Comment Text:
lO-OOl
COMMENT
CL-08620
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Alexis Hall
Friday, March 19, 2010 3:35 PM
secretary
Regulation of Retail Forex
PFGBEST Comment Letter.pdf
Alexis L. Hall*
Ruddy Law Office, PLLC
1225 15th Street NW
Washington, DC 20005
(202) 797-0762
(202) 318-0543 (fax)
www, ruddvlaw, corn
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under Federal tax law. Member, New York State Bar and District of Columbia Bar.Via FedEx and E-mail I [email protected])
Mr. David Stawick, Secretary
Commodity Futures Trading Commission
1155 21
st
Street, NW
Washington.. DC 20581
Re: R~ 3038-AC61
Dear Mr. Stawick:
March 18, 2010
These comments are submitted on behalf of Peregrine Financial Group, inc. d/5/a
PFGBEST. PFGBEST is one of the largest non-clearing U.S. Futures Commission Merchants
(FCMs), inco~orated in 1990. Our firm offers futures, forex and options as well as Nli service
brokerage, trader education and direct online trading, with customers, affiliates and brokerage
offices in more than 80 count~es. Our Commodity Futures Trading Commission ("CFTC")
ranking has grown from the
30
th
iargest {in terms Of customer assets) to number 11 {excluding
banks) in the past three years. Currently, PFGBEST customer assets in some 60,000 accounts
total approximately $400 million, plus $50 mitlion accounted for in separate forex accounts.
Allow me to also note that I serve on the FCM Advisory Committee of the National Futures
Association (~FA").
PFGBEST strongly endorses the investor protection regulatory initiatives of the CFTC.
To this end, we support most components of the rule proposed on January 20, 2010 by the CFTC
"Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries.
''~
However we are opposed to (i) the requirement that introducing Brokers (IBs) and Futures
Commission Merchants ("FCMs") or Registered Forex Exchange Dealers ('°RFEDs") enter into
guarantee agreements; (ii) mandatory quarterly disclosures; (iii) net capital add-on; and (.iv) the
requirement that each RFED and FCM that engages in retail forex transactions collect a security
deposit equal to ten percent (10%) of the notional vabae of the transaction.
Guarantee Agreement Requirement
The CFTC's proposed role requires all IBs to enter into a guarantee agreement with either
an RFED or an FCM. Although the CFTC believes that this requirement wili aid in the
prevention of fraudulent solicitation, and sales practices in the forex industry, this proposed rule
will not achieve the CFTC's intended objectives.
Federal Register
Vol. 75, No. 12, pp. 3282-3330.Mr. David Stawick
March 18. 2010
Page 2
We recognize that essential differences between trading futures cor~tracts and trading
forex contracts exist. Despite these differences, trading forex contracts involves no ~eater -risk of
fraudulent solicitation and sales practices than trading futures contracts. Thus. with respect to
regulations designed to prevent fraudulent solicitation and sales practices: iBs in -the forex
industry should not be subjected to greater requirements than IBs in the futures trading industry.
As such. we believe that the proposal to require guarantee agreements between IBs and FCMs or
RFEDs (a) is inconsistent with the intent of Congress and (b) fails to accomplish the CFTC's
stated goal.
A. The Guarantee Agreement Requirement is Inconsistent with Legislative History
As previousiy set forth, trading forex contracts involves no greater risk of fraudulent
solicitation or sales wactices than trading futures contracts. Thus, the legislative history
surrounding the Futures Trading Act of 1982. wh.ich required the registration of IBs in the
futures trading industry, provides valuable insight with respect to IBs in the forex industr>.
Prior to the establishment of the IB registration category, small firms registered as
"agents" of FCMs. The CFTC sought to hold FCMs liable for the acts of agents by requiring
agents to register as associated persons of the FCMs. Congress reco_m~ized that agems, fbr the
most part., were independent finns. As such. FCMs could not exercise the same control over
agents as they could over their own employees. Thus, Congress rejected the x~otion that FCMs
should be liable for the acts of these agents and instead established the IB registration category.
Congress determined that registrants in this newly created registration category should be held
accountable for their own conduct. Consequently, it established a minimum net capital
requirement for IBs "to guarantee the acco-untability and responsible conduct of introducing
brokers.
