According to economists, competition in any industry is usually a good thing. It lowers prices for the consumer. It encourages innovation. It promotes quality service, but we seldom hear about the dark side of competition and what it can create in the way of shady business practices. Questionable business dealings and, sometimes, outright fraud are the result when competition heats up, especially when growth is tailing off. Signs of desperation appear. Ethical conduct can be thrown out the window when it comes to attracting or stealing customers away from the broker across the street.
The binary options industry has come under fire in the press for these alleged bad practices, and the latest regulator to step forward to deal with the issue is the FSMA, the regulator for Belgium. Belgian officials have not only banned the marketing of binary options to its citizens, a step already taken by the Autorité des Marchés Financiers (AMF) in France, but it has also gone a step further by banning the sale of these products to Belgian traders, as well. There has been a plethora of derogatory articles decrying the nasty behavior of several binary option brokers in their dealings with Europeans. The level of complaints regarding aggressive marketing tactics, the refusal to honor withdrawal requests, and deliberately misrepresenting expiration prices has gone through the roof.
France’s securities regulator, the AMF, has been in the press lately broadcasting that complaint levels have risen over the past five years from a smattering of 100 or so to over 6,000 in calendar 2015. It was also recently reported that, in a recent press conference, “The Public Prosecutor of the High Court of Paris, along with the AMF, the Office of Fair Trading of the Economy Ministry and the Prudential Supervisory Authority of the Bank of France, urged victims to come forward. Over 25,000 victims have responded to date, representing an estimated €4 billion in alleged fraud in the past six years.” These figures represent France, but it may only be the tip of the iceberg for the entire European Union. In most cases, regulators have been either caught flatfooted or have refused to jump into an arena they describe as “the latest online gambling fad.”
What within the binary options industry is causing this wave of “bad practices”?
The simple answer to this question is one word – competition. For a period of roughly five years, binary options were the new craze of forex trading. Simplicity and exorbitant returns in only minutes were the immediate attraction, and it worked. Converts from traditional trading venues rushed to this new group of brokers, which were often based in far off tax havens with little or no regulation to speak of. Stocks, indices, and commodities were soon added to the mix of asset types to broaden the appeal from just currency pairs. The potential of a 70% return in only five minutes was far too good a deal to pass up, even if the odds required your being right 60% of the time just to break even.
Traditional brokers looked on with skepticism, assuming the fad would pass and that reason would prevail. The customers they were losing in droves would surely return once they noticed that they had been scammed by a greedy House that always set the odds in its favor. Yes, there were winners, but there were far more losers. Some critics claimed the casualty rate was close to 90%, much higher than with traditional forex trading where 65%, a high level on its own, prevailed. Binary options trading is definitely high risk, much more so than it would appear for ordinary forex trading at this time.
The public, however, could not control their enthusiasm for this new genre. Binary options soon became the fastest growing sector of forex trading. The demand was so great that new brokers were jumping into the fray almost weekly. The pie, so to speak, was expanding rapidly. Every participant in the industry was raking in the winnings, except of course for the losers, who were funding every part of the operation. No instruments were actually being traded in any market. Brokers were setting the odds in their back offices or buying the service directly from giants like the IG Group (IG) and Teddy Sagi’s Paytech corporation. Times were good, but they were not sustainable.
Competition was also delivering good tidings. Payoff ratios were improving, as new entrants improved the odds for consumers in hopes of stealing them away from another broker. Ratios that had averaged 70% were now approaching 85% to 90%, the level that prevails today at the high end of the market. Brokers also created new enticements in the form of welcome bonuses, risk free trades, competitions, and promotional gambits that seemed almost too good to be true. The majority of these promotions were tricks. The fine print of the terms and conditions often stipulated the need for trading volumes in excess of “30X” the bonus or even more before any withdrawal request would be honored. Most newcomers were shocked to find out down the line that their own funds could not be withdrawn. Complaints began to mount instantly.
