industry have lobbied for the CFTC’s authority to be amended by an act of congress to include the aforementioned retail financial transactions. This lobbying effort finally paid off during the early summer of 2008 when congressional representatives acted on their requests. In May of 2008, HR 6124, which is commonly referred to as the “Farm Bill” was passed. Within this bill were provisions which amended the Commodity Exchange Act to give the CFTC authority to apply its anti-fraud provisions to certain off-exchange retail foreign currency transactions (“forex”). In addition, these provisions also created a specific registration category for retail currency brokers which solicit for and/or exercise discretion over retail forex transactions. Sounds simple enough, everyone is required to get registered as of May 2008 right? Well not exactly.
Am I Required to Register?
You might be wondering: “If the farm bill has passed, how come I am not yet required to be registered?” The reason is that the farm bill has yet to be ratified and thus has not been enacted into law. Due to this fact its forex provisions are also not yet enforceable for the CFTC. It is this realization that has lead some in the industry to think that they do not have to become registered and created a great deal of regulatory uncertainty. So what’s the truth of the matter in this situation?
The truth is that even though forex contracts were not seen as being futures by the US court system, there has been little doubt that over the counter forex market makers were acting in a capacity similar to futures clearing firms or leveraged transaction merchants. As a result, forex dealers have been required to be registered and to join the membership of at least one self regulatory organization (“SRO”) for quite some time. This is crucial to your understanding of the registration debate and determining if you must become a member of an SRO.
Since a forex dealer is required to become a registrant and to be a member of an SRO, these firms must also adhere to the rules of their specific SRO. Here it is crucial to recognize that there is a difference between “regulations” and “rules” although it may not seem like it. As a result of the CFTC’s inability to federally regulate forex transactions, the responsibility of governing forex has fallen squarely on the largest SRO’s (FINRA and NFA*) and their rules. SRO rules apply solely to the respective members of a particular SRO and are not considered to be hard and fast law.
*Since NFA has emerged as the most prevalent regulatory authority in the forex market space, I will focus primarily on the rules their membership must adhere to for the remainder of this article.
How Do NFA’s Rules Affect You?
NFA has worked diligently to adapt their membership rules to handle the regulation of all forex transactions. Based on the information presented above, NFA has gone about this through the creation of stringent new rules for their Forex Dealer Members (“FDM’s”). Of these rules most require FDM’s to more adequately supervise and monitor the forex agents that they do business with. This has been necessary as neither the CFTC nor NFA has any legal authority over those entities. Although rules for forex IB’s, CPO’s, and CTA’s have also been created, they are often more vague, ineffective, and inconsistent with respect to how they are applied due to this lack of disciplinary authority. Thus, with no available CFTC support until the farm bill is ratified, NFA will continue to pressure the industry into compliance through its FDM membership, regardless of how efficient that methodology may be.
Thus, as an unregistered forex IB, CTA, or CPO it is currently true that you do not have to register with the CFTC or become an NFA member. However, if you choose not to do so you could be making one of the poorest decisions of your business career. At some point in the near future you will be pressured or forced into becoming a member not only by NFA, but also by your respective FDM. Further still as soon as the farm bill is ratified you will be required under US Federal law, through CFTC regulation, to become a member. So rather than fighting the inevitable, it is a necessity that you ask yourself what steps you or your firm must take in order to meet your unique regulatory obligations.
Getting Registered, Becoming and NFA Member
Since registration is all but required, how do you take the next steps? For starters you should contact a regulatory professional to assist you in further evaluating your unique business situation. I wrote on the reasons this is a good idea for any CFTC registered, NFA member previously when I touched on the “Three Common Mistakes New CTA’s Make.” Since I wrote on this previously, step one would be to review that article. After this, it is critical to understand that the forex trading community operates in a manner which is drastically different from that of the futures and or securities market spaces. The forex industry is evolving almost on a daily basis, many of the rules are slightly more than a year old, and not that many people are familiar with them. I mention this because standard service providers are likely to improperly guide you if they apply futures and securities specific rules and regulations to your unique forex questions. Therefore, unless you’re willing to become a guinea pig, it is imperative that you utilize a firm that is familiar with all of NFA’s forex rules to ensure your registration process goes as smoothly as possible.
But how do you know if a firm of this type knows the forex industry? For starters they should be able to readily assist you in ensuring you have the proper policies, procedures, and business practices in place to adhere to NFA’s forex rules. In particular any firm you select must be intimately familiar with all of the requirements included in NFA’s “Forex Transactions Regulatory Guide”. They should also know what is required of your operations from the ground up, that is they should readily be able to address any questions you might have about any of the following areas: NFA Rule 2-41, NFA Rule 2-36, the Series 34 Examination, Bylaw 1101, if you’ll need a disclosure document, what your federal anti-money laundering (“AML”) requirements might be, your supervisory requirements, how to manage your solicitation practices, how you handle customer orders, and any other questions that relate to NFA’s requirements of its forex membership. In general if you’d like more information on how to get started my company is offering a free forex start-up guide that details your route to registration. If you’re interested in receiving this material sign up via the link above and I’d be more than happy to personally send additional information.
As you can see becoming a registered entity and member of an SRO can be a complicated process, especially if you already have an established business. It is for this reason you should not go through the process of becoming an NFA member and CFTC registrant alone. There is no time to waste as the regulatory risks to your current business grow by the day. The time for you and or your firm to become an NFA member is now, but whatever you decide to do be sure you understand the ramifications of your actions. For if you choose to remain unregulated, when the moment comes, your decision could literally mean life or death for your business.
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