RULE ENFORCEMENT REVIEW 

OF 

NORTH AMERICAN 

DERIVATIVES EXCHANGE 

Division of Market Oversight 

 November 15, 2013

 
2 

RULE ENFORCEMENT REVIEW OF 

NORTH AMERICAN DERIVATIVES EXCHANGE (NADEX) 

TRADE PRACTICE SURVEILLANCE 

Commodity Futures Trading Commission – Division of Market Oversight 

Contents 

I. Introduction .......................................................................................................................... 3

II. Methodology ........................................................................................................................ 3

III. Summary of Findings and Recommendations ..................................................................... 4

A. Findings ............................................................................................................................ 4

B. Recommendations ............................................................................................................ 5

IV. Nadex Operations................................................................................................................. 6

A. Historical Overview ......................................................................................................... 6

B. Current Products ............................................................................................................... 7

C. Market Maker ................................................................................................................. 10

D. Nadex Governance ......................................................................................................... 11

1. Ownership and Board of Directors ............................................................................. 11

2. Regulatory Oversight Committee ............................................................................... 11

V. Trading Volume during the Target Period ......................................................................... 13

VI. Staffing, Organization and Training .................................................................................. 16

VII. Trade Practice Surveillance Program ................................................................................... 19

A. Automated Surveillance System .................................................................................... 21

B. Investigations ................................................................................................................. 23

1. Investigation Process .................................................................................................. 24

2. Adequacy of Investigations ........................................................................................ 25

3. Timeliness of Investigations ....................................................................................... 34

4. Investigation Log ........................................................................................................ 34
3 

I. Introduction 

The Division of Market Oversight (“Division”) of the Commodity Futures Trading 

Commission (“Commission”) has completed a rule enforcement review of the trade practice 

surveillance program of North American Derivatives Exchange Inc. (“Nadex” or “Exchange”).1

 

The review covered the period from June 15, 2011 through June 15, 2012 (“target period”). The 

Division’s review focused on compliance with two core principles under Section 5(d) of the 

Commodity Exchange Act (“Act” or “CEA”),2 as amended by the Dodd-Frank Wall Street 

Reform and Consumer Protection Act (“Dodd-Frank Act”).3 In particular, the Division’s review 

focused on Core Principles 2 (Compliance With Rules) and 12 (Protection of Market 

Participants) which relate to an exchange’s trade practice surveillance program. 

II. Methodology 

 Division staff interviewed members of Nadex’s Compliance Department (“Compliance” 

or “Compliance Department”) and reviewed documents used by Compliance in fulfilling the 

Exchange’s self-regulatory responsibilities. In addition, Nadex provided Division staff with a 

 

1

 Rule enforcement reviews prepared by the Division are intended to present an analysis of an exchange’s overall 

compliance capabilities during the period under review. Such reviews deal only with programs directly addressed in 

the review and do not assess all programs or core principles. The Division’s analyses, conclusions, and 

recommendations are based, in large part, upon the Division’s evaluation of a sample of investigation and 

disciplinary case files, and other exchange documents. This evaluation process, in some instances, identifies 

specific deficiencies in particular exchange investigations or methods but is not designed to uncover all instances in 

which an exchange does not address effectively all exchange rule violations or other deficiencies. Neither is such a 

review intended to go beyond the quality of the exchange’s self-regulatory systems to include direct surveillance of 

the market, although some direct testing is performed as a measure of quality control. The findings and 

recommendations herein, represent the view of the Division only, and do not necessarily represent the position or 

view of the Commission or of any other office or division of the Commission. 

2

 7 U.S.C. 1 et seq.

3 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376 (2010). 

The Division's review focused on Sections 5(d)(2) (“new Core Principle 2”) and 5(d)(12) (“new Core Principle 12”) 

of the Act as amended by the Dodd-Frank Act because the new Core Principles were in effect for approximately 

eleven months of the target period. 
4 

live demonstration of its trade practice surveillance system. Documents reviewed by Division 

staff included the following: 

 reports used routinely for trade practice surveillance; 

 investigation files for Trade Practice Inquiries, General Inquiries, and Complaints; 

and associated work product;4

 minutes of meetings of the Board of Directors and the Regulatory Oversight 

Committee (“ROC”) held during the target period; 

 annual reports of the ROC;5 and 

 an investigation log tracking the disposition of trade practice matters. 

