UK: The Dark Side Of Binary Options: A Stark Warning To Investors

Last Updated: 16 January 2017
Article by Gabriele Giambrone

Binary Options: fixed-odds betting on movements in financial markets

  1. Binary options differ from more conventional options in significant ways as they are a type of options contract in which the payout will depend entirely on the outcome of a yes/no proposition. Typically a trade in binary options involves a simple question of whether an event will happen or not – for example, will the price of a particular share or asset go up. The outcome is either yes or no, hence the term binary option.
  1. If the investor is correct, they 'win' and should see a return on their investment. If the investor is wrong, they lose their full investment.  The yes/no proposition typically relates to whether the price of a particular asset that underlies the binary option will rise above or fall below a specified amount. Once the option holder acquires a binary option, there is no further decision for the holder to make as to whether or not to exercise the binary option because binary options exercise automatically.
  1. A customer can choose various commodities to trade in such as gold, oil or stocks etc. The value of a Binary Option is made up from the value of the asset he wants to trade. Typically, a binary options Internet-based trading platform will ask a customer to deposit a sum of money to buy a binary option call or put contract and ask to bet at 2.00pm that the value of gold will either increase or decrease in price by 2.05pm.
  1. Unlike other types of options, a binary option does not give the holder the right to purchase or sell the underlying asset and the customer is not buying or selling the gold, just predicting whether the price of it will rise or fall. Time periods involved tend to be very short (5 or 10 minutes) but some firms offer longer periods to bet over. Another example: a customer may be asked to pay €50 for a binary option contract that promises a 50% return if the stock price of XYZ Company is above €5 per share when the option expires.
  1. When the binary option expires, the option holder will receive either a pre-determined amount of cash or nothing at all. If the outcome of the yes/no proposition (in this case, that the share price of XYZ Company will be above €5 per share at the specified time) is satisfied and the customer is entitled to receive the promised return, the binary option is said to expire "in the money." If, however, the outcome of the yes/no proposition is not satisfied, the binary option is said to expire "out of the money," and the customer may lose the entire deposited sum. Given the all-or-nothing payout structure, binary options are sometimes referred to as "all-or-nothing options" or "fixed-return options."

Fraudulent Binary Options Trading Platforms

  1. Over the last 24 months, we have received numerous complaints of fraud associated with websites that offer an opportunity to buy or trade binary options through Internet-based trading platforms. Most consumers describe having lost substantial sums of money.
  1. While this might be expected given the high risk win or lose nature of the activity, we are particularly concerned about the experiences many consumers report to us when trying to deal with unauthorised or unlicensed binary options firms. Investments fraudsters will do everything they can to obtain large amounts of money by taking advantage of an unregulated market and convincing their victims that they are making worthwhile investments.
  1. Unfortunately many of the complaints received are from clients who have dealt with fraudulent binary options firms that have no regulatory status either with the FCA, Gambling Commission or other EEA or non-EEA regulators.
  1. Fraudulent firms operating in the binary options market without the necessary authorisations or licenses tend to be based outside the UK yet often claiming to have some kind of presence here, often at prestigious City of London addresses. 
  1. Since 2010, binary options have become the new investment scam. Platforms are being set up all the time to appear legitimate, but are actually fake and the companies operating these fake binary trading platforms make 100% profit - a percentage of which goes to the brokers and the remainder to the rest of the company.
  1. We regularly hear about such firms suddenly closing consumers' trading accounts, refusing to pay back their funds and ceasing any further contact with the consumer. Victims who invested never see any returns and when the customers attempt to withdraw funds it's made very difficult for them to do so and at times the company ignores them completely ceasing all contact
  1. The complaints fall into at least three categories:
  1. refusal to credit customer accounts or reimburse funds to customers;
  2. identity theft; and
  3. Manipulation of software to generate losing trades.
  1. The first category of alleged fraud involves the refusal of certain Internet-based binary options trading platforms to credit customer accounts or reimburse funds after accepting customer money. These complaints typically involve customers who have deposited money into their binary options trading account and who are then encouraged by "brokers" over the telephone to deposit additional funds into the customer account.
  1. When customers later attempt to withdraw their original deposit or the return they have been promised, the trading platforms allegedly cancel customers' withdrawal requests, refuse to credit their accounts, or ignore their telephone calls and emails.
  1. The second category of alleged fraud involves identity theft. For example, some complaints allege that certain Internet-based binary options trading platforms may be collecting customer information such as credit card and driver's license data for unspecified uses. If a binary options Internet-based trading platform requests photocopies of your credit card, driver's license, or other personal data, do not provide the information.
  1. The third category of alleged fraud involves the manipulation of the binary options trading software to generate losing trades. These complaints allege that the Internet-based binary options trading platforms manipulate the trading software to distort binary options prices and payouts. For example, when a customer's trade is "winning," the countdown to expiration is extended arbitrarily until the trade becomes a loss.

