The emerging sector of prop trading was subjected to a massive blow recently with the lawsuit from the US commodities regulator against My Forex Funds. Though the action was only against the platform and Murtuza Kazmi, its owner, for fraud, it raised questions about the practices of all prop trading companies. Finance Magnates approached multiple prop trading for interviews, but they preferred to stay behind the curtains after the My Forex Funds fiasco.

Prop Trading: A Fad to Fade?

Prop trading firms, short for "proprietary" trading, provide funds for traders to trade on live markets. They claim to reduce clients' risks of losing capital while trading. Also, the firms split the trading profits, which are sometimes as high as 90 percent, with the traders. This sounds great on the surface, but there are caveats.

Traders need to pay these prop trading firms to take on trading challenges. If the traders successfully complete the challenge, they will be allowed to trade with the company's money, of course, on many conditions. Some prop trading shops even charge monthly subscription fees.

"The models do vary depending on the prop trading firm," FXStreet's Senior Analyst, Ian Coleman, explained. "In a nutshell, they entice traders in by offering larger trading capital than you could normally afford. You pay a fee. You prove that you can consistently make a profit. The monies made are then split between the prop trading firm and the trader. It sounds great, but there are a lot of rules (set by the prop firm) that need to be adhered to."

The offerings of these firms, at least on the surface, made them very popular in the retail trading industry. While the concept of prop trading has existed for decades, many of these firms/platforms have popped up in recent years, including The Trading Pit, FundedNext, Traders With Edge, and Lux Trading Firm.

"Fundamentally, there is nothing wrong with prop firms trading with their own money," said Tom Higgins, the Founder and CEO of Gold-i. "The problems arise when it is not their own money, or they use client orders to front-run the market."

The Bust of My Forex Funds

My Forex Funds, which ran an extensive advertising campaign on social media globally, was a typical prop trading firm, at least on paper.

Like any other prop trading firm, My Forex Funds offered a trading challenge on a demo account, with a fee, of course. Further, traders had the option to "skip" the challenge. However, they need to deposit a certain amount, and the platform matches that.

Business-wise, the platform was also doing very well: it has generated at least $310 million in fees over the last couple of years. My Forex Fund was founded in 2020.

However, the entire prop trading operation of My Forex Funds turned out to be an alleged scam, according to the charges raised by the Commodity Futures Trading Commission (CFTC).

According to the 40-page court document, Murtuza Kazmi and his two companies, New Jersey-incorporated Traders Global Group Inc. and Canada-based Traders Global Group Inc, operated as My Forex Funds, decided their clients in many ways.

My Forex Funds promised retail customers that they could become "professional traders" by using Traders Global's money to trade against third-party "liquidity providers" and share any of the trading profits. However, the platform claimed that it had earned the money when the customers did, but, in reality, Traders Global acted as the counterparty party to most customer trades, meaning it gained at the loss of the traders.

To minimize the probability of customers' profitability, the company used pretexts to terminate customer accounts and misleadingly assess commissions to reduce customer account equity. The company even allegedly used manipulative software to execute customers' orders at worse prices. It only allowed a small number of "successful customers" to decrease customer profits and increase customer losses.

However, with massive marketing campaigns and the growing popularity of prop trading, My Forex Funds had more than 135,000 customers who signed up for its trading program after November 2021, and they paid at least $310 million in fees.

The CFTC's complaint charged the defendants for "fraudulently soliciting customers to trade leveraged, margined, or financed retail foreign exchange (retail forex) and leveraged retail commodity transactions." The US regulator, and also the state regulator of Canada's Ontario, froze the funds of My Forex Funds.

"According to the complaint, My Forex Funds conducted their clients' trades not against a 'third party liquidity provider' but against the firm's own funds; and then made sure there are no profits to share with the clients," said Remonda Z. Kirketerp-Møller, the Founder and CEO of Muinmos.

"It is also worth noting that in an OTC market, the broker is always the counterparty to the trades, and in most cases, trades will not be hedged one-to-one with an external liquidity provider, meaning the broker will make money if clients lose money."

Incoming Regulations?

As prop trading firms do not handle clients' funds, ideally, they are not subjected to stringent regulations like brokers. They only provide liquidity and execute the orders on other brokerages.

"We anticipate seeing guidance from other global regulators on how their current framework applies to these operating models," said Quinn Perrott, the Co-CEO of TRAction. "This type of guidance is not unheard of and has been released in the past by regulators such as ASIC, FCA, and CySEC in regards to cryptocurrencies, social trading, buy now pay later, crowdfunding, and other financial innovations (even CFDs back in the day). As the market evolves and innovates, regulators will always experience a lag between the state of their law and what it needs to cover to protect consumers."

He added that existing laws around advertising and bonus structures and payments should be sufficient tools for the regulators to stop any deceptive or unlawful practices.

Questionable Model of My Forex Funds

Although prop trading firms bypass regulations, the case of My Forex Funds is tricky as it accepted clients' monies who skipped the trading challenge.

"Anyone offering or entering into leveraged retail forex contracts without registration, or offering or entering into leveraged retail commodity contracts off-exchange, is acting in clear violation of the law," said Kirketerp-Møller.

The Future of Prop Trading

After the charges against My Forex Funds, the possibility of regulatory attention on the prop trading industry has increased. The UK and European regulators are still silent on prop trading, but any action by them might reshape the industry tremendously; most of these platforms are operating outside the US.

The early FX/CFDs and then the binary options industry have seen such My Forex Funds-like alleged manipulation. Although binary options, which are very complex on their own, are non-existent in Europe, CFDs have become an established industry with stringent regulatory oversight.

"I have seen this (My Forex Funds-like alleged scam) in FX and Binary Options," said Higgins. "Whenever the broker is executing against their own book (B-book), rather than applying an LP markup, the possibility for manipulation arises. I have seen examples in FX where the broker charges a huge commission fee on managed accounts and keeps going in and out of the market until the client balance is zero. They B-book the trades, so the broker makes the spread and the commission! In binary options the market was designed from the outset to rip off the clients, and they relied on naïve clients who did not know the odds of losing (almost 100%)."