The Division provided Nadex with an opportunity to review and comment on a draft of 

this report on October 21, 2013. On October 31, 2013, Division staff conducted an exit 

conference with Exchange officials to discuss the report’s findings and recommendations. 

III. Summary of Findings and Recommendations 

A. Findings 

 The Exchange maintains an adequate trade practice surveillance system. Nadex has the 

ability to detect potential rule violations, including trade practice violations, through 

SMARTS, an alert and analysis program. In addition, Compliance detects and analyzes 

potential rule violations by analyzing Nadex’s trading database and reviewing FCM error 

accounts. 

 Nadex tracks three types of investigations: Trade Practice Inquiries, General Inquiries, 

and Complaints. All trade practice issues, regardless of their source, are classified as 

Trade Practice Inquiries. Compliance drafts an Investigative Memorandum and an 

Investigation Origination Form for each Trade Practice Inquiry. 

 The Division found that Nadex generally maintains adequate documentation of its 

investigations. However, some, but not all, Investigation Memoranda contain a CRO 

 

4

 Because the Exchange conducted only one Trade Practice Inquiry, the Division’s review included all investigations 

conducted during the target period. See Section VII(B)(1) for a discussion of investigation categories at Nadex. 

5

 The Division reviewed the ROC annual reports for 2010, 2011, and 2012. 
5 

signature and CRO approval date. In addition, in one investigation, the Division found 

that the Exchange’s written analysis was lacking with regard to the issue of jurisdiction. 

 The Division found that Nadex’s investigation log lacks necessary information. 

Specifically, the log does not identify when an investigation was completed by staff, nor 

does it identify the date of the CRO’s approval. 

 The Exchange conducted eleven investigations during the target period, one of which was 

a Trade Practice Inquiry. At the conclusion of the target period, all but one investigation, 

a General Inquiry, had been closed. The remaining investigation was closed 

approximately four months after the target period ended. 

 The Division found that all investigations were conducted in a timely manner. Each of 

the eleven investigations was completed in 115 days or less, and the average length of 

investigation was approximately 46 days. 

 The Division found the quality and documentation of investigative work to be thorough 

and complete. In general, the Exchange reviewed relevant documents and used those 

documents effectively when conducting investigations, drafting summaries and analyses 

of investigations, and determining whether or not violations occurred. 

 Division staff found that for all investigations conducted during the target period, the 

Exchange’s actions, and the sanctions imposed, if any, were appropriate. However, in 

one investigation, the sanctions imposed would be inappropriate under current 

Commission regulations. 

B. Recommendations 

 The Exchange should ensure that each Investigation Memoranda includes a CRO 

signature and a CRO approval date. 

 In cases where the Exchange determines that it lacks jurisdiction over persons subject to a 

disciplinary investigation, the corresponding investigation memoranda should include a 

written analysis of the reasons jurisdiction is lacking. 

 The Exchange should ensure that Nadex’s investigation log contains all necessary 

information for each investigation, including the date on which each investigation was 

completed by staff and the date of CRO approval. 

 The Exchange should implement tie-breaking procedures to resolve tie votes of the ROC, 

or alternatively, the Exchange should ensure that the committee is composed of an odd 

number of members greater than one. 

 As is now required by Commission Regulation 38.158(e), the Exchange may not issue 

more than one warning letter to the same person or entity found to have committed the 

same rule violation within a rolling twelve month period. 
6 

IV. Nadex Operations 

A. Historical Overview 

Nadex, under the name HedgeStreet, initially applied for designation as a contract market 

and registration as a derivatives clearing organization (“DCO”) on March 12, 2001. On February 

18, 2004, the Commission approved HedgeStreet’s contract market designation and DCO 

registration applications. 

 Specifically, the Commission approved HedgeStreet to offer option contracts on a nonintermediated basis.6

 Clearing services were provided by HedgeStreet acting as a registered 

DCO. Each transaction was fully paid, meaning that there would be no margining of positions 

on the Exchange.7 Pursuant to a regulatory services agreement that HedgeStreet submitted to the 

Commission with its designation application, the Exchange contracted with the National Futures 

Association (“NFA”) to assist it in carrying out various self-regulatory responsibilities, 

including, but not limited to, trade practice surveillance, market surveillance, and investigative 

and disciplinary functions. HedgeStreet completed its first day of trading on October 4, 2004. 

