For years, the currency industry had a reputation as the “Wild West” of trading, and much of it was deserved. Fly-by-night operators made fraudulent b

For years, the currency industry had a reputation as the “Wild West” of trading, and much of it was deserved. Fly-by-night operators made fraudulent business transaction by day, then skipped town by night before anybody could catch them.

Since 2000, when the Commodities Futures Modernization Act (CFMA) gave the Commodity Futures Trading Commission (CFTC) more power in controlling fraud, the forex industry has been cleaned up.

However, fraud still exists, and a recent court ruling has several industry participants wondering how much power the CFTC actually has and asking Congress for help in increasing it. In CFTC vs. Zelener, a federal court ruled that spot forex transactions that called for delivery of a commodity within two days were cash contracts and therefore not under the jurisdiction of the CFTC, even though the contracts were often “rolled over” like a typical futures contract and were bought on margin. This, obviously, opens a potential can ofworms when it comes to spot, or cash, forex trades.

“The CFMA clarified that the CFTC has jurisdiction over retail foreign currency futures and option contracts, whether transacted on exchanges or over-the-counter, as long as they are not otherwise regulated by another agency,” says Sharon Brown Hruska, CFTC chairwoman.

“However, as demonstrated in the recent adverse Zelener decision, the CFTC continues to face challenges to its jurisdiction based on how retail forex transactions are characterized. “It has been the subject of much discussion within the industry as to how to respond to the Zelener decision whether we need additional authority or clarity in our jurisdiction, or whether we simply need to prove our cases better.”

However, Brown Hruska points out that since the CFMA was passed in 2000, the CFTC has filed 70 cases — losing only three — on behalf of more than 20,000 customers and prosecuted more than 265 companies.Those cases have resulted in more than $240 million in fines and restitution.

According to Chuck Carey, chairman of the Chicago Board of Trade, the court’s ruling in the Zelener case goes beyond the forex market.

“The contracts at issue case were nothing more than speculation in foreign exchange,” Carey says. “The effect of the decision, however, cannot be limited to foreign exchange speculation. It provides a roadmap for unscrupulous persons to engage in over-the-counter contracts involving agricultural and other commodities, with no government supervision whatsoever, and entirely free of the anti-fraud jurisdiction of the CFTC.”

Terry Duffy, chairman of the Chicago Mercantile Exchange, says the defendants in the Zelener case took advantage of a loophole in the rules. The loophole allowed them to place a disclaimer on their Web site notifying counterparties that the dealer is not absolutely obligated to enter into an opposite, offsetting transaction, or that under some circumstances an opposite transaction will not offset existing positions.

This, Duffy says, made the contracts outside the realm of the CFTC, and it points out the need for both the futures industry and Congress to consider changing the rules.

“The sharp operators and bucket shops have already figured out that the rationale of the Zelener opinion can apply to commodities other than FX,” Duffy says. “How soon will it be before the CFTC’s jurisdiction and its retail consumer protections are reduced to irrelevance?

John Damgard, president of the Futures Industry Association, says the CFTC has been essentially fighting a lone battle against foreign currencyfraud, with a little help from the Department of Justice.

However, the original text of the CFMA was purposely written to avoid giving the CFTC too much jurisdiction in certain over-the-counter transactions.

While he’s not against new legislation that would help the CFTC in situations such as the Zelener case, he cautions that any new laws would need to avoid going too far.

“Any legislation must be carefully tailored,” Damgard says. “We are concerned that the temptation would be to draft legislation that is broad in scope in order to address all OTC transactions in all commodities where a retail participant is a counterparty. That could inadvertently interfere with legitimate riskmanagement transactions entered into by commercial parties.”

The National Futures Association (NFA) also agrees that new legislation must be carefully worded, and it has a suggestion — Congress should specifically address the loophole mentioned by Duffy that allowed the Zelener defendants to avoid CFTC scrutiny. That, says, NFA president Daniel Roth, would also help address another issue of great concern to the forex industry.

“A number of firms that do not engage in any other regulated business have nonetheless registered as FCMs to qualify to be an otherwise regulated entity for the sole purpose of acting as counterparties in (OTC) transactions,” Roth says.

According to Roth, on June 23, 14 firms were registered by the NFA as Forex Dealer Members, accounting for about $170 million in retail customer funds. As of March, there were 28 firms with more than $520 million under account. And, the growth has not come without its problems.

“Though relatively few in number, forex dealers have accounted for 50 percent of our emergency enforcement actions and more than 20 percent of our arbitration docket,” Roth says. Several retail brokers contacted for this story declined to comment.