''~
lBs that maintained such minimum net capital were cl assified as independent.
Congress held that in lieu of mairttaining the required minimum net capital, an IB could
become a guaranteed IB by enterir~g into a guarantee agreement with an FCM. Pursuant to a
guarantee agreement, an FCM is expressly responsible for the IB's obligations under the
Commodity Exchange Act ("CEA"). The legislative history of the Futures Act of !982 makes
clear that Congress never imended guarantee agreements to be executed in conjunction with the
maintenance of the required minimum net capita1.
Through the proposed rules, the CFTC now seeks to hold FCMs and RFED's liabte for
the conduct of IBs regardless of whether the IB is independent or g~aarameed. The CFTC has not
established any basis for subjecting IBs in the forex industry to greater requirements than IBs in
the futm'es industry. Without such basis~ the CFTC cannot now obtain what Congress has
already denied.
~ FederalRegister
Vol. 48. No. 150, p. 35248.Mr. David Stawick
March !8~ 20!0
Page 3
Requirement of a Guarantee A~eement is Unnecessary to Further the CFTC~s Goals
By requiring IBs and FCMs/RFEDs to enter into guarantee agreements, the CFTC
believes that FCMs/RFEDs will be forced to more carefully vet the persons who solicit business
on their behalf. The proposed rule, however, requires that all [Bs in the forex industry register
with the CFTC. Since the CFTC's paramount obligation is to assure, to the extent reasonably
possible, the fitness of every registrant
3,
IBs will have already been carefuily vetted during the
registration process. Any additional vetting arising from the existence of a guarantee agreement
will be superfluous.
Furthermore, guarantee agreements were originally designed to ensure that wrongdoing
could not occur without accountability. The registration and minimum net capital requirements
placed the once unaccountable IBs in a position to be he!d accountable for their own actions.
Consequently, it is no longer necessary to hold another party liable for the actions of IBs.
As evinced by the history of guaranteed and independent IBs in the futures trading
industry, it is clear that requiring guarantee agreements is not necessary to further the CFTC's
goal to prevent fraudulent solicitation and sales practices in the forex trading industry. Like the
futures trading industry, the registration requirement along with the minimum net capital
requirement is sufficient to establish proper accountability for the actions of IBs.
Risk Disclos _r_e_s
Proposed Regulation 5.5 requires RFEDSo FCMs and lBs to provide retail forex
customers a ri sk disclosure statement which is similar to that currently required to be provided to
futures customers under Regulation 1.55. However, in addition to the disclosures required under
Regulation 1.55, forex dealers will also be required to disclose its total number on non-
discretionary accounts and the percentage of such accounts that were profitable for each of the
four most recent quarters.
In order for a regulation to avoid being deemed arbitrary and capricious under the
Administrative Procedure Act: it must be shown that the CFTC has ~'examine[d~ the relevant data
and articulate[d] a satisfactory explanation for its action including a rational connection between
the facts and the choice made.
''4
The CFTC presents no explanation or data demonstrating the
need for disclosure of the percentage of profitable accounts maintained by forex dealers, when
no such disc!osure is necessary on the futures side. In fact, nothing indicates that forex
transactions are any less profitable than futures transactions. Accordingly, requiring forex
dealers to make such disclosures appears arbitrary and capricious.
Federal Regtster
Vol. 48, No. 150, p. 35249.
Motor Vehicle Manufacturers Ass 'n v. State Farm Mutual Automobile I~surance Co..
463 U.S. 27 (1983).Mr. David Stawick
March 18, 201C'
Page 4
Additionally, Section 15(b) of the CEA requires the CFTC to use the least
anticompetitive means in achieving the objectives of the CEA. Imposing unwarranted greater
requirements on forex deaiers gives FCMs, which do not deai in forex, an unfair competitive
advantage.
Alternatively, and congruous with our peers operating exclusively in the commodity
futures industry, we propose that FCMs and RFEDs should be left with the discretion to
determine on a case-by-case basis which customers require some additional risk disclosure, and
supplement disclosures as is necessary in particular instances,
s
III.