And then traditional brokers jumped into the action with wholly-owned subsidiaries offering binary options, thereby creating a one-stop-shop-under one-roof scenario, often in a very regulated district, that became very appealing to clients that suspected fraud from their current binary option broker. These actions, along with a gradual slowdown in the global economy, soon led to increased competitive pressure. The pie was no longer expanding. Revenues were in decline. Costs were rising. The industry was entering a new phase of its growth cycle, which would normally entail consolidation and the departure of many losing programs. A new fight for survival was in the offing.
How did regulators react to the advent of binary options?
Regulatory agencies react to change like other governmental entities – very slowly. To begin with, their resource budgets are typically thin. They learn about changes in the marketplace during their routine audits of financial service companies in their domestic country or through the investigation of complaints. If complaints arise due to a foreign-based entity, there is very little that the regulator can do, other than request assistance from the foreign regulator, if there is one in place. In most cases, the foreign regulator will not act unless local citizens have been harmed. Their budgets are just as constrained and devoted to higher priorities.
The learning curve for regulators regarding binary options did not get started in earnest until after 2008. Binary options had been around prior to that date, but only in OTC markets for large institutions or high net worth investors. The market changed dramatically in the U.S. when the SEC approved binary options as a tradable instrument and the Chicago Board Options Exchange (CBOE) and the American Stock Exchange began selling these exchange-traded securities to retail investors. In 2009, IG acquired HedgeStreet, a defunct California exchange, revamped its technology and product line, and soon offered binary option trading via the North American Derivatives Exchange, known today as Nadex, the first Internet-based event futures/derivatives exchange to be regulated in the U.S. by the CFTC.
The look and feel of binary options on the Nadex were more like real options than today’s popular product. Innovations in the form of expanded asset lists, simplified trading platforms, and the variety of options offered were soon to take the industry by storm, especially in Europe where regulators took a blind eye approach to the proceedings. These products were sold directly to the consumer, without any exchange in the background. These new operations were more like pari-mutuel betting, and most regulators regarded them as the latest online gambling fad. The CFTC nixed the sale of the new items in the U.S. Japan followed suit and formed a regulated exchange.
Across the Atlantic, the binary options industry was exploding on the European scene. New brokers began appearing weekly, primarily from Cyprus and a host of tax havens. These entities were not exchanges. Each broker set the odds and fixed payoffs in their back offices, much in the same fashion as a gambling casino. The appearance was also radically changed and soon came to resemble today’s all-or-nothing approach with potential returns and risk parameters clearly fixed at the order execution stage. CySEC was unprepared. The local regulator had little in the way of resources to actively audit over sixty new entities on the island. Lax oversight led to innovation at first, but as competition increased, questionable behaviors began to arise.
To cut costs, brokers outsourced the selling and marketing activities to fledgling bucket shops in Israel. The Times of Israel has been running a series of articles exposing the aggressive selling and blatantly fraudulent practices of these organizations, but, since Israeli citizens did not suffer losses, the local regulator refused to police the situation. Irate investors across Europe are presently mounting legal assaults against these firms, but the possibility of any retribution or actual settlement is far down the road at this point.
Victims respond with similar tales of woe, but here is one account: “At first, their broker was friendly, knowledgeable and highly attentive. After they made their initial deposit, they would experience a series of successful trades, and seeing how easy it was, keep adding funds to their investment account. Until one morning they woke up to see a large portion of their balance wiped out. When they complained, their broker turned cold and unresponsive or, alternatively, tried to persuade them to invest more to try to recover what they’d lost. Eventually, the losses piled on and the client gave up, or had their account closed against their will, while the fraudsters disappeared with the cash.”
Complaints about shady business practices by many global binary option brokers have gone astronomical. Many regulators, including the FSMA in Belgium, have taken steps to ban the sale and advertising of these products to their local citizens. Blacklisted broker lists are now common that alert consumers about unauthorized firms that solicit cross border deposits in an aggressive and sometimes fraudulent manner. Trading platforms may be rigged against you, where the House will eventually clear out your account. Investor losses are in the billions. Yes, there are legitimate binary option brokers out there, but desperate brokers can resort to desperate acts to survive.
The message is clear – Beware of cold calls or Internet links to sales reps that are overly persuasive about the benefits of binary option trading. You are your first line of defense when it comes to fraud prevention. Stay vigilant!