Questions, Questions, Questions

FXCM has known its share of controversy in recent years and now the firm has been barred from operating in the US. Profit and Loss staff report on an issue that has triggered another round of introspection in the FX industry.

Just over two years after staving off bankruptcy due to losses resulting from the Swiss National Bank’s decision to unpeg the Swiss franc, FXCM has been forced to withdraw from operating in the US, changed its name and seen its two principals step down from the business.

The unravelling of FXCM has impacted across the FX industry with questions being asked around the effectiveness of self-regulation, how the Global Code of Conduct could deal with a repeat offence, and how the industry moves forward in an atmosphere of mistrust?

The trigger for the changes was an order issued by the US Commodity Futures Trading Commission (CFTC), which fined FXCM and its founding partners $7 million for defrauding retail FX customers.

In the order the Commission settled charges against FXCM, its parent company, FXCM Holdings, and two founding partners, Dror (“Drew”) Niv, and William Ahdout, who were the CEO and managing director of FXCM, respectively.

“The Order requires Respondents jointly and severally to pay a $7 million civil monetary penalty and to cease and desist from further violations of the Commodity Exchange Act and CFTC Regulations, as charged. FXCM, Niv, and Ahdout agree to withdraw from CFTC registration; never to seek to register with the CFTC; and never to act in any capacity requiring registration or exemption from registration, or act as a principal, agent, officer, or employee of any person that is registered, required to be registered, or exempted from registration with the CFTC,” it says in a release issued by the CFTC. As a result of the closure, FXCM’s US business was sold to Gain Capital Holdings.

“In 2016, FXCM’s US business had unaudited net revenues of approximately $48 million and generated an EBITDA loss, but the costs associated with the business will not be transferring to Gain,” FXCM says in a statement.

FXCM says that selling its US business will free approximately $52 million in capital and that the proceeds from the account sale and the release of capital will go toward repaying of FXCM’s loan from Leucadia National Corporation. That loan was arranged in the wake of the SNB’s floating of the franc, a move that cost FXCM in the region of $300 million.

Rather optimistically, FXCM said in a statement that it wanted “to stress that these settlements have no impact on any customer of FXCM’s global businesses”, however just weeks later it announced it was changing its name and its leadership following the scandal.

The company changed its name to Global Brokerage, Inc. effective at the opening of trading on February 27, 2017. Niv has submitted his resignation to FXCM from his positions serving as a director and chairman of the board, effective immediately. He is also resigning as CEO, but will remain at the company in an advisory role “to assure an orderly transition”, says FXCM in a statement.

Niv has initially been succeeded by Brendan Callan, who has been promoted to interim CEO of FXCM Group. Callan joined the firm in 2001, and has been the CEO and president of European operations since 2010, a period during which he developed FXCM UK into FXCM Group’s largest operating subsidiary.

Meanwhile, Ahdout has submitted his resignation to FXCM from his position serving as a director on the company’s board of directors, effective immediately.

“At this time all parties have decided that it is in the best interests of the company for Mr Niv and Mr Ahdout to resign from the board of directors,” says FXCM in a statement.

The firm also announced that Jimmy Hallac, a managing director of Leucadia National Corporation, has been appointed chairman of FXCM Group. The six-member board of directors of FXCM Group will now consist of Hallac; Rich Handler, CEO of Leucadia; Brian Friedman, president of Leucadia; David Sakhai, COO of Global Brokerage; Robert Lande, CFO of Global Brokerage; and Kenneth Grossman, managing director of Global Brokerage.

In addition to these changes, FXCM’s board, with the recommendation of the board’s nominating and corporate governance committee, appointed Bryan Reyhani to serve as chairman of the company’s board of directors. Reyhani has been an independent director at FXCM since February 1, 2016.

Abusive Practices

The investigation by the National Futures Association (NFA) says that market maker Effex Capital was able to slip clients and arbitrage immediately out of certain trades because it was seeing the other liquidity provider (LP) feeds – something that has, inevitably, cost those other LPs significant revenue over the years.

