This day in history: August 12, 2011 – NFA fines FXCM $2 million for assymetrical slippage

Best execution has become a term that has made its way into the parlance of regulators since the structure of the retail financial market has become electronic, and even more importantly, since its emulation of the institutional trading methodology via the connection of retail platforms to live liquidity feeds from Tier 1 banks.

Five years ago, there were still a number of retail FX brokerages which did not connect to a live liquidity stream provided by a prime brokerage, instead offering fixed spreads and a trading environment provided by an internal dealing room with MetaTrader 4 being used in its original form – that being as a closed system with no connectivity outside the brokerage.

One particular retail FX brokerage that adopted the model of providing live price feeds and direct market access to its clients was North American electronic trading giant FXCM, which spent several years advocating the modus operandi which features absolutely no dealing desk at all, instead sending its entire order flow to the liquidity provider which subsequently is processed by the banks that are providing prices via an aggregated electronic price feed to FXCM’s proprietary Trading Station platform.

This indeed is all well and good, and FXCM appeared to be conducting its business in a very ethical way. That is until the grey suits came in.

On this day five years ago, August 12, 2011, the National Futures Authority (NFA) made a formal complaint, citing that FXCM had made and retained gains which came about as a result of positive price slippage.

Additionally, the NFA stated in its complaint that FXCM failed to adopt or carry out adequate procedures to ensure the efficient execution of all customer orders as well as, perhaps most interesting of all, failing to treat all customers equally with regard to giving price adjustments and not investigating suspicious activity in customer accounts.

To add to this, the company’s CEO Drew Niv was also charged with failing to supervise these activities.

The same day that the complaint was made, FXCM offered a settlement to the NFA, in which FXCM would credit the accounts of its customers to the amount of the positive slippage which its customers experienced on their trades from and after June 2008, within 30 days of the NFA’s decision to accept this settlement proposal.

As well as crediting customer accounts, and FXCM having been ordered by the NFA to provide verification of the credits, the NFA requested that FXCM paid a $2 million monetary sanction.

One day subsequent to this, FXCM made a commercial statement on the matter, with CEO Drew Niv having explained

We are pleased to have reached an agreement that resolves the NFA’s concerns and that we believe is in the best interests of FXCM, our shareholders and most importantly, our clients,” said Drew Niv, Chief Executive Officer of FXCM. “We previously enhanced our execution system to pass along all price improvements on every order type and remain committed to providing the most robust forex trading platform available.”

FXCM’s platforms display the best bid/ask spread streamed from the firm’s liquidity providers plus FXCM’s mark-up. Every FXCM NDD forex trade is automatically offset in a two-step process, designed to ensure that FXCM does not profit from a trader’s losses. In the first step of the execution process, a trader clicks on the price and the order is sent to FXCM. In the second step, FXCM automatically sends the client’s order to one of its liquidity providers to offset the trade.

The company stated that FXCM’s execution system prior to August 2010 only offered price improvements to clients in the first step of the process.

If a better price became available on FXCM’s platform in the fraction of a second after the client submitted the order but before the order was received by FXCM, the client would benefit from the price improvement. However, FXCM’s previous execution system did not provide clients with price improvements in the second step of the execution process, even if FXCM was able to offset the order at a better price, excluding FXCM’s markup.

FXCM enhanced the execution system in 2010 so that clients now benefit from price improvements in both steps of a transaction for all order types.

FinanceFeeds believes that, whilst North America’s regulatory structure and method of ensuring that the best interests of customers and the behavior of companies are two factors that are absolutely covered with regular reporting, inspections and very little tolerance for error, in this case it was really a matter of FXCM being a pioneer of the ‘no dealing desk’ model and falling foul of its own good intentions.

Photograph: FXCM headquarters, Downtown Manhattan. Copyright FinanceFeeds