Net Capital Requirement
We appreciate that customers in the forex market rely on the dealer's financial stability
and creditworthiness; and therefore support the Commission's initiative for higher minimum net
capital requirements that, at some level, increases with customer liabilitieso However, m our
view. and without offering up any concrete proposals, any reguIatory framework needs to
address the true economic requirements of trade practices, including the practice of straight-
through-processing.
6
It will make for bad public policy to implement u~mecessarily stringent
capital requirements and instead any rule must strike a balance to ensure net capital standards are
equitable and not unduly burdensome° If not, we fear that the mantra offered up by many of our
peers may hold true - th~s business will move offshore without regard for any sort of regulation,
and opening up a greater possibility of fraud.
IV.
Security Deposits for Retail Forex Transactions
Proposed Regulation 5.9 would require each RFED and each FCM that engages in retail
forex transactions to coilect a security deposit equal to ten percent (10%) of the notional value of
the transaction. In proposing this rule, the CFTC is attempting to reduce forex customers'
exposure to risk. For the reasons set forth below, we beiieve that the proposed rule regarding
leverage wi!l not meet all of the CFTC's stated purposes.
Purpose of Margin
Proposed Regulation 5.9 is based on a misunderstanding surrounding the role of margin
in the commodities industry. Despite the CFTC's current proposal to use margin as a means to
protect customers from risk, it has long been held that margin has a special status under the
commodities 1 a~vs because it is a protection for the FCM and not the customer. In
Levi-Zeligman
NFA Compliance Rule 2-30: NFA Interpretive Notice 90 !3.
The NFA m ~ts current capital reqmrements recognizes the straight-through-processing lhat a lesser capital
requirement shoald be imposecl on parties offering a trade via straight through processing.
See
NFA Financial
Requirements Section 11 (a).Mr. David Stawick
March i8.2010
Page 5
v. Merrill Lynch
~,
the CFTC stated tlnat "[t]he purpose axad law surrounding margin is clear., o
Futures Co~ission Merchants are closely protected by margins and liquidation because
without that protection, they would be exposed to overwhelming risk." Thus, the CFTCo itself~
recognizes that margin is a mechanism designed to protect the FCM and not the customer. The
courts have consistently held that margin rules are not customer protection rules,
s
Additionally.~ conditions in the forex arena can change very rapidly and if the authority to
set margin is taken away from FCMs. they will be deprived of their ability to protect themselves
from market volatility. In fact. the CFTC has stated
[p]articularly in those market situations where a prompt response is
required, a t~atures commission merchant is free to exercise its power to
demand the deposit of additional funds by its customer and to liquidate an
account without hesitation if the demand is not met. The exercise of these
powers is available as a matter of business judgment, a judgment not
curtailed by fear of subsequent claims of constructive fraud which have no
basis.9
Thus. it is clear that an FCM should be able to set its own margin requirements as it deems fit
and not be required to impose arbitrary and obstructive margin requirements on its traders.
B.
Historical Customer Protection Mechanisms
By asserting that there is an. increased need for customer protection from risk. the CFTC
is removing the long held view that traders are responsible for determining their own risk
tolerance. Forex FCMs are required to provide forex customers with the same risk disclosure
statements as other commodity or ~qatures FCMs provide to their traders and should be held to the
same standard of self-determination for risk tolerance. Since the CFTC has not established any
foundation for applying different standards in the forex industry, the CFTC should treat forex
customers the same as other commodity traders. By imposing a blanket margin requirement of
I0%. the CFTC is removing the ability of customers to set their own teverage limit, and hence
establish their own risk exposure, in the commodities world, risk tolerance is determined on a
case by case~, individual basis by the customer, not by estabIishing standards that reduce
universal risk; to do so reminds one of the suitability standards found in the securities world.
which hav~ been categorically refused i~ the commodities world and, at times, by the CFTC
itself.
In 1978 the CFTC first announced that it would not adopt a suitability rule because to do
so would merely codify principles already implicit in the antifraud provisions of the CEA and
CFTC Rules.
