Disclosure: Short Plus500.
At root, what illicit online brokerages have in common is the promotion of trading activity as a form of gambling rather than investment.
In my last letter, I mentioned that the Times of Israel has recently drawn attention to abuses within the online brokerage industry in Israel. The Times kindly asked me to provide a perspective on ways to detect potentially abusive firms. My opinion piece has a dual audience: it lists a few quick tips for individuals who may be considering a new brokerage relationship, and it provides a longer list of potential red flags for regulators and the broader industry to consider.
Over the past year, Cable Car has communicated with more than a dozen regulators around the world regarding Plus500 and other abusive online brokerages. It has become clear that, like the online gambling businesses they emulate, many brokerages take advantage of very aggressive regulator shopping, while operating with impunity and little oversight in many jurisdictions.
Operating a broker-dealer generally requires licensing, capital requirements, and strict regulatory supervision. Despite laws on the books prohibiting online brokerages from accepting local clients without registering, many countries defer to a brokerage’s home regulator for enforcement. Scandalously, the home regulators often refuse to supervise conduct that occurs outside their borders. In some cases this confers an artificial air of legitimacy on the worldwide activity of companies that may be conforming to requirements only for clients in regulated jurisdictions.
The Times noted in its initial exposé that some brokerages target customers in impoverished parts of the world with hopes of quick riches. Others seek customers in countries with significant demand for investment but less developed securities markets and regulatory apparatus. When a brokerage based in Israel or Cyprus violates local law in Qatar or Sudan, local authorities have few resources to do anything about it. When a brokerage flaunts regulatory requirements in more established markets like Hong Kong or Singapore, the local authorities may investigate, but to-date they have done little more than warn potential customers.
The United States, ever the world’s policeman, has been relatively effective at bringing enforcement actions against some of the worst offenders who operate within its borders. Hopefully we will see more actions in the future. Yet smart brokerage operators avoid the small handful of countries that have refused to tolerate illegal conduct by overseas firms, such as the United States, Canada, and New Zealand. Even the US has been reluctant to bring enforcement actions against companies that make only indirect use of US means of commerce. In my view, a great deal of responsibility rests with the Israeli Securities Authority to take a more active role in supervising the worldwide actions of its companies.
Below is an excerpt from the op-ed. Please read the whole piece on the Times of Israel website. Comments are welcome.
As the online brokerage industry faces increased regulatory scrutiny in Israel and around the world, it is essential for regulators and prospective customers to understand what separates a legitimate brokerage firm from the “wolves of Tel Aviv.” At root, what illicit online brokerages have in common is the promotion of trading activity as a form of gambling rather than investment. It is no coincidence that many brokerage developers got their start in the online gambling business, and gambling firms have recently diversified into online trading.
Although the bulk of industry criticism has focused on trade in binary options, many binary brokers at least have the virtue of explicitly describing client positions as wagers. Spread betting, a form of contract for difference (CFD) trading popular in the UK, is similarly upfront about what customers are really doing (allowing the results to be taxed as gambling losses rather than capital gains).
Far more insidious, in my view, is the way in which other brokers offering complicated financial products blur the lines between trading for investment purposes and trading for entertainment. Gambling may have its place, but it should not involve financial products. It harms the integrity of capital markets when companies encourage financially unsophisticated individuals to take risks they may not fully understand or have adequate resources to bear.
Complex derivatives like binary options, CFDs, futures, and other leveraged financial instruments were originally developed for professional investors to manage risk and lower tax and transaction costs. They were never intended as gambler’s chits. The risks of binary options, CFDs purchased on margin, and highly leveraged forex trading are wholly unsuitable for all but the most sophisticated individual investors.
Existing laws governing customer suitability, registration requirements, false advertising, and contract fairness already prohibit much of the industry’s conduct, but they have not been adequately enforced across national boundaries. It is not enough for brokerages to simply be registered. There is an urgent need for coordinated international regulatory enforcement to protect the public. Jurisdiction shopping is common, and companies facing sanctions in one country sometimes simply move customer accounts to another.