FXCM: No Conflict in the Pitch, a Profit Share in the Books

The FXCM CFTC No Dealing Desk fraud settlement required a $7 million joint civil penalty over allegations that the broker advertised conflict-free execution while sharing in a connected market maker’s trading profits. If you worked with liquidity providers, execution settings or rebate accounts, the gap between that sales pitch and the business behind it is the heart of this case.

The Commodity Futures Trading Commission’s February 6, 2017 consent order covered Forex Capital Markets, its parent FXCM Holdings and two founding partners. The agency alleged that, from September 4, 2009 through at least 2014, FXCM misled retail foreign-exchange customers about its relationship with the provider taking the largest share of their trades. The agency’s Division of Enforcement investigated FXCM.

Among CFTC fraud cases, FXCM shows how much can sit behind a claim about execution. The agency traced the relationship through an employment agreement, a trading algorithm, service invoices, routing preferences and answers to the National Futures Association.

What FXCM’s No Dealing Desk Customers Were Told

According to the order, FXCM’s No Dealing Desk pitch promised that customer profits and losses would be irrelevant to the broker’s bottom line. Customers would get prices from competing banks and independent market makers, with FXCM earning fees from the volume of trading.

Retail forex happens off-exchange. As the Commodity Futures Trading Commission explains in its description of retail foreign exchange dealers, the dealer is the retail customer’s counterparty. FXCM likewise acted as counterparty when customers bought one currency and sold another on its platform. The promise concerned what FXCM would do with the other side of that transaction.

The order describes how, around 2007, FXCM moved most of its retail customers from an internal dealing desk to what it called an agency model. It described that model as simultaneously placing offsetting trades with the customer and an outside market maker. FXCM presented itself as the credit intermediary between them and said it added a markup to the market maker’s price.

Its explanation of how it earned money was explicit:

That distinction gave customers a reason to trust the model: their broker said it had removed the financial conflict created by taking positions against them. The agency alleged that the connected provider put that conflict back into the business while the promise stayed in the marketing.

Retail Forex No Dealing Desk Trading With a Concealed Counterparty

The concealed counterparty in FXCM’s retail forex No Dealing Desk arrangement allegedly grew out of the broker’s own trading operation. The Commodity Futures Trading Commission alleged that, in 2009, FXCM’s chief executive and managing director helped develop an algorithmic trading plan to compete with outside market makers for customer trades.

The order alleged that FXCM hired a high-frequency trader as a managing director, with an employment agreement assigning most trading profits to FXCM. It described compliance staff raising concerns that the operation contradicted the No Dealing Desk advertising, followed by FXCM arranging a separate company for the trader to operate as an external liquidity provider.

The agency alleged that the trader’s resignation left the economic relationship intact: FXCM supplied a $2 million interest-free loan, access to its prime broker and rent-free office space. According to the order, the new company used an algorithm that remained FXCM’s intellectual property, along with FXCM servers and email systems for a time.

The connection extended to personnel. Two FXCM employees allegedly helped the provider and received supplemental bonuses through FXCM, reimbursed by the provider. One allegedly spent approximately 80% of the workweek at the provider’s offices from 2011 through 2014.

We would call that a remarkably well-supported independent business. The allegation reaches the money, the technology and the people doing the work. A separate company name did little to explain the relationship customers were buying into.

How the Connected Market Maker Got the Trades

The Commodity Futures Trading Commission alleged that FXCM gave the connected provider advantages in routing and execution. The provider could win every tie with another market maker, see competitors’ price quotations in real time and benefit from smaller markups than FXCM added to other providers’ prices.

A claim that providers compete for customer orders depends on how that competition works. Who sees the competing quotes, who wins an equal-price contest and whose prices receive the smaller markup all affect the offer that reaches the customer.

The 2016 Futures and Derivatives Law Report article The Exercise of Anti-Spoofing Authority in U.S. Futures Markets: Policy and Compliance Consequences explains how quickly revising quotes lets market makers manage risk and offer narrower spreads and larger trades. That analysis concerns futures markets, but it helps explain why the connected provider’s alleged real-time access to competitors’ quotes was a valuable preference.

A Hold Timer and the Customer’s Limit Order

The order also alleged that FXCM let the provider use a hold timer to choose execution at the start or end of a waiting period, whichever suited the provider better. A further practice involved the price in a customer’s limit order. After the provider submitted a quote, FXCM allegedly sent an execution request based on the customer’s trading limit instead of the previous quote FXCM had provided. The customer’s willingness to trade at a particular price became part of the execution request.