 On December 5, 2005, the Commission amended HedgeStreet’s Order of Designation 

and authorized HedgeStreet to allow its member accounts to be carried by FCMs.8

 Since 2008, a 

total of two FCM members, one of which is an affiliate of Nadex, have facilitated trading on the 

Exchange. During the target period, a single FCM operated on the Exchange. After July 2012, 

Nadex has operated purely on a non-intermediated basis. 

 

6

 See Section IV(B) for more information about contracts currently offered by Nadex. 

7

 Prior to trading, HedgeStreet members were required to fund their HedgeStreet account from a bank account in the 

United States. 

8

 The Commission specified that contracts could be cleared by a DCO without collecting prepaid collateral prior to 

acceptance of clearing, provided that collateral sufficient to cover one hundred percent of the maximum possible 

loss incurred by each participant would be collected no later than the day after contracts were accepted for clearing. 
7 

 Effective December 10, 2007, IG US Holdings (“IG US”), a wholly owned subsidiary of 

IG Group Holdings plc (“IG Group”), became the sole owner of the entire equity interest in 

HedgeStreet. Following the acquisition, three significant changes occurred. First, on February 

8, 2008, the Exchange notified the Commission that Market Risk Management, a subsidiary of 

IG US, would be acting as the sole market maker on the Exchange.9 Second, on May 8, 2009, 

the Exchange terminated its regulatory services agreement with NFA and the Exchange took 

over full performance of its self-regulatory functions. Third, on June 21, 2009, HedgeStreet 

changed its name to Nadex. 

B. Current Products 

Nadex currently offers two types of products: binary options and bull spreads. Binary 

options, which account for the vast majority (89.5 percent) of the trades on the Exchange, allow 

members to take risks based on the occurrence or non-occurrence of an event or condition.10 At 

expiration, each binary option settles at zero (if the event does not occur) or 100 (if the event 

occurs). Prior to expiration, the price of the option will fluctuate based on the market’s 

perspective on the likelihood of the occurrence. Members who seek to profit from the event’s 

occurrence can buy the binary option at the prevailing offer price (which will range from zero to 

100). Conversely, members who seek to profit from the event’s non-occurrence can sell the 

option at the prevailing bid price. Sellers’ and buyers’ potential losses are known at the time of 

purchase or sale. A buyer’s profit is limited to the difference between the purchase price and 

100, while a buyer’s loss is limited to the difference between the purchase price and 0. A seller’s 

 

9

 During the target period, Market Risk Management was the sole market maker active on the Exchange. In 

response to concerns raised by the Division regarding an affiliate acting as a market maker, the Exchange agreed to 

make changes to its operations. In addition to ensuring appropriate separation between Market Risk Management’s 

and the Exchange’s computer systems, the Exchange agreed that Market Risk Management would not have access to 

any material non-public information from the Exchange. 

10 See Section V for detailed product volume information. 
8 

profit is limited to the difference between the purchase price and 0; a seller’s loss is limited to the 

difference between the purchase price and 100. 

Nadex offers binary options based on prices and events. Price-based binary options set 

forth a yes/no proposition on stock index futures prices, forex rates, and commodity futures 

prices. The values of these options are based on whether the price of products, typically offered 

by other exchanges, is above or below a certain price at a certain time. For example, Nadex’s 

Gold binary option contract is based on the price of COMEX Gold futures. A corresponding 

binary option on Nadex may offer, for example, a chance to bid on whether the price of gold 

futures will be above $1,382 per troy ounce at 1:30 PM on a certain date. Event binary options 

allow members to take risks on the value of the fed funds rate set by the Federal Open Market 

Committee, jobless figures released by the Department of Labor, and nonfarm payrolls statistics 

released by the Bureau of Labor Statistics. 