~°
Instead, it adopted a requirement that risk disclosure statements be given to
= Levi-Ziligman v. Merrill Lynch ~utures, Inc..,
Comm. Fur. L. Rep. (CCH)~25,767 (CoF.T.C. 1993).
a ADM investor Services, Inc. v. Collins,
515 F.3d 753
(7
m
Cir. 2008).
~ Baker v. EdwardD. Jones c~ Co..
Comm. Fut. L. Rep. (CCH) ~-21.i67 at 24.772 (C.F.T.C. 1981).
~0 Proposed Standards of Conduct for Commodity Trading Professionals for the Protection of Customers, [ ! 977-
1980 Transfer Binderl Comm. Fur. k. Rep. (CCH) ~ 20.474 at 21.928 (Sept. 6, 1977).Mr. David Stawick
March 18.2010
Page 6
customers so as to warn them of the risk of commodity trading and tl~e need to deten~line for
themselves if they are suitable for the conternplated transaction (i.e. whether or not they can
~°afford to lose" the funds invested). The practice of providing risk disclosure statements has
been upheld by the CFTC since 1978 and is effectively in use across the con~r~odities and futures
industry as the appropriate treatment of the issue. In addition, due to the nature of corr~modities
and futures trading and the unique elements of each relationship between a trader and the traded
commodity or his trading style, the CFTC has been unable to formulate meaningful standards of
a universal suitability application. This means that in the world of commodities, it is not possib!e
to establish a standard whereby all traders are uniformly judged according to whether or not they
can afford to lose their ir~vestment.
C.
Pr_2p__posed Regulation 5.9 Will Likely Increase Risk to Forex Customers
Upon adoption of proposed Reguiation 5.9~ retail forex dealers registered in the United
States will no longer be 2~le to compete with tbreign based retail forex dealers, who routinely
offer forex trading to customers at leverage levels of 200:! or greater° Consequently. UoS
registered dealers wil! be forced out of the forex business, and U.S. customers will be forced deal
witln foreign based, unregulated retai! forex dealers° Thus~. instead of reducing U.S. customers'
exposure to risk, the proposed requirement increases it.
Tl~e NFA has recently adopted leverage restrictions of 100:1 on major currenc~.es and
25:1 on non-major cu~encieso We believe that these restrictions will enable UoS. registered
retail forex dealers to effectively compete witl~ foreign based forex dealers.
The most s~gnificant threat to a forex customer is not risk; it is the element of fraud that
has been allowed to fester due to inadequate regulatory oversight of industry professionals. The
CFTC very effectively addresses this elemem of the industry in the other proposed rules found in
RIN 3038~AC61o By requiring intermediaries to register, increasing net capital reqmremems~
and properly defining forex transactions so that nefarious individuals are prohibited from
operating outside the regulatory structure, the CFTC is effectively working to protect investors
from fraud. Altering margin requirements serves no purpose in the fight against fraud and m.ay in
fact promote fraud if it serves to drive business a~ay from U.S. regulatory jurisdiction and to
other regulatory or non-regulatory environments that do not share the same vigilance towards
customer protection.
As previously expressed, PFGBEST strongly endorses the reg'alatory initiatives of the
CFTC that focus on investor protection. For the reasons stated above, we do, however, oppose
the proposed requirement that that IBs and FCMs and RFEDs enter imo guarantee agreements
and the proposed Regulations I. 10, 5.5~ 5.7, and 5.9.Mr. David Stawick
March ! 8, 2010
Page 7
Thank you for your time and consideration of our points. Please do not hesitate to
contact us if you wish to further discuss our views.
Sincerely.
cc: Attached List
PFGBEST
By:
....... 2 "~ ...... ~ J"t~
"~
.........
/
-~
Chief Executive Officer and.¢Chai~ancc:
Hon. Gary Genslero Chairman
Hon. Michael Dunn, Commissioner
Hon. Jil! E. Sommers. Commissioner
Hon. Bart Chilton. Commissioner
Hon. Scott D. O'Malia~ Commissioner
Dixdsiop,_ of Clearing and Intermediary Oversight
Ananda Radhakrishnan: Director
Office of the Oer~eraI Counse~
Dan Berkovitz. General Courlsel
Mark E. Ruddy, Ruddy Law Office, P~.LC
