AML RightSource
Beware binary options. Described by one commentator as speculation “on speed”, these contracts have been banned in Europe and are the subject of regulatory action in the US. But unethical and downright illegal brokerages continue to push them on unsuspecting investors.
A binary option is deceptively simple. It offers an investor the opportunity to speculate on whether the price of an asset – a stock or index, most commonly – will be above or below a certain level at a particular time. If so, they get a fixed return; if not, they lose their money.
To take a simple example, assume shares in oil company BP currently trade at 498p. A binary option might have a strike price of 505p and expire tomorrow at midday; the investor can buy the option for £40. If BP shares are above 505p at midday tomorrow, the option expires in the money and is worth £100. The investor makes £60 (£100 minus £40). But if BP shares are still below 505p, the option expires out of the money and the investor loses their entire £40 stake.
In other words, while binary options are dressed up in the language of finance, they’re really no more than a simple wager in which the winner takes all. Each contract is a high-risk gamble – all the more so, since brokers often offer contracts over very short timeframes. No investor really has a chance of analysing whether BP shares will hit a particular price over the next 30 seconds, say, but such trades are on offer.
Understandably, regulators are unimpressed. The European Securities and Markets Authority banned sales of most binary options in July 2018 and the UK’s Financial Conduct Authority introduced its own ban, which went even further, in April 2019.
Their concern is twofold. First, binary options have often been pushed at retail investors for whom they are completely unsuitable, sold as get-rich-quick schemes that enticed investors with free gifts, special offers and cheap deals, before sucking them into an addictive pattern of trading. Losses have been substantial. Second, alongside brokers operating legally, a shadow community of outright fraudsters has grown up, conning investors out of their cash through artificial pricing scams, or simply disappearing with the money. City of London Police says 700 people lost £18m in the first half of 2017 alone through such scams.
In the US, meanwhile, binary options remain legal, but the authorities are cracking down in illegality. The Securities and Exchange Commission first warned consumers to tread carefully with the contracts more than six years ago, and has been monitoring the market closely ever since. In September last year, it revealed it had charged three people with a string of offences, alleging they had used boiler room operations in Germany and Israel to con US investors out of tens of millions of dollars in a binary options scam. In December, a fraudster convicted of masterminding a binary options fraud was jailed for 22 years in Maryland and ordered to repay $28m to investors.
But despite the tough stance of regulators, the binary options market on both sides of the Atlantic shows no sign of disappearing. Even in Europe, where a ban is in place, brokers continue to operate. The ban, in any case, does nothing to deter outright fraudsters, while more legitimate operations are able to circumvent the rules by allowing retail investors to register as professional investors, who aren’t covered by the regulation. Some are working with European investors through brands based in other regions of the world not directly policed by Europe’s regulators.
The banking sector’s exposure to the binary options scandal is potentially significant. While not engaged in binary options trading themselves, banks could find themselves on the hook for compensating customers who have lost out in certain markets.
Consumer groups in markets such as the UK routinely advise victims of binary options scams to seek redress from their credit card providers under legislation such as the Consumer Credit Act; customers may also be eligible for redress via the chargeback system when using debit cards.
In addition, law enforcement agencies and regulators have made it clear they expect the banking industry to be able to recognise binary options transactions – and possibly to intervene. The FBI, for example, began advising credit card companies on what to look for in 2017 as part of a broader investigation into binary options fraud worldwide.
Banks and credit card providers lacking technologies and systems to identify binary option transactions, including the entities involved them, are therefore at risk. They potentially face significant claims for compensation from customers caught out by scams – and even regulatory action. The challenge for fraud investigators – and AML investigators, since money laundering often follows – is tracing binary options transactions, as this article from ACAMS explains which red flags to look for.
Certainly, there is no room for complacency, with new scams continuing to come to light. In the UK, one of the first announcements made by the FCA in 2020 was a warning that it had identified yet another firm engaged in unauthorised activities, including binary options sales. The frauds continue.