The National Futures Association (NFA) has engaged in a spree of regulatory scrutiny of FX and OTC derivatives firms during the course of the last week, with the announcement of a potential imposition of capital adequacy requirements on CPOs and CTAs.
Whilst last week's potential imposition was aimed at attempting to bolster the security of client funds when operating with an entire category of industry participants, today the NFA has displayed a baring of its teeth toward one particular company - ILQ.
Hedging Consigned to History Books
Today, ILQ issued a memorandum to its entire client base stating that important changes will be made to the company's MetaTrader 4 platform which may have an impact on the actual functionality, as well as current open positions.
ILQ has detailed the means by which the changes will affect traders, in that if a 1.0 lot “Buy” position is open for EUR/USD on MetaTrader 4, ILQ's customers will not be able to place or maintain a 0.3 lot “Sell” position for EUR/USD.
In the past and until now, ILQ has allowed this functionality on the MetaTrader 4 front-end, while the netting of positions had been performed through the use of ILQ’s proprietary back-office solution that nets opposite direction orders for the same currency pair, and displays your actual net position on your daily and monthly account statements.
Taking this as an example, the existing functionality allows both positions to be displayed on the MetaTrader 4 front-end, whereas ILQ’s back-office solution nets the 1.0 lot “Buy” position with the 0.3 lot “Sell” position, displaying the actual net position as 0.7 lot “Buy” in EUR/USD on the traders' account statement with margin and swap calculations being based on the net position accordingly.
Although ILQ’s back-office performs this netting function, ILQ has identified instances in which offsetting positions maintained in MT4 could potentially result in the improper liquidation of positions for customers entering a margin liquidation event. As such, after this week, ILQ will no longer allow clients to place or maintain offsetting orders in MT4.
This correspondence was issued as a direct result of a complaint filed by the NFA on December 31, 2013, alleging that the company and three members of its senior management, Jason Tanner, James Pieron and Mark Krier had failed to co-operate with the NFA, as well as non-observance of what the NFA considers to be correct supervision criteria.
NFA Probes Business Activities of ILQ
The events which led the NFA to lodge this particular complaint stems from the regulator's assertion that ILQ had been registered as an FCM since August 2006 and became an RFED and FDM in April 2011, subsequently becoming an omnibus FCM in October 2013, during which time it began to hold customer segregated funds.
The NFA claims that it has observed ILQ's primary business to date which has been acting as the counterparty to FX customer transactions, and that since 2011, ILQ has routinely suffered net losses virtually every month.
The NFA alleges that it has concerns relating to the management structure of ILQ, and that it failed to co-operate promptly and fully with the NFA during an investigation by the regulator.
The operational structure had come into question by the NFA, along with scrutiny relating to the business activities of a number of the company's key figures, including the assertion that at the time that the NFA's investigation began in March 2013, ILQ had approximately 1,300 customer accounts and over $13 million in total customer liabilities.
Since 2011, ILQ has relied extensively on Harrison Associates to support the company's operations and meet minimum net capital requirements. The NFA further asserts that Harrison Associates is presently owed over $38 million through subordinated loans agreements (SLAs) granted to ILQ.
ILQ was formerly known as I Trade FX LLC when the firm was owned and operated by Jared Martinez and his sons, Jacob and lsaac Martinez.
ln April 2009, an NFA Hearing Panel fined I Trade $250,000 for failing to implement an adequate anti-money laundering program by not sufficiently investigating irregular activity in several customers' accounts to determine if the firm should have filed suspicious activity reports.
NFA's Appeals Committee affirmed the Hearing Panel's Decision as to I Trade in January 2010, and also found that lsaac Martinez failed to exercise his supervisory duties, in violation of NFA Compliance Rule 2-36(e), and ordered him to pay a $50,000 fine.
A central figure in the suspicious activity at I Trade was David Smith, a former I Trade principal who controlled several of the I Trade accounts that were the focus of NFA's disciplinary case against the firm, and ran a Ponzi scheme that bilked about 6,000 investors in Florida and the Caribbean out of $220 million. In August 2011, a federal judge in Orlando, Florida, sentenced Smith to 30 years in prison, after he pled guilty to charges of fraud and money laundering.
ln May 2009, while NFA's disciplinary case against I Trade was pending, the firm ceased operating and stopped holding customer funds, even though its FCM registration and NFA membership statuses remained intact. A few months after the disciplinary case ended, I Trade was sold to Navitas Investments LLC.
Navitas was formerly known as Institutional Liquidity Holdings LLC, but changed its name to Navitas in August 2010. Navitas changed the firm's name from I Trade to ILQ in August 2010, and ILQ resumed holding Forex customer funds under its new ownership on April 29, 2011.
The NFA's complaint further asserts that the regulator had been concerned about ILQ's capital position for some time. In August 2012, NFA noticed that ILQ's daily forex filings showed a significant increase in capital charges on its uncovered forex inventory, which greatly impacted the firm's excess net capital (ENC).
For example, from July 31 , 2012 to August 9, 2012, the firm's total capital charges more than doubled, rising from just under $900,000 to over $2.3 million. However, as of August 9, 2012, ILQ's net capital only amounted to slightly more than $233,000, while the firm's liability to forex customers totaled almost $20 million.
