SEC Adopts Final Rule for Retail Foreign Exchange Transactions
Commentary by Bob Zwirb
The SEC has adopted a final rule to permit registered broker-dealers ("BDs") under its supervision to engage in retail foreign exchange transactions, provided such BDs comply with the Securities Exchange Act of 1934 and SEC and FINRA rules as they are applicable to retail forex transactions. The rule adopted by the SEC, Exchange Act Rule 15b12-1, is substantially the same as that previously adopted as an interim final temporary rule two years ago and includes a three-year sunset provision that expires on July 31, 2016.
Unlike retail forex rules adopted by the CFTC and several banking agencies two years ago, the SEC rule does not prescribe substantive regulatory requirements for retail forex transactions, such as disclosure, recordkeeping, capital and margin, reporting, business conduct, and documentation requirements. Instead, the rule requires BDs to comply with existing Exchange Act and SEC and FINRA rules in those areas. The three-year sunset provision is intended to provide the SEC with additional time to consider whether to develop more targeted rules for retail forex.
Of importance to investors in the securities market, the SEC rule release clarifies that so-called "conversion trades," in which a currency trade is made in connection with a foreign securities transaction with a settlement period (T + 3) exceeding that for spot FX trades (T + 2), will nevertheless be considered to be spot transactions outside the scope of retail forex. However, consistent with statements issued by the CFTC and banking agencies, the SEC will treat "rolling spot" forex transactions as "retail forex futures," rather than spots and accordingly, subject such transactions to its retail forex rule.
See: CEA Section 2(c)(2)(E).
See also: Retail Foreign Exchange Transactions, Exchange Act Release No. 64874 (July 13, 2011), 76 FR 41676 (July 15, 2011) ("2011 Interim Rule Release"), Extension of Interim Final Temporary Rule on Retail Foreign Exchange Transactions, Exchange Act Release No. 67405 (July 11, 2012), 77 FR 41671 (July 16, 2012) ("2012 Extension Release"), and Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries, 75 FR 55409 (September 10, 2010) ("CFTC Final Rule"); Commissioner Aguilar's Statement: "Addressing Investor Risks in the Retail Forex Business."
Note: The Federal Deposit Insurance Corporation ("FDIC"), the Office of the Comptroller of the Currency ("OCC"), and the Board of Governors of the Federal Reserve System ("Board") have adopted similar rules. See Retail Foreign Exchange Transactions, 76 FR 40779 (July 12, 2011) ("FDIC Final Rule"), Retail Foreign Exchange Transactions, 76 FR 41375 (July 14, 2011) ("OCC Final Rule"), and Retail Foreign Exchange Transactions, 78 FR 21019 (April 9, 2013) ("Board Final Rule").
Commentary
The SEC has been rather late in issuing retail forex rules compared to other financial regulators, which issued theirs two years ago. Instead, market participants in the securities markets have operated under an "interim final temporary rule" during the past two years. The rule adopted here allows BDs to continue to engage in retail forex transactions subject to existing requirements under SEC and FINRA rules, buys the agency more time in which to consider more comprehensive requirements, clarifies the legal status of "conversion trades" that has been the focus of market participants for the past two years, and adopts a narrow view of "spot contracts" consistent with that of the CFTC and banking regulators.
The last point regarding the legal status of rolling spots, which are common in the FX industry, deserves a few words. As with other financial regulators, the SEC takes its cue from the CFTC, which refuses to regard rolling spots as spots, notwithstanding federal and administrative case law that firmly establishes that a rollover provision deferring delivery forward indefinitely does NOT convert either a spot or forward transaction into a futures contract. This includes federal appellate case law to which the CFTC was a party on the losing side. See e.g., CFTC v. Zelener, 373 F.3d 861, 867 (2004), reh'g and reh'g en banc denied, 387 F.3d 624 (7th Cir. 2004), CFTC v. Erskine, 512 F.3d 310 (6th Cir. 2008), reh'g and reh'g en banc denied (6th Cir. 2008) (rejecting CFTC's position that "rolling spot" forex contracts sold to the general public are illegal off-exchange futures). It also includes the CFTC's own case law, which holds that "[n]either the existence [n]or exercise of an option to roll delivery obligations [i]s incompatible with intent to deliver the underlying commodity." In re Grain Land Cooperative, CFTC Docket No. 97-01 (Nov. 25, 2003). While it is possible that Dodd-Frank's interpretation of what constitutes a swap changes the outcome, at least with respect to swaps (i.e., that a rollover provision transforms a spot into a swap), that is not at all clear. Moreover, the SEC here compares a rolling FX spot to a rolling FX future, not to a swap. It, thus, remains difficult to reconcile this view, and that of the CFTC, with that of the case law.