There is a myriad of online brokers, under different regulatory environments to choose from, and it is expected that they will represent your best interests as a fiduciary. Each will have a regulatory framework to work within, but again there will be different financial environments with geographical locations to navigate.This article aims to steer an investor through the risks that may exist when signing up to an online broker. A broker might be ‘cutting corners’ around regulation while others that are fully compliant will offer you a fully regulated service putting your financial interests before their own. Of course, there is a small minority of fraudulent brokers, attracted by the potentially large and regular transactional money flows and custodial activity. It is imperative to be able to spot the warning signs and to avoid those brokers at all costs. No one wants to become their next victim.
As part of the summary, there is a ‘checklist’ to consider when deciding which online broker to choose and what level of protection a client should have in place.
There is a myriad of online brokers, under different regulatory environments to choose from, and it is expected that they will represent your best interests as a fiduciary. Each will have a regulatory framework to work within, but again there will be different financial environments with geographical locations to navigate.
How to spot fraudulent activity
Let’s be clear, it is crucial to recognise that there is a distinction between typical investment losses and online broker fraud. Losing money on your investments does not imply you have been a victim of fraud. Additionally, there are occasions when a clerical error may have been made. Again, that is not fraudulent, but if it becomes a consistent or regular error then a thorough investigation will be necessary. The critical focus for concern will be when your broker places its interests before yours. Or at the very least the lines are blurred between the two. That is where ethical standards can lead to crossed wires, and a red flag should be raised that fraudulent activity might be taking place.
There are several types of online broker fraud that will help you to identify whether you are at risk of becoming a financial victim.
– Has your online broker executed a trade that you had not approved in advance, outside of granting discretionary authority? This type of activity is illegal and could be disguising in-house trading activity.
– Is your online broker failing to execute your investment orders in a timely way? If that is the case, then there is potentially front running of your instruction or in house trading execution happening around your order.
– Has a broker ever asked you to use an address other than your home or business, or perhaps used information about you for purposes other than for the setting up of your account? Setting up erroneous or illegal accounts is another example of fraud.
– Has your broker promoted unsuitable investments to you at any time? Unsuitable investments would be ones that do not fit your investment profile. Your online broker should have a map of your investment preferences and any recommending of trades outside that framework could be deemed as fraudulent.
– Has your broker provided you with misleading information or trading techniques that may have impacted your investment decision? If your online broker is offering trading advice, it has to be based upon factual information or transparent modelling. Any broker claiming to have ‘inside information‘, unverifiable investment recommendations or misleading information regarding the potential risks or rewards of investment, could be acting fraudulently.
– For those clients who have a discretionary relationship with their broker, it is essential to monitor that over-concentration within the portfolio could lead to excessive losses with one investment. It is also worth keeping tabs on whether there is a consistent pattern around over trading or churning. Both activities could determine if you are a fraud victim.
– Clients of online brokers need to be able to keep tabs on the depositing and withdrawal of their funds. Any persistent delays with withdrawals, in particular, over and above standard practise should be reported. A transparent process of money flows is a key remit for a regulated online broker.
– All online brokers need to be formally regulated in their local jurisdiction to enable them to execute investment trades or make investment recommendations. Any falsifying or expiry of the broker’s regulatory position by the underlying entity could indicate fraudulent activity.
– Indications of money laundering activity is a clear red flag to any purported online broker, and a report of any suspicious activity must be made immediately. To this end, no funds may be withdrawn from a client’s account without prior and written, authorisation.
Case studies do exist in the real world
While not wishing to be alarmist, there are many examples of misconduct patterns in financial markets around the world. Each will have a specific regulatory abuse outcome but in all situations it is the end client that suffers. Periods of high volatility and trading activity in the financial markets tend to trigger financial misconduct and that is something of which clients must be made aware. It can be easier to disguise fraudulent behaviour in a period of high volume financial activity. There isn’t a specific fraudulent activity that is more prevalent than any other; however, business and client fraud feature heavily.
An example is an online broker acting as an agent rather than as a principal, or a broker offsetting client transactions to close out an in-house position when the valuation of an asset is more difficult to mark transparently. Ramping or front running an existing in-house position has also been seen to be a prevalent fraudulent activity. The underlying liquidity of the asset in question becomes a critical factor in these situations.
