Shares of FXCM Inc. lost half its value to close at a record low Tuesday, a stark reminder of the risks of currency trading for retail investors.
The Commodity Futures Trading Commission issued an order settling National Futures Association charges against Forex Capital Markets LLC, Chief Executive Officer Dror Niv and Managing Director William Adhout with “engaging in fraudulent activities” with respect to FXCM’s retail customers, by telling them they used a “No Dealing Desk” order execution model, meaning orders would be executed directly in the market without using a liquidity provider, or market maker.
But in fact, FXCM used a “Dealing Desk” model, by routing orders through market maker Effex Capital LLC that was actually supported and controlled by FXCM, allegedly in exchange for kick backs to FXCM on profitable trades.
There were several other charges in the NFA’s complaint, but the gist was that FXCM, Adhout and Niv would be permanently barred from NFA membership, and FXCM could no longer operate in the U.S. FXCM agreed to pay a $ 7 million fine.
The stock FXCM, -49.64% plunged 50% to $ 3.45 on Tuesday, enough to make it the biggest decliner on the Nasdaq exchange. The close was below the previous split-adjusted record close of $ 5.30 on Dec. 11, 2015. Volume spiked to about 2 million shares, which was about 81 times the full-day average of about 24,300 shares over the past 30 days, according to FactSet.
Considering the stock underwent a 1-for-10 reverse split on Oct. 1, 2015, the stock would have closed at a pre-split-adjusted 34.5 cents, compared with a pre-split-adjusted record close of $ 19.76 seen on Sept. 27, 2013.
Meanwhile, shares of Gain Capital Holdings Inc. GCAP, +5.36% rallied 5.4% Tuesday, after FXCM reached a deal to sell its U.S. customer accounts to Gain. Analyst Kyle Voigt at Keefe, Bruyette & Woods said he believed the “forced sale” by FXCM was a positive for Gain’s stock, as it would likely significantly add to earnings in the first year.
If FXCM sounds familiar, it’s because the broker nearly blew up two years ago during the Swiss currency crisis. The Swiss National Bank scrapped its exchange rate floor of 1.20 francs per euro on Jan. 15, 2015, sending the Swiss franc rocketing and the euro tumbling against most of its rivals.
FXCM’s stock crashed after the company said significant client losses generated by that extreme currency volatility left it with negative equity balances, prompting Jefferies Group parent Leucadia National Corp. LUK, -3.15% to step in with $ 300 million in financing to keep the broker alive.
This acts as a reminder to retail foreign exchange investors to be diligent with respect to risks associated with potential market volatility and fraudulent broker activity.
The CFTC has a section in its foreign currency trading regulations page dedicated to helping potential investors “avoid fraud,” with links to an NFA page that allows investors to check whether a broker is registered and how many regulatory actions it has faced.
So while FXCM was recently ranked by DailyForex as the second best U.S. forex broker for 2017, investors who did their due diligence would have seen that before Monday, FXCM had faced 8 regulatory actions, 17 NFA arbitration decisions and 13 CFTC reparations cases since 2005.
For example, FXCM was ordered in October 2011 to pay more than $ 14.2 million to settle CFTC charges related to its failure to supervise customer accounts with respect to changes in price between order placement and execution on both market (at best) and margin liquidation orders. The order found that FXCM prevented its customers from receiving the benefit of price movements in the customers’ favor, but allowed them to suffer from unfavorable price movements.
In such cases, if the broker happened to have a market maker in its pocket, then the market maker would be able to receive the benefit of favorable price movements that the customers didn’t receive, and wouldn’t be hurt by the unfavorable price movements. And as investors learned Monday, that is exactly what FXCM had.
While prior regulatory actions doesn’t necessarily suggest future wrongdoing, it might put the potential retail client on notice.
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Meanwhile, the forex broker ranked No. 1 by DailyForex is Forex.com, which is owned by Gain Capital. The NFA site shows that Gain Capital has faced two prior regulatory actions by the NFA, in 2007 for using deficient promotional material and “failing to uphold high standards of commercial honor and just and equitable principles of trade,” and in 2010 for engaging in “margin and liquidation practices that had a detrimental impact on certain Gain’s customers on certain slipped trades.”
But in all five complaints that went to arbitration, the arbitrator had denied claims against Gain Capital.