NFA audits Gain, finds many severe violations, fails itself!

NFA just issued a very severe Complaint against Gain Capital and its CEO Glenn Stevens for violating a whole lot

NFA just issued a very severe Complaint against Gain Capital and its CEO Glenn Stevens for violating a whole lot of its regulations. Reading through the Complaint it is evident that while Gain may have indeed violated some rules the real culprit here is the NFA itself!

Gain Capital is just another for-profit company in corporate America – it is making money any way it can, as long as it is legal. And if NFA explicitly allows market making activity which is the most profitable financial activity in the world, then Gain and EVERY other NFA registered company will make market to the most possible extreme.

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It seems in this case that while NFA’s one hand allows market making, its other hand is punishing brokers for making market! This my friends is either hypocrisy or incompetence. In NFA’s case I believe this to be the latter.  Ever since this blog was started about a year ago I made it very clear that NFA has absolutely no idea what forex is and what forex brokers do. I’ve claimed time after time that NFA is incompetent and its leadership doesn’t fully understand its role or how it should regulate the activities it chose to regulate. NFA knows or should have known that brokers allowed to make market will make market and will profit from client losses any way they can. This ‘sudden’ discovery of market making practices (by the way it is very interesting how NFA which knows absolutely nothing about forex or forex software knew EXACTLY which plugins and which settings to check and what those settings meant, but that’s another story) only goes to show you how inept NFA is.

All this is now very apparent to any one who reads the Complaint against Gain embedded below.

Not only NFA failed in its role as a prominent Forex regulator but it is also to blame for creating a deceptive perception to forex trades that regulation is a good thing and that NFA knows what it is doing and is protecting clients. It’s not! This is another issue I’ve been lengthily discussing – regulation is not necessarily a synonym for market fairness and customer safety. While some of customer funds may be safer when placed with regulated brokers, those very same brokers are de facto allowed (as we see in this Complaint) to do just about anything they want in order to help clients lose their money.

Lastly, I said it a few times before and I’ll say it again: NFA (or any other regulatory entity to replace it should it be, hopefully, disbanded) MUST ban retail forex market making altogether. This would be the only way to ensure market fairness and transparency and to eliminate conflict of interest which all market makers have when dealing with their clients and which will ALWAYS prevail because it is so much profitable. Until NFA realizes that and bans market making I suggest traders to treat NFA ‘regulated’ brokers exactly the way they treat ‘offshore’ brokers – with caution. It is actually ironic how ‘offshore’ was always a synonym for lack of transparency or lack of market fairness, yet ‘proper’ and ‘regulated’ brokers are not better if not worse…

I’ve always wanted to say this: By reason of the foregoing acts and omissions NFA and CFTC are charged with violations of their own rules and regulations as well as with being incompetent and inadequate in what they are doing.

All of the above shouldn’t detriment from the content of the NFA’s complaint against Gain, as according to the complaint Gain cynically abused its market making mandate and made many actions which turned out to be not in the favor of the client. However as I wrote extensively above, you can’t really blame Gain as the NFA has openly sanctioned these practices. All US NFA ‘regulated’ brokers are doing exactly the same.

Gain also should take this Complaint very very seriously as NFA states that “The allegations in this Complaint may constitute a statutory disqualification from registration under Section 8a(3)(M) of the Commodity Exchange Act… Pursuant to the provisions of Commodity Futures Trading Commission (“CFTC) Regulation 1.63 penalties imposed in connection with this Complaint may temporarily or permanently render Respondents who are individuals ineligible to serve on disciplinary committees, arbitration panels and governing boards of a self-regulatory organization, as that term is defined in CFTC Regulation 1.63.” That is to say that NFA may bar Gain from its membership and also may bar its CEO Glenn Stevens.

It is also very interesting to see how profitable Gain Capital is: In 2009, Gain earned over $150 million in gross revenue from its forex activities and net income of about $42.5 million. As of May 31, 2009, Gain had roughly 60,000 retail customers – approximately 34,000 of whom were U.S. retail customers – with total equity of approximately $136 million.

There are quite a few interesting facts found in the complaint which I’ll summarize below, or you can skip and read the full embedded complaint.

Key topics in the Complaint:

  • Gain routinely  and repeatedly  adjusted leverage  and margin requirements  on Fridays, without giving affected  customers  adequate  prior notice of the adjustment, denied customers  the opportunity  to deposit additional  funds to maintain  their open positions  or, at the very least, select which positions  to liquidate,  and caused  them to experience  significant losses in their accounts. Because of the liquidations that occurred on these dates, affected customers realized overall losses totaling nearly $425,000.
  • Gain used an add-on tool to the MetaTrader trading platform – called the Virtual Dealer Plug-ln – for both its retail and institutional servers. The Virtual Dealer Plug-ln allowed slippage tolerance to facilitate the execution of orders. Gain established the following slippage parameters for the Virtual Dealer Plug-ln used for its retail server:

Delay: 1 second

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Maximum Volume: 50 contracts

Maximum Losing Slippage: 2 pips

Maximum Profit Slippage: 2 pips

Maximum Profit Slippage Volume: 5 contracts

The setting for “maximum profit slippage volume” dictated that if the volume of a customer’s order exceeded five standard contracts and the market moved in favor of the customer after Dlacement but before execution of the order, then the customer’s order would be requoted.

As a result, from May 1, 2009 through July 31, 2009, customers trading greater than five standard contracts on the retail server experienced $169,502 in losses due to unfavorable slippage, yet never received any gains when favorable slippage occurred. Thus, the Virtual Dealer Plug-ln’s “maximum profit slippage volume” parameter only negatively impacted customers but never benefitted them.

  • Gain established the following slippage parameters for the Virtual Dealer Plug-lnused for its institutional server:

Delay: 1 second

Maximum Volume: 100 contracts

Maximum Losing Slippage: 20 pips

Maximum Profit Slippage: 3 pips

Maximum Profit Slippage Volume: 5 contracts

Like the retail server, the institutional server also limited profitable slippage (slippage favorable to the customer) to five standard contracts while negative slippage (slippage unfavorable to the customer) was allowed on order sizes up to 100 contracts by default (the maximum volume setting). However, unlike the retail server, the institutional server had asymmetrical seftings for maximum losing and maximum profit slippage and allowed for negative slippage up to 20 pips before the customer would be requoted. Therefore, customers were far more likely to have their orders filled when there were large market movements unfavorable to them as opposed to when they were favorable to them. Customer orders on the institutional server were negatively affected by slippage due to the “maximum profit slippage volume” setting (i.e., greater than five standard contracts).

From May 1, 2009 through July 31, 2009, customers ordering greater than five standard contracts on the institutional server experienced almost $100,000 in losses due to unfavorable slippage when the market moved against them, but their orders were rejected when the market moved in their favor resulting in them experiencing zero gains.

  • At the time of NFA’s 2009 audit, Gain had 215 unregistered solicitors that solicited U.S. customers for Gain. NFA reviewed eleven websites of these unregistered solicitors and found numerous deficiencies in these websites. Gain had also noted many of these deficiencies during its own review of these websites and had advised its unregistered solicitors to correct these deficiencies. However, Gain failed to follow-up with its unregistered solicitors to ensure that they had taken appropriate corrective action to remedy these deficiencies.
  • According to the NFA Gain were also very slow in responding and not very collaborative in general.

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