Regulation of binary options in UK, EU and USA

  1. In the United Kingdom, trading in binary options is not currently regulated by the by the Financial Conduct Authority (FCA) and therefore firms involved in binary options may not necessarily require authorisation by the FCA to operate legitimately. Under S. 36 of the Gambling Act 2005, the Gambling Commission regulates businesses offering binary options if they have remote gambling equipment located in Great Britain. If this is not the case, any binary options that a firm offers will not be regulated either by the Gambling Commission or by the FCA.
  1. In March 2015, the Government announced that it was providing draft secondary legislation provisions which will provide that certain binary options are regulated and supervised by the FCA, rather than the Gambling Commission. The UK Treasury has published a consultation which set out some proposed amendments to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, to transfer the regulation and supervision of binary options from the Gambling Commission to the Financial Conduct Authority (FCA) but so far, no changes have been implemented.
  1. As a result, the current regulatory framework in the UK is contradictory and fragmented as the FCA currently regulates spread betting (contracts for difference on financial markets) and other financial products which may resemble binary options, such as Collective Investment Schemes.
  1. A firm based in Great Britain with a current licence to offer bets on binary options from the Gambling Commission may or may not be authorised by the FCA for other financial services business but please note that, even if you deal in binary options through an FCA authorised firm, you will not be protected by the UK's financial services complaints and compensation scheme, because binary options are not currently an FCA regulated financial instrument
  1. However, some European Union (EU) countries consider binary options to be a financial, rather than a gambling product. Under EU financial services law, firms which are legally established and authorised in one European Economic Area (EEA) country are entitled to do business in any other EEA country once certain procedural safeguards are met. This means that although the FCA does not currently regulate binary options, firms offering binary options trading which operate as financial services firms in other EEA countries, are able to do business in the UK and consequently appear on the FCA's  Register of financial services firms
  1. In the United States, some binary options are listed on registered exchanges or traded on a designated contract market that are subject to oversight by the regulators such as the CFTC or SEC, respectively, but this is only a portion of the binary options market.
  1. Much of the binary options market operates through Internet- based trading platforms that are not necessarily complying with applicable U.S. regulatory requirements. The number of Internet-based trading platforms that offer the opportunity to purchase and trade binary options has surged in recent years. The increase in the number of these platforms has resulted in an increase in the number of complaints about fraudulent promotion schemes involving binary options trading platforms.
  1. Some binary options Internet-based trading platforms may overstate the average return on investment by advertising a higher average return on investment than a customer should expect given the payout structure.
  1. Because of their lack of compliance with applicable laws, if an unsuspecting customer purchases binary options offered by persons or entities that are not registered with or subject to the oversight of a regulator, they may not have the full benefit of the safeguards of the federal securities and commodities laws that have been put in place to protect investors, as some safeguards and remedies are available only in the context of registered offerings.
  1. In addition, individual investors may not be able to pursue, on their own, some remedies that are available for unregistered offerings.

