Foreign exchange fraud

Foreign exchange fraud is any trading scheme used to defraud traders by convincing them that they can expect to gain a high profit by trading in the foreign exchange market. Currency trading "has become the fraud du jour" as of early 2008, according to Michael Dunn of the U.S. Commodity Futures Trading Commission.^[1] But "the market has long been plagued by swindlers preying on the gullible," according to The New York Times.^[2] "The average individual foreign-exchange-trading victim loses about $15,000, according to CFTC records" according to The Wall Street Journal.^[3] The North American Securities Administrators Association says that "off-exchange forex trading by retail investors is at best extremely risky, and at worst, outright fraud."^[4]

The foreign exchange market is at best a zero–sum game,^[5] meaning that whatever one trader gains, another loses. However, brokerage commissions and other transaction costs are subtracted from the results of all traders, making foreign exchange a negative-sum game.

"In a typical case, investors may be promised tens of thousands of dollars in profits in just a few weeks or months, with an initial investment of only $5,000. Often, the investor’s money is never actually placed in the market through a legitimate dealer, but simply diverted – stolen – for the personal benefit of the con artists."^[6]

Government interventions

In August, 2008 the CFTC set up a special task force to deal with growing foreign exchange fraud.^[7] In January 2010, the CFTC proposed new rules limiting leverage to 10 to 1, based on " a number of improper practices" in the retail foreign exchange market, "among them solicitation fraud, a lack of transparency in the pricing and execution of transactions, unresponsiveness to customer complaints, and the targeting of unsophisticated, elderly, low net worth and other vulnerable individuals."^[8]

Types of fraud

Frauds might include churning of customer accounts for the purpose of generating commissions, selling software that is supposed to guide the customer to large profits,^[9] improperly managed "managed accounts",^[10] false advertising,^[11] Ponzi schemes and outright fraud.^[4][12] It also refers to any retail forex broker who indicates that trading foreign exchange is a low risk, high profit investment.^[13]

Increase in fraud

The U.S. Commodity Futures Trading Commission (CFTC), which loosely regulates the foreign exchange market in the United States, has noted an increase in the amount of unscrupulous activity in the non-bank foreign exchange industry.^[14] An official of the National Futures Association was quoted as saying, "Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically."^[15] Between 2001 and 2006 the U.S. Commodity Futures Trading Commission has prosecuted more than 80 cases involving the defrauding of more than 23,000 customers who lost $350 million. From 2001 to 2007, about 26,000 people lost $460 million in forex frauds.^[1] CNN quoted Godfried De Vidts, President of the Financial Markets Association, a European body, as saying, "Banks have a duty to protect their customers and they should make sure customers understand what they are doing. Now if people go online, on non-bank portals, how is this control being done?"

Not beating the market

The foreign exchange market is a zero sum game^[5] in which there are many experienced, well-capitalized professional traders (e.g. working for banks) who can devote their attention full-time to trading. An inexperienced retail trader will have a significant information disadvantage compared to these traders.

Retail traders are, almost by definition, undercapitalized. Thus, they are subject to the problem of gambler's ruin. In a "Fair Game" (one with no information advantages) between two players that continues until one trader goes bankrupt, the player with the lower amount of capital has a higher probability of going bankrupt first. Since the retail speculator is effectively playing against the market as a whole, which has vastly more capital, they will almost certainly go bankrupt. The retail trader always pays the bid/ask spread which makes their odds of winning less than those of a fair game. Additional costs may include margin interest or, if a spot position is kept open for more than one day, the trade may be "resettled" each day, each time costing the full bid/ask spread. In some variations of foreign exchange trading, forex dealers serve as the counterparty to the contracts sold to the retail customer. The underlying contract is not traded on an actual exchange such as the Chicago Board of Trade, but rather entered into off-exchange. Thus, if the investor loses money, while the dealer makes money.^[16]

Although it is possible for a few experts to successfully arbitrage the market for an unusually large return, this does not mean that a larger number could earn the same returns even given the same tools, techniques and data sources. This is because the arbitrages are essentially drawn from a pool of finite size; although information about how to capture arbitrages is a nonrival good, the arbitrages themselves are a rival good. (To draw an analogy, the total amount of buried treasure on an island is the same, regardless of how many treasure hunters have bought copies of the treasure map.)

Paul Belogour, the Managing Director of a Boston-based retail forex trader, was quoted by the Financial Times as saying, "Trading foreign exchange is an excellent way for investors to find out how tough the markets really are. But I say to customers: if this is money you have worked hard for – that you cannot afford to lose – never, never invest in foreign exchange." ^[17]

High leverage

By offering high leverage some market makers encourage traders to trade extremely large positions. This increases the trading volume cleared by the market maker and increases their profit, but increases the risk that the trader will receive a margin call. While professional currency dealers such as banks and hedge funds tend to use no more than 10:1 leverage, retail clients may be offered leverage between 50:1 and 400:1.^[2]

Alleged scamming by country

Cyprus

A large number of forex companies are registered with the Cyprus Securities and Exchange Commission (CySEC) to take advantage of light regulation while allowing access to all European Union countries via MiFID. Many of these focus on attracting foreign customers. In one incident, a client sued the firm Easy Forex, alleging that it paid brokers bonuses when clients lost money and fined brokers when clients made a profit. An Israeli television report quoted an Easy Forex broker saying, "I had this evil grin on my face one day, when a client lost $35,000 in a quarter of an hour. A guy gets wiped out – I get my commission. A guy comes up a winner and turns a profit – I pay."^[18][19]

Convicted scammers

• Russell Cline
• Russell Erxleben
• Joel N. Ward
• WinCapita^[20][21]

External links

• US Commodity Futures Trading Commission Forex Fraud Advisory

See also

• Boiler room
• Bucket shop
• Foreign exchange market
• Forex scandal
• Fraud
• Gambler's conceit
• Gambler's ruin
• High-yield investment program

References