The issue of regulation in the binary options market is one that has generated a lot of debate in many quarters. Many binary options brokerages are located in Europe, with most of them concentrated in Cyprus. This is because the requirements for starting a binary options brokerage business in many European countries are not so stringent.
The same cannot be said of the US jurisdiction, where regulation of the binary options market is given the same strict oversight as obtains for other markets.
Legal implications of trading Binary Options in the US
With regards to the state of the legality or regulatory status of the binary options market in the US, the issues that generate most concern is not really the legality of binary options, but in the proliferation of binary options brokerages in many offshore locations which have been listed by the US government as non-cooperative tax-free havens.
Countries like the British Virgin Islands, Cayman Islands, etc, have long been used by businessmen looking to reduce their tax exposures in their countries of origin. The United States taxes all worldwide income by its citizens, so opening and operating a binary options trading account in some of these tax-free havens would potentially constitute a breach of the tax laws in the US.
The way out of the legal predicament facing US binary options traders would be to open trading accounts with binary options brokers located in the US, who require clients to fill tax declaration forms that would enable the proceeds of their trading activity to be appropriately taxed by the IRS.
Best broker for American traders:
Regulation of the Binary Options market in the US
The binary options market is regulated in the US by the Commodities and Futures Trading Commission (CFTC), and examples of brokers in the US territory that are deemed compliant with US tax laws on investments include the North American Derivatives Exchange (NADEX).
When it comes to regulation of the binary options market in the US, what constitutes the regulatory practices that binary options brokerages are supposed to follow?
- As a baseline, binary options firms are expected to be well-capitalized. This means that any binary options brokerage firm that wants to start a business in the United States is expected to have a minimum capital requirement before their application even comes up for consideration.
- A big problem that was seen with some brokerage firms was that when they went insolvent, they also caused the loss of trading capital to their clients. To prevent this, brokerage firms are now required to keep the trading capital of their clients in sequestered accounts. No money can be drawn from these sequestered accounts to fund the operating costs of the brokerage firm. Not only does this force brokers to maintain good accounting practices, it protects traders in the event of insolvency of the brokerage firm.
- Regular accounting checks are performed by regulators to detect any early signs of trouble with the broker’s finances.
- Brokers are mandated to respond in writing to any accusations of wrongdoing by clients, and to submit themselves to thorough investigations of any accusations without blocking the process or tampering with evidence.
These systems are in place in the US jurisdiction, and the CFTC has a reputation of taking their regulatory function seriously. In 2010, a broker was slammed with a $14million fine after complaints of price manipulation by traders were investigated and found to be true. Such actions are what have set the US aside as a country that has taken a strong stance on effecting regulatory function on brokers.
Many of these regulatory frameworks are missing in several jurisdictions. For instance, there are some areas where anyone can set up a binary options brokerage with as low as $20,000. Such a development portends trouble for traders as there is virtually no regulatory oversight, and traders have absolutely no protection from financial and pricing malpractices.
In order to stay within the confines of the law and get adequate regulatory protection for their investments, binary options brokers in the US are advised to trade only with brokers who are directly regulated by the CFTC. There are a few European brokers who have achieved regulatory status in the US; these can also be used in addition to the locally domiciled brokers.
(Risk warning: Trading involves risks)