Illegal Options Transactions

  1. In addition to ongoing fraudulent activity, many binary options trading platforms may be operating in violation of other applicable laws and regulations, including certain registration and regulatory requirements of the CFTC and SEC, as described below.
  1. For example, some binary options may be securities and in certain countries, such as Australia and the US, a company may not lawfully offer or sell securities unless the offer and sale have been registered or an exemption from such registration applies. For example, if the terms of a binary option contract provide for a specified return based on the price of a company's securities, the binary option contract is a security and may not be offered or sold without registration, unless an exemption from registration is available. If there is no registration or exemption, then the offer or sale of the binary option to you would be illegal.
  1. If any of the products offered by binary options trading platforms are security-based swaps, additional requirements will apply. In addition, some binary options trading platforms may be operating as unregistered broker-dealers.
  1. A person who engages in the business of effecting securities transactions for the accounts of others in the U.S. generally must register with the SEC as a broker-dealer.  If a binary options trading platform is offering to buy or sell securities, effecting transactions in securities, and/or receiving transaction-based  compensation (such as commissions), it likely should be registered with the SEC.
  1. Some binary options trading platforms may also be operating as unregistered securities exchanges if they matched orders in securities of multiple buyers and sellers using established non- discretionary methods. However, there are cases where a registered broker-dealer with a trading system or platform may legitimately have no obligation to register as an exchange.
  1. It is illegal for entities to solicit, accept offers, offer to or enter into commodity options transactions (for example, foreign currencies, metals such as gold and silver, and agricultural products such as wheat or corn) with U.S. citizens, unless those options transactions are conducted on a designated contract market, an exempt board of trade, or a bona fide foreign board of trade, or are conducted with U.S. customers who have a net worth that exceeds $5 million. The most recent list of exchanges that are designated as contract markets offering binary options in the U.S. are Cantor Exchange LP; Chicago Mercantile Exchange, Inc.; and the North American Derivatives Exchange, Inc.  All other entities offering binary options that are commodity options transactions are doing so illegally.
  1. Further entities that solicit or accept orders for commodity options transactions and accept, among other things, money to margin, guarantee, or secure the commodity options transactions must register as a Futures Commission Merchant. Entities that act as the counterparty (that is, they take the other side of the transaction from the customer as opposed to matching orders) for foreign currency options transactions for customers with a net worth of less than $5 million must register as a Retail Foreign Exchange Dealer.

Final Words

Before investing in binary options, you should take the following precautions:

  • Remember—much of the binary options market operates through Internet-based trading platforms that are not necessarily complying with applicable regulatory requirements and may be engaging in illegal activity.
  • Be aware that some internet based binary options companies are run by Israelis through a number of shell companies incorporated in offshore countries and via EEA firms based in a Member State (usually Cyprus), which are authorised to deal in binary options and supervised by their home Member State's financial services regulator. These brokers usually passport their services into the E.U.
  • Do not invest in something that you do not understand. If you cannot explain the investment opportunity in a few words and in an understandable way, you may need to reconsider the potential investment. If you're considering any type of investment, always remember: if it seems too good to be true, then it probably is.
  • If you get a call out of the blue from someone offering investment opportunities, be wary; do not agree to any deals immediately and insist on time to obtain independent/legal advice before making a decision and do not transfer money to them or provide them with your bank details. If in doubt don't be polite, just hang up.
  • Check to see if the binary options trading platform has registered the offer and sale of the product with a regulator. Registration provides investors access to key information about the terms of the product being offered. If US based, check to see if the binary options trading platform itself is registered as an exchange. Check to see if the binary options trading platform is a designated contract market.
  • Before investing, check the registration status and background of any firm or financial professional that you are considering. If you cannot verify that they are registered, don't trade with them, don't give them any money, and don't share your personal information with them
  • Be mindful of any bonus structures and clauses preventing you from withdrawing funds and ensure that you have read and considered conditions set out by the company making it mandatory to "turn over" your original deposit over a multiple amount of times before you can withdraw your money.
  • If you have any doubts about whether an operator is licensed, do not use them: an unlicensed operator is likely to be acting illegally. They will not abide by any code of conduct and have no incentive to deal fairly with you.  Unlicensed operators are likely to use false names, addresses and contact numbers – they can disappear with your money and without a trace, making recovery almost impossible. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Gabriele Giambrone
 
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