The CFTC, Wash Sales, and You

The CFTC does it again!

In its latest hunt for fraudulent market activity, the Commodities Futures Trade Commission (CFTC) homed in on SMP Bank from Russia and Epaster Investments, Ltd. in Cyprus for engaging in wash sales, a practice banned by the regulatory agency.

Before I proceed, lemme first explain to you what the heck wash sales are.

Wash sales are transactions that involve the near-simultaneous selling and repurchasing of a security at the same volume and price. The net effect on the balance sheet would effectively be zero. In this case, the securities that were traded were yen options contracts.

You might be wondering, “Why would anyone sell a security only to buy it back a second later? What’s the point?”

While a wash sale would result in a net zero effect on the balance sheet, it would allow an institution to book an unrealized loss on its income statement. This unrealized loss would result in lower taxable income, which would mean a smaller tax bill, while the institution would still have the asset on its balance sheet.

In the case of SMP and Epaster, the CFTC found that SMP engaged in wash sales on three occasions using March 2012 Japanese yen options. At the same time, the agency also discovered that SMP and Epaster were on opposite sides of two different trades using the same option.

Keep in mind that it was SMP employees who executed the trades for both SMP and Epaster. The CFTC believes that in executing the orders, the SMP employees knew that the trades were riskless, and that the trades that SMP had conducted with itself would counteract the loss. As a result, the CFTC is charging SMP and Epaster to pay civil monetary penalties of $700,000 and $280,000 respectively.

While this doesn’t directly affect spot traders like you and I, it’s good to know that the CFTC is still cracking its whip on those brokers who are looking for loopholes and trying to pull a quick one.

By eliminating wash sales, the CFTC pushes forward with its goal of promoting integrity and transparency, decreasing the chances of price manipulation, and weeding out those brokers who do not have the best interest of clients in mind.

It may take time, but hopefully, we’ll eventually develop a trading environment that is safe for newbies and experts alike.

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