Last Friday, the US Securities and Exchange Commission (SEC) issued a notice stating that, effective in less than 70 days (July 31), broker-dealers will no longer be able to engage in leveraged foreign exchange (forex or FX) business with persons other than “eligible contract participants” as defined in Section 1a(18) of the Commodity Exchange Act (CEA), including those that are dually registered with the US Commodity Futures Trading Commission (CFTC) as Future Commission Merchants (FCMs). What this effectively means is that only standalone CFTC registered and National Futures Association (NFA) member FCMs or retail FX dealers, as well as certain banks, may serve as counterparties in retail forex transactions.

Specifically, the SEC issued notice that Rule 15b12-1 under the Securities Exchange Act of 1934 (Exchange Act) is expiring on July 31, 2016. In brief, Rule 15b12-1 defines “retail forex business” to mean “engaging in one or more retail forex transactions with the intent to derive income for those transactions, either directly or indirectly.” A “retail forex transaction,” in turn, is defined to mean “any account, agreement, contract or transaction in foreign currency that is offered or entered into by a broker or dealer with a person that is not an eligible contract participant as defined in section 1a(18) of the [CEA]” and that is

  1. a contract of sale of a commodity for future delivery or an option on such a contract;
  2. an option, other than an option executed or traded on a national securities exchange registered pursuant to section 6(a) of the [Exchange] Act; or
  3. offered, or entered into on a leveraged or margined basis, or financed by a broker or dealer or any person acting in concert with the broker or dealer on a similar basis, other than: (A) a security that is not a security futures product as defined in section 1a(47) of the [CEA] or (B) a contract of sale that: (1) results in actual delivery within two days; or (2) creates an enforceable obligation to deliver between a seller and buyer that have the ability to deliver and accept delivery, respectively, in connection with their line of business.

The SEC’s notice may come as a surprise to some, especially with such short notice that the SEC does not intend to renew the rule. Rule 15b12-1 does contain an indicated expiration of July 31, which the SEC could argue should have given the industry and investors sufficient notice that the rule be expiring. Some may question, however, whether the SEC should have given the industry and investors more notice of its intent to let the rule expire, as it has done in similar circumstances previously.

Indeed, in connection with the temporary Advisers Act rule for principal trades, which is set to expire on December 31, we understand that the SEC staff reached out to industry participants in February 2016 to assess the extent to which the temporary rule is relied upon so that the staff could inform itself of the rule’s use before determining whether to let it expire. Further, the industry and investors have developed a reasonable expectation, based on prior practice, that the SEC and its staff will renew expiring rules and no-action positions, as it has done with the temporary rule regarding principal trades and for anti-money laundering/customer identification program obligations. On this note, the SEC had, for all intents and purposes, previously extended the expiration date for Rule 15b12-1.

With less than 70 days’ notice, the SEC action will likely leave affected broker-dealers and investors who engage in retail FX transactions scrambling.