NFA shared its concerns about ILQ's financial situation in an August 15, 2012 letter addressed to Mr. Krier, a Chief Compliance Officer, and asked the firm to submit daily net capital computations until further notice so NFA could ensure the firm remained in compliance with NFA Financial Requirements.
With the NFA's penchant for customer protection in mind, and the concerns over capital adequacy, the method by which ILQ provides hedging to its clients came under scrutiny. At present, it is entirely possible to allow ILQ's MetaTrader 4 platform to show simultaneous buy/short positions, thus avoiding the US ruling on hedging.
Under this circumstance, it is displayed on the back-office system as an account standing at zero, therefore is legal. However for clients, this means having to pay the spread twice unless they use MetaTrader 4's 'close by' function.
On this basis, the NFA has put an end to this practice resulting in ILQ announcing to its customers that as of January 31 at 5:00pm ET there will no longer be a facility in which they can place or maintain positions in opposite directions for the same currency pair on the front-end order management platform (MetaTrader 4).
Man of Substantial Wealth
Because the January 2013 capital infusion made up all of ILQ's ownership equity at the time, and because the $12.5 million represented 34o/o of the outstanding SLAs between ILQ and Harrison Associates, NFA commenced its investigation to determine the ultimate source of the January 2013 capital infusion and ensure that ILQ properly disclosed any person who contributed 100/o or more of the firm's capital.
The NFA also wanted to determine if Harrison Associates had the financial wherewithal to continue funding lLQ. In addition, NFA wanted to check to see if there was any suspicious activity in connection with the capital infusion which was of particular interest to NFA based on the relationships among lLQ and its owners, as well as Trevor Cook, and the Martinez family.
In order to go about this, the NFA wrote to ILQ and Mr. Krier in March 2013 outlining he exact details required by the NFA to complete a verification of the source of all funds, including a request for ILQ's bank statements as well as monthly bank statements from October 2012 to February 2013 for Navitas, Harrison Associates and several individuals involved in contributing funds to ILQ. Navitas is owned by Harrison Associates Limited and Mr. Pieron.
Prior to this, Mr. Pieron had owned a now defunct company called JDFX Holdings, which was a British Virgin lslands registered FX company located in Switzerland.
JDFX had a business relationship with Trevor Cook, a former NFA Associate who pled guilty to operating a $200 million Ponzi scheme and was sentenced to a 25-year prison term in 2010. In a matter unrelated to Mr. Cook's Ponzi scheme, Mr Cook himself was also sanctioned by an NFA Hearing Panel in 2005 for failing to uphold high standards of commercial honor and just and equitable principles of trade.
During the months following the NFA's requests in March 2013, a paper trail ensued, with the NFA attempting for several weeks to establish the actual source of ILQ's capital, with Mr. Tanner, Mr. Krier and Mr. Mawdsley replying to the NFA's letters but avoiding compliance with the NFA's requests.
The NFA asked Mr. Tanner about the chain of supervision at ILQ. Tanner testified that as Chief Operating Officer (COO), he reported to Mr. Pieron, as did Mr. Krier.
Mr. Tanner also represented that as COO, his responsibilities included the day-to-day operations of the firm as well as overseeing mergers and acquisitions, and that Pieron supervised these activities. However, Tanner stated that Pieron only occasionally reviewed his work and that he had a "good degree of autonomy" at the firm.
During his deposition, Tanner also stated that he had recently assumed the position of CEO at lLQ, and that as CEO he reports to no one. Nevertheless, Mr. Tanner said he provided information about the firm's activities to ILQ's "financial partner and his representatives." Mr. Tanner described the financial partner to the NFA as a "man of substantial wealth."
According to Mr. Tanner, he based this assessment on financial statements he had seen for the financial partner and his companies and on the Foreign Bank's representation regarding its relationship with the financial partner and the "amount of capital" the financial partner had. However, Mr. Tanner also admitted during his deposition that he had never personally met or spoke with the financial partner even though he had worked at ILQ for almost eight months at the time of his deposition.
In a remark to the NFA, Mr. Tanner likened the financial partner to Warren Buffet and claimed, "I wouldn't expect if I ran a company for Warren Buffett that I would probably speak to Warren Buffett either."
Finally, in September 2013, approximately six months after NFA's inquiry began and only after threatening ILQ with disciplinary action, the NFA received the remaining documentation which it had requested and was able to complete its investigation into ILQ's January 2013 capital infusion.
The NFA considered this to be a failure to co-operate with the NFA within a reasonable time period, for which the firm has now been censured. This led to the NFA applying a secondary complaint, alleging that ILQ failed to supervise its operations, business activity and employees, including Mr. Krier and Mr. Tanner.
Whether ILQ's amendment to the functionality of its trading environment is sufficient to satisfy the NFA is a matter which the NFA may have to take a decision on, however the firm is still within the statutory thirty day period during which it must address the complaint and reply, with the NFA requiring to be satisfied that the figures displayed on ILQ's MetaTrader 4 trading accounts now fit within the regulatory criteria.
Forex Magnates contacted Mr. Tanner in order to ascertain his perspective on these matters and how the company intends to resolve its relationship with the NFA, as well as adapt its business model to ensure that its new functionality remains profitable and secure for clients, however no reply was forthcoming. QED.
