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Regulatory Backdrop to Prop Trading: Navigating Jurisdictions

For any traders who missed it, the prop trading firm just got hit by a massive curve ball. Last month, the forex commodity pool and trading advisor My Forex Funds was charged with fraudulently seizing over $300 million in client funds. My Forex Funds also operated as a prop firm – and this case marked a pivotal moment in the history of prop trading and opened the (potentially $300 million dollar) question: How are proprietary firms regulated and how do the areas differ in legal requirements?

An important question yet not one that can be answered in a few lines, nor even a few paragraphs. Proprietary trading lies in a sort of financial grey area and while this can open revenue opportunities for both broker and trader, there are also sharks in the water. In this article, we will explore the legal definition and regulation of prop trading in a range of geopolitical jurisdictions.

Before we pop open the bonnet on the legal nitty-gritty behind this fast-growing industry, what exactly is prop trading, and why are ever more traders joining these firms?

Prop trading: the go-to capital goldmine for ambitious traders

Prop trading: the buzzword in online trading. A relatively new phenomenon, proprietary trading or “prop trading” is a funding concept whereby traders can seek the use of company capital in return for ceding a portion of any profits earned. Prop firms differ in the funding models and revenue models, but the general premise is this: if a trader can prove his/her profit potential by passing an internal trading test or series of “Challenges” then the prop firm will bring them on as a “Funded Trader.” A trading evaluation or Challenge often uses a demo account, and traders must meet certain criteria (profit targets, minimum and maximum drawdown) and there may be a time limit.

Funded traders will be given accounts loaded with company capital with which to trade across a variety of assets and markets. The majority of any profits generated will be kept by the trader, but in return for the use of the capital, the prop firm will keep a percentage (it varies from firm to firm, but the industry average is 20%).

The ever-evolving landscape of Prop Trading

This is a very basic summary as the prop trading firm has exploded in popularity the field has become more competitive, and companies have added more features and elevated their platforms to keep their edge. For example, today some firms offer “instant funding” to traders (sometimes referred to as “fast-track” or “Accelerated” accounts) whereby traders can pay a higher entry fee in return for immediate use of real funds and profit earning. Prop firms are beginning to add competitions with cash prizes, Leaderboards, educational add-ons, and even career opportunities for traders to scale up through the company. (Here is a handy comparison chart of the most popular prop firms).

The specifics vary widely around the industry. Some firms have lower profit-sharing arrangements – but make up for this with a more flexible Challenge – while others have less flashy features and free resources but make up for it with superior spreads and leverage on offer. An important feature that traders often overlook when deciding which prop trading firm to invest in is the legal and regulatory position. Prop trading is an online venture open to traders around the globe, but regardless of their client demographic, these firms will be bound by the legal and regulatory requirements of their company geographic authority.

It is important that traders are aware of the legal restrictions and regulatory requirements of their prop firm as this could play a significant role in the access and use of funds and their rights over data, privacy, and finances. You do not want to be in the position of one of the 135,000 My Forex Funds clients who potentially lost significant funds over the alleged scam.

Tightening Regulatory Pressure on Prop Trading

Tightening Regulatory Pressure on Prop Trading

What's the 'buzz' about? My Forex Funds Scam Might Trigger Regulation Push on Prop Trading

My Forex Funds was a commodity pool operator and commodity trading advisor. As the name suggested, the company operated in the foreign exchange. My Forex Funds also worked as a proprietary trading platform. In 2013, the U.S. Commodity Futures Trading Commission (CFTC) took legal action against My Forex Funds and its chief owner, Trevor G. Cook. The case marked one of the most notorious legal disputes in forex in recent history.

The CFTC accused My Forex Funds and Cook of engaging in fraudulent activities, the misappropriation of client funds, and operating a Ponzi scheme. It transpired through the legal battle that Cook and his associates had assured clients of high returns through forex trading. They offered to pool investor funds for trading in forex. Instead, Cook misappropriated most of the funds for personal use and to make Ponzi-style payments to earlier investors.

The case was brought to light when investor redemptions were halted, and clients realized that the firm was unable to meet its financial obligations. By the end, it turned out that over $190 million had been misappropriated from trusting investors – a fraction of which was ever used for actual forex trading.

What happened to Cook?

Following the CFTC's legal action, Cook was sentenced to 25 years in federal prison. The My Forex Funds case stands as a beacon of the importance of caution when investing in forex and thoroughly researching any companies before entrusting funds to invest. It also bears testament to the protective role of regulatory bodies like the CFTC in combatting fraudulent activities and safeguarding client funds.

The Future of Prop Trading: Learn and move on

My Forex Funds is a cautionary tale and the perfect example of why one should do due diligence before making any financial investment, it is not to say that all prop trading firms need to be tarred with the same brush. For every trader burnt by the My Forex Funds swindle, there will be many more who have utilized the generous leverage offered by prop firms to get not only a foot in the trading door but an opportunity to trade with hundreds of thousands of dollars, vastly increasing position sizes and maximizing profits accordingly.

Now onto the prop firms' specific regulations and the legal implications presented by their districts. In the world of proprietary trading, legal and regulatory considerations play a pivotal role in defining their operations, obligations, and scope of influence. The jurisdiction in which a prop firm operates has an enormous influence on its potential activities, compliance requirements, and overall viability. If you are a trader considering a prop firm, it is critical you understand these legal and regulatory aspects in order to make an informed decision in the prop trading landscape. Let us see how the horizon differs from company to company:

Location, Location, Location!