Clients should be aware of signals around purported ‘insider trading’, that is another more common misconduct practice, when a broker may have non-public information that they wrongly share to attract investment activity. The regulatory authorities will not necessarily distinguish between broker and end client when penalising activity of this nature.
Regulation exists to protect the client
While the scenarios laid out above are very rare, the impact of being a victim of one of these fraudulent activities should not be underestimated. The situation has led to a strengthening in the regulatory framework since the global financial crisis of 2008. Broadly, the regulation of online brokers has been expanded to provide far more protection and transparency to the end client. There are, of course, different levels of regulatory support that may be set at a local or global level. However, there is regular cross-regional consultation, so it is important to be aware of what your online broker has signed up to in terms of approved regulation.
The UK’s approach to financial regulation involves several other bodies, each with their responsibilities and objectives. The details are laid out under the umbrella of the Financial Conduct Authority (FCA). The UK, like other leading regulatory bodies, regularly engages with a wide range of European and international counterparts and stakeholders to enhance cooperation, share best practice and discuss issues of common interest. The International Organisation of Securities Commissions is representative of global standard bodies and offers guidance around the world.
Formed on 1 April 2013, the FCA works to protect clients in a wide range of ways. The FCA, like other regulators, monitors which firms, brokers and individuals can enter the financial markets, making sure they meet the relevant standards before authorising them. They will supervise these firms and brokers, and where firms are not following the rules, they will intervene and could impose penalties while ring-fencing clients’ assets. As an example, regulators recently shone a light on ‘contracts for difference’, in response to concerns that retail investors can suffer substantial losses on these widely-marketed products. That has led to consultation papers from both the FCA and the International Organisation of Securities Commission.
There is a specific monetary safety net that the FCA has at its disposal to support retail investors. The Financial Services Compensation Scheme would protect retail clients up to £30,000 if an FCA regulated forex broker was to go bankrupt. Customers may also get 90% of the next £20,000. Other leading Financial regulators echo that safeguard. Furthermore, the FCA has developed a comprehensive online portal, which provides information about brokers, presents current data and findings that support investors’ choice.
An important point to consider is that with regulations, the FCA sets the benchmark, particularly so when compared with other organizations, such as CySEC in Cyprus. Having an FCA license is regarded as vital by a large number of brokers because the organization is known to be one of the oldest and most respected regulatory agencies. Firms that are FCA Regulated Forex Brokers provide their clients with a high level of protection because the obligations under regulations are strict and precise. That respect is confirmed by the high status with which the FCA is regarded worldwide.
Time needed: 1 hour and 30 minutes.
Checklist before signing up to an online broker
- Ensure your broker is fully regulated and approved
Take some time to read the small print and assess what the relevant regulator offers in terms of protection. Be aware that some multi-regional or global brokers will have had to satisfy more than one regulatory framework.
Countries with dedicated financial regulatory agencies include:
South Africa (FSB) – Financial Services Board.
USA (SEC) – Securities And Exchange Commission (FINRA) – Financial Industry Regulatory Authority
Eurozone (MiFID) – Markets In Financial Instruments Directive
UK (FCA) – Financial Conduct Authority
Australia (ASIC) – Australian Securities and Investments Commission
India (SEBI) – Securities and Exchange Board of India
Japan (JSDA) – Japan Securities Dealers Association
Switzerland (FINMA) – Swiss Financial Market Supervisory Authority
(CySEC) – Cyprus Securities and Exchange Commission
- The broker has a safe and secure website and encryption processes to protect from any third-party intervention.
- The broker is fully insured and deals with recognized, regulated banks within the jurisdiction where it operates.
- The broker can ring-fence client funds to protect against it going bankrupt or being asked to cease trading.
The broker will likely achieve this via a third party, like a regulated bank.
- The broker executes withdrawal and deposit activities within three working days
- The broker has a 24-hour dedicated client live support process that allows for a quick response to any queries the client may have.
- Source any credible broker reviews or client feedback before agreeing to execute through their trading portal.
It is always useful to learn from other’s experiences. The broker should be willing to provide how many clients it has signed up.
- Ensure the broker has the availability and range of trading instruments that you require and will not be offering products that are not relevant to your needs.
- The broker has a demo account that a client can try to ensure a better understanding of how the broker operates with your money.
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