For an execution employee, these are recognizable decisions inside a system: how quotes are compared, when acceptance happens and which price is passed along. We connect those decisions to the terms customers were shown and the people who authorized the settings.

The Revenue Share Behind the Fees

The Commodity Futures Trading Commission alleged that the provider’s payments preserved an arrangement intended to give FXCM approximately 70% of the provider’s trading profits. The services agreements expressed the payments as a fee for trading volume, while the agency described the substance as profit sharing from trading against retail customers.

The order alleged that FXCM incorporated the provider’s profits into its preliminary monthly profit-and-loss calculation and lowered the volume-based payment rate when tighter spreads reduced the provider’s profits. The agency said no other market maker paid FXCM for order flow during the period described.

The invoice language was revealing. FXCM allegedly requested “Rebate for FX Trades” and described the billed amounts as “P&L.” The agency put the trading revenue rebated to FXCM from 2010 through 2014 at approximately $77 million, against the settlement’s $7 million civil penalty. And the customer-facing explanation still said trading profits and losses did not drive FXCM’s revenue.

A related incentive appears in the Yukom allegations of binary options fraud. The Commodity Futures Trading Commission’s complaint alleged that brokers earned commissions on customer deposits after withdrawals and chargebacks were deducted. A customer withdrawal therefore reduced the salesperson’s commission base. The alleged incentives ran against the customer: FXCM shared in trading profits from taking the other side, while Yukom brokers earned less when customers took money out.

What the Public Saw About the Liquidity Providers

The Commodity Futures Trading Commission alleged that FXCM concealed the connected provider while presenting its liquidity pool as independent banks and financial institutions. A public diagram grouped the provider under a prime-broker category instead of identifying it separately, even though it supplied by far the largest volume.

Internally, the order describes employees discussing whether to black out the provider’s entry on a list of the leading liquidity providers. A later compliance exchange concerned hanging orders and a technology adapter that differed from the bank adapters. The compliance officer’s response focused on visibility:

The agency alleged that FXCM did not disclose the provider to retail customers until late 2012. Even then, its public response invoked nondisclosure agreements as a reason not to identify providers, although the agency said no such agreement existed with this provider.

That response also disputed the provider’s ability to choose customer trades. The agency pointed back to its real-time view of competing quotes and its ability to win ties.

What FXCM Told the National Futures Association

The Commodity Futures Trading Commission alleged that FXCM also misrepresented the relationship during the National Futures Association’s examination. The order described a compliance officer’s 2013 denial that FXCM had a direct or indirect ownership interest or affiliation with entities providing retail liquidity.

According to the order, another response extended that denial to connections involving present or past employees, and a later email described the provider’s owner as a former consultant who had mainly done software coding. The agency alleged that he had been an executive with an employment agreement, developing the algorithm used to trade against customers.

The chief executive generally participated in and approved the responses, according to the order. The agency attributed responsibility for the customer-facing deception to both founding partners through their control of FXCM. It attributed the separate false-statement violation to the chief executive, FXCM and FXCM Holdings. The order tied the parent’s responsibility to its control of FXCM’s operations and their intertwined business activities.

For an insider, the connection between internal records and information supplied to regulators can matter as much as the sales pitch. Here, the alleged employment relationship, the algorithm’s purpose and the responses to the examiner described the same person’s work very differently.

What the CFTC Settlement Required

The settlement imposed the joint civil monetary penalty on FXCM, FXCM Holdings and the two founding partners. FXCM agreed to stop accepting new customer accounts. FXCM and the founding partners also agreed to withdraw their CFTC registrations. The order also barred them from applying for registration again and restricted their work in businesses overseen by the agency.

What Evidence Is Required to Prove Fraud?

Evidence in a concealed-counterparty case connects the promise of independent execution to the provider relationship, trade handling and payments. We build those connections with you, whether your knowledge starts with a provider agreement, a routing setting or an invoice that contradicts the sales pitch.

We bring in CFTC whistleblower lawyers who understand forex execution to pursue the conduct you can explain. You can start with the part of the business you know.

CFTC whistleblower awards can total 10% to 30% of monetary sanctions collected in a qualifying action. The False Claims Act offers a separate reward program. A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers.

You Know What the Execution Model Hid

If you saw a provider getting preferred trades or payments that contradicted the customer pitch, speak with our whistleblower experts about the forex operation. We build your strongest case around the execution and revenue decisions you can explain, with whistleblower lawyers who know CFTC trading-platform cases. We stay beside you as that inside knowledge becomes a case the agency can investigate.