When it comes to prop trading, jurisdiction matters – enormously. Prop firms' choice of jurisdiction is not arbitrary but strategic. Global regions vary widely in the regulatory framework permitted to prop trading firms and these can enable or hinder certain activities.

  • United States: The U.S. is famously tough on regulations. North American prop trading firms are subject to regulations like the Dodd-Frank Act and the Volcker Rule, which were implemented to safeguard against excessive risk-taking.
  • Europe: European Union countries are under MiFID II regulations, which are strong on transparency and investor protection. Firms operating in the EU must comply with these rules.
  • Offshore Jurisdictions: Some prop firms opt for offshore authorities like the Cayman Islands or the British Virgin Islands for favorable tax treatment and fewer regulatory constraints.
Prop Firms Jurisdiction

Prop Firms Jurisdiction - worldwide locations

Location. A complete list of Prop Firms. This summary is updated; however, sometimes there are changes. Always confirm them with your prop firm.
Prop Firm Location
FunderProMalta
FTMOPrague (Czech Republic)
UltraCap TradingFort Lauderdale, Florida, United States
Toptier TraderDelaware (USA)
the5ersLondon (UK)
SabioTradeDublin, Ireland
OspreyFXSaint Vincent & Grenadines
SurgeTraderFlorida (USA)
FundedNextUAE, USA, UK, and Bangladesh
FidelCrestCyprus and Estonia
City Traders ImperiumLondon (UK)
E8 FundingTexas (USA) and the Czech Republic
Lux Trading FirmLondon (UK) and Bratislava
The Trading PitLiechtenstein
My Forex FundsToronto (Canada)
The Funded TraderFort Lauderdale, Florida, United States
MyFundedFXTexas (USA)
Nations TradingMiami (USA)
Smart Prop TraderTexas (USA)
Super FundedAustralia
Funding PipsTexas (USA)
ThorFXSaint Vincent & Grenadines
True Forex FundsHungary
Goat Funded TraderCanary Islands (Spain)
Ment FundingTexas (USA)
Funded Trading PlusLondon (UK)
Alpha Capital GroupLondon (UK)
AlphachainLondon (UK)
Audacity CapitalLondon (UK)
Bespoke FundingLondon (UK)
BuoyTradeSingapore
Finotive FundingBudapest, Hungary
Leveled Up SocietyMiami (USA)
FTUKLondon (UK)
Funded AcademyNew South Wales (Australia)
Blue GuardianWest Midlands (UK)

Compliance and Oversight

Compliance requirements also come under the umbrella of legal and regulatory aspects. Owners of proprietary trading firms must ensure they meet the requirements for capital adequacy, risk management, reporting, and more.

Depending on the jurisdiction, there will be regulatory bodies to oversee prop firms’ activities. In the United States, this will be handled by the U.S. Securities and Exchange Commission (SEC) while in Great Britain it is under the wing of the Financial Conduct Authority (FCA). From the prop firm's perspective, failing to meet these rules is a dealbreaker: compliance with these authorities is non-negotiable.

Investor Confidence

The legal and regulatory framework in a jurisdiction can impact investor confidence. If you are reading this from the position of a trader, then you will likely have experienced the feeling of reassurance and greater trust in a tightly regulated financial body. That said, operating outside the realm of traditional authority can offer some organizations greater market freedom which can be beneficial for their clients.

Risk Mitigation

Regulations are put in place to mitigate or entirely offset risks in the financial markets. The silver lining of the constraints is the level of assurance that market integrity is protected. Not all investors need the same level of regulatory assurance and therefore the weight of these criteria will vary among individuals.

Cross-Border Operations

Some prop firms operate across borders with clients situated around the globe. International operations require an understanding of the legal and regulatory nuances that transcend political lines. Firms that need to comply with more than one jurisdiction and their relative bodies can be complex but essential for global expansion.

Business Viability

The legal and regulatory small print surrounding a prop firm can be the beginning or the end of a prop firm. As the case of My Forex Funds demonstrates all too clearly, violations or non-compliance can result in severe penalties, legal action, or in some cases prop firms may have to shut down altogether.

Innovation and Adaptation

Legal and regulatory environments are not static. They adapt and evolve in response to the challenges thrown before them. With the rise of electronic trading technologies such as trading bots or the unique legal requirements of niche sectors such as prop trading these innovative companies must be agile and able to mold new environments in order to remain compliant.

Conclusion:

Traders be warned: navigating the legal and regulatory aspects of proprietary trading firms can be complex. There is a world of difference (pun intended!) in the requirements and confines of prop firms depending on their jurisdiction. If you are considering investing in a proprietary trading firm, then doing your due diligence could bring you not only peace of mind but potentially protection of funds. The level of regulation you are looking for will not necessarily mirror those of another trader. What one person needs as a basic level of structure to instill confidence before trading could be entirely different from that of another.

Remember too that what may be true today could be different tomorrow: the global landscape of proprietary trading is subject to occasional trimming or planting of new regulations by national and international bodies. Whether you are a prop firm owner or funded trader, the more you stay in the loop of this fast-changing horizon the better for your financial prospects.

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Posted by
George Milios

George Milios

Lead Generation & Business Growth Specialist

Helping Companies Scale their Organic Traffic & Conversions over the long-term by implementing strategies that work. In addition, George is an avid cryptocurrency researcher, advisor, investor, and trader.

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