NFA Overview “Regulation Redefined” Presented by: Michael Braden Manager, Compliance

NFAExchanges

NFA Membership Categories Exchanges Futures Commission Merchants (FCMs) Introducing Brokers (IBs) Commodity Trading Advisors (CTAs) Commodity Pool Operators (CPOs) Retail Foreign Exchange Dealers (RFEDs)

Membership Breakdown by Primary Category This chart shows membership in each area as of 10/22/12 Total NFA Members: 3464

What is Forex? Forex trading is the act of speculating in which direction the foreign currency exchange rate will move The primary market is an interbank market where large financial institutions manage their currency exposure. As secondary market has opened up to retail investors. This is the market that NFA regulates.

Retail Foreign Exchange Dealers (RFED): –An individual or organization that acts, or offers to act, as a counterparty to an off-exchange foreign currency transaction with a person who is not an eligible contract participant. –RFEDs are required to be members of NFA in order to conduct business with the public and are designated as Forex Dealer Members (FDMs). Futures Commission Merchants (FCM): –FCMs may also act as counterparty to retail Forex transactions. They do not need to be registered as RFEDs if they are primarily and substantially engaged in on-exchange futures activity. They must still be designated as an NFA FDM. 6 NFA Member Forex Counterparties

Dealers –May have currency exposure due to uncovered customer positions –Must take haircuts on uncovered positions –Typically have desk responsible for risk management –Pricing based upon a widened aggregation of liquidity providers’ prices – i.e. mark ups Straight -Through Processors (STP) –No inventory risk –Ensures order can be offset with a liquidity provider prior to filling customer order –Less conflicts of interest –Typically pricing is based upon marking up prices from liquidity providers and/or charging commissions 7 Forex Counterparty Business Models

Historical Information on Forex Counterparties YearNumber of Forex Counterparties Liability to Customers December, $82 million December, $573 million December, $906 million

Historical Information on Net Capital Requirements YearCapital Requirement for Forex Counterparties 2002Minimum of $500, Minimum of $1 million for all other forex counterparties 2007Minimum of $5 million 2008Increase from $5 million to a minimum of $20 million

NFA Member Forex Counterparties Currently, NFA has 11 members that are acting as a forex counterparty Each firm has a net capital requirement of at least $20 million. As of June 30, 2012, these firms has a combined customer liability of $654 million and a total of 70,000 active retail customer accounts 65% of which are unprofitable.

Problems Noted: Regulatory Response Disclosure –“Commission Free Trading” August 2004 – Firms were required to disclose the mark-up price associated with trading. –“Customer funds are segregated” February 2006 – Firms were required to disclose that customer funds may not be protected under bankruptcy laws.

Problems Noted: Regulatory Response Financial –Security Deposits 2002 NFA Initiative: Customers have margin requirements, similar to futures clients. 2% major pairs, 5% exotic pairs –Liability to Customers 2007 NFA Initiative: FDMs have to maintain enough assets to cover liabilities to forex customers, which have to be held in major money market centers –Increase in Capital requirements

Problems Noted: Regulatory Response Slippage –In 2009, NFA started seeing that FDMs were manipulating the prices that they were giving to customers. NFA Response: –Fortress System – Daily reporting of all forex transactions –Slippage settings must be asymmetrical

Risk Based Audit System System analyzes the risk factors associated with each firm Risk factors that may prompt an examination –Customer complaints –Business background of principals –Suspicious rates of return –A highly leveraged trading program or pool

Financial testing Promotional and Advertising Material, and Sale Solicitations Anti-Money Laundering Program Systems/Trading Platform 15 Testing at Forex Counterparties

Since 2001, NFA has issued 31 Member Responsibility Actions involving Forex. These are emergency actions taken by NFA against its Members and Associates. Since 2001, NFA has issued 129 Business Conduct Committee Complaints involving Forex. 16 Total NFA Forex-Related Disciplinary Actions

Gain Capital Group LLC - NFA Member FDM Located in Bedminster, NJ Unequal Slippage Tolerances: Customer would always experience unfavorable slippage when the market moved against him/her but his/her order would be rejected and re- quoted when the market moved in his/her favor. FX Diversified LLC - NFA Member CTA Located in Sandy, Utah Promotional material, Registration, Solicitation 17 Examples of NFA Forex Fraud- Related Disciplinary Actions

FX Bootcamp LLC – NFA Member IB Located in Peachtree City, GA Net Capital, AML, Promotional Material violations Integrity FX LLC – NFA Member CPO Located in Riverside, CA Misappropriation of funds 18 Examples of NFA Forex Fraud- Related Disciplinary Actions

Up & Coming Issues Credit Card Funding Transparency –Fees charged to customers (i.e. mark-up on the transaction)

Forex Investor Resources NFA provides the following resources to investors –BASIC – this is a tool where a customer can look up the background information on an NFA member before choosing to invest. –NFA Info Center By phone: (800) By

Forex Resources Forex Investor Resources Trading Forex: What Investors Need to Know Forex Online Learning Program NFA Investor Alerts Forex Member Resources Forex Transactions: A Regulatory Guide Compliance Workshop for Forex IBs, CPOs and CTAs – Chicago Compliance Issues for Forex IBs, CPOs and CTAs webinar

Questions? Michael Braden (312)