The NFA complaint also found that FXCM’s margin and liquidation practices, as described in paragraphs 62 and 63 in the complaint, were “reprehensible” in that they routinely allowed clients to enter positions only to be liquidated due to the firm’s abusive practices around margin.

Although FXCM is the sole focus of the complaint, there is a significant line in the NFA’s complaint, which states, “…FXCM allowed Effex to engage in abusive execution tactics, which denied FXCM’s retail customers favourable price improvement and benefitted Effex and FXCM financially.” 

It is worth noting, however, that this claim is disputed by some sources familiar with the matter, as Profit & Loss has documented in detail, in FXCM: The Other Side of the Story.

Despite this, sources suggest that the allegations in the NFA complaint could mean that Effex was complicit in the practice and as such as an institutional participant, leading to questions about whether legal action could be taken against the firm?

In spite of the findings against FXCM – which were neither accepted nor denied by Niv and Ahdout – there remains real uncertainty over what regulatory authority could take action against Effex Capital and its principals. Sources suggest that other US agencies could be preparing a case against the firm, but at time of going to press nothing had been said.

Given that the NFA finds these actions as part of a programme of “abusive market practices” eyes are inevitably turning to the Global Code of Conduct, seeing the issue as an early test, and an opportunity, for the Code’s authors. How would the Code and the intended enforcement framework handle this issue? Could anything be done about a firm that has, according to a local regulator, been abusing its position in the market and lying about it?

Although the Code in its final version is not due for release until May, sources familiar with the content have mixed messages for how it would treat practices such as those allegedly conducted by FXCM and Effex Capital.

As a set of principles, clearly the Code cannot mandate a punishment for the firms should it be considered necessary, and some sources bemoan the fact that it has – apparently – failed to commit to a strong set of recommendations over the use of last look, specifically around the practice of “pre-hedging”.

The sources say the practice of last look, as expected, will not be frowned upon, however participants will have to be transparent about how they use it. More of a concern, the sources, observe, is that the group developing the Code have been unable to agree on pre-hedging principles. “The group is saying this principle, number 17, will be subject to further investigation after the Code is released in its final form.

The key issue, however, remains enforcement. “The problem is we are saying the participant has to be transparent, but both FXCM and Effex Capital appear to have been anything but,” observes one source who has worked on the Code. “What do we do with firms that don’t play ball? That is the real challenge.”

Optimists suggest that the industry would handle a repeat instance in much the same way it has now – FXCM as a business found it could not continue without its institutional liquidity providers who withdrew from trading with it. This would appear to be self-regulation working at its best – a regulatory authority found against a firm, the industry cut all ties to said firm.

There is another way of viewing it, however, for the industry was actually pre-warned of what was going on at FXCM three years earlier.

In February 2014, the UK’s Financial Conduct Authority (FCA), said in a release, “The Financial Conduct Authority (FCA) has fined Forex Capital Markets Ltd and FXCM Securities Ltd (“FXCM UK”) £4,000,000 for allowing the US based FXCM Group to withhold profits worth approximately £6 million ($9,941,970) that should have been passed on to FXCM UK’s clients.”

So the firm was fined for the same practice in the UK three years previously, but there is an even more significant line in the FCA report which states, “FXCM UK also failed to tell the FCA that the US authorities were investigating another part of the FXCM Group for the same misconduct.”

This has prompted people to ask, was the industry asleep at the wheel on this? The FCA report noted the US was investigating the same practice, but as an industry were enough questions asked of FXCM and was the industry a little complacent when it came to stricter checks?

“The trouble is, firms that operate in the retail FX space are often fined, so we become a bit immune to it,” says a senior prime brokerage industry source. “It sounds strange but a $7 million fine in the FX industry barely warrants a mention given the huge sums that have been paid out elsewhere. I honestly don’t think anyone thought it was that important, and no-one made the connection with the US investigation.

“The SNB incident also diverted attention,” the prime brokerage source continues. “All of a sudden we were totally focused on whether the firm would even survive – that grabbed everyone’s attention and we forgot anything to do with the apparently ongoing investigation.”

Galen Stops

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