 Like binary options, Nadex’s bull spread options allow members to take risks based on 

the price of an underlying instrument (“spot rate”). Stock index futures prices, forex rates, and 

commodity futures can serve as the spot rate. In contrast to binary options, spreads are expressed 

in ranges. However, as with binary options, buyers’ and sellers’ maximum potential gains and 

losses are known at the time of sale because Nadex’s spreads settle at rates referenced to the 

level of the spot rate. For example, the spread contract, euro / U.S. dollar (“EUR/USD”) 1.3000-

1.3250 (3pm) would settle at: the spot rate, if the spot rate is within the range at 3 pm; 1.3000, if 

the spot rate is below 1.3000; or 1.3250, if the spot rate is above 1.3250. Prior to expiration, 

according to Nadex, the price of the spread will fluctuate based on the underlying EUR/USD rate 

and the optional insurance value of the floor and ceiling of the spread. If the underlying rate is 
9 

close to the spread’s floor (1.3000), the spread would typically trade at a price slightly higher 

than the underlying rate. 

Nadex’s binary options and bull spreads are swaps subject to the regulatory framework 

established by Title VII of the Dodd-Frank Act.11 Section 721 of the Dodd-Frank Act added new 

section 1a(47) to the CEA, defining ‘‘swap’’ to include not only ‘‘any agreement, contract, or 

transaction commonly known as,’’ among other things, ‘‘a commodity swap,’’ but also ‘‘[an] 

option of any kind that is for the purchase or sale, or based on the value, of 1 or more . . . 

commodities . . . .”12 The Commission’s regulations define a commodity option transaction or 

commodity option as ‘‘any transaction or agreement in interstate commerce which is or is held 

out to be of the character of, or is commonly known to the trade as, an ‘option,’ ‘privilege,’ 

‘indemnity,’ ‘bid,’ ‘offer,’ ‘call,’ ‘put,’ ‘advance guaranty’ or ‘decline guaranty’.’’13 All binary 

options and bull spreads currently offered by Nadex fall under this definition. As swaps, the 

regulatory requirements to which Nadex’s products are subject include the real-time reporting of 

swap transaction data, swap data recordkeeping and regulatory reporting requirements, and 

recordkeeping and regulatory reporting requirements for pre-enactment and transition swaps, as 

 

11 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376 (2010). 

12 See 7 U.S.C. 1a(47)(A)(i). The swap definition excludes options on futures (which must be traded on a DCM 

pursuant to part 33 of the Commission’s Regulations) (see CEA section 1a(47)(B)(i), 7 U.S.C. 1a(47)(B)(i)), but it 

includes options on physical commodities (whether or not traded on a DCM) (see CEA section 1a(47)(A)(i), 7 

U.S.C. 1a(47)(A)(i)). Other options excluded from the statutory definition of swap are options on any security, 

certificate of deposit, or group or index of securities, including any interest therein or based on the value thereof, 

that is subject to the Securities Act of 1933 and the Securities Exchange Act of 1934 (see CEA section 

1a(47)(B)(iii), 7 U.S.C. 1a(47)(B)(iii)) and foreign currency options entered into on a national securities exchange 

registered pursuant to section 6(a) of the Securities Exchange Act of 1934 (see CEA section 1a(47)(B)(iv), 7 U.S.C. 

1a(47)(B)(iv)). 

13 17 CFR 1.3(hh). 
10 

applicable.14 As they were not applicable during the target period, the Division’s review did not 

address these requirements. 

C. Market Maker 

As noted above, during the target period, Nadex had a Market Maker Agreement with 

one entity, Market Risk Management, an Exchange affiliate. As the only market maker on the 

Exchange, Market Risk Management offers a bid-ask spread for each of Nadex's products. It 

adjusts its prices based on the level of the underlying instrument, and according to Compliance 

staff, Market Risk Management almost always serves as the best bid or offer for all products. 

Consequently, it is a party to the vast majority (over 99 percent) of trades on the Exchange. 

 Nadex adheres to policies designed to maintain separation between the Exchange and 

Market Risk Management. During the on-site interview, Compliance staff explained that the 

entity is treated like any other member with respect to information access and investigations. 

Nadex does not provide Market Risk Management with any information that is not shared with 

members. Although the Exchange has never sanctioned or investigated Market Risk 

Management, Compliance staff explained that Nadex carefully monitors the market maker's 

activity by reviewing trade practice alerts which involve the market maker.15 Compliance staff 

monitors the offers made by Market Risk Management to verify that the market maker is 

adhering to the terms of the Market Maker Agreement. In addition, on a monthly basis, the 

Exchange sends Division staff a list of all ALMAS alerts triggered by Market Risk Management 

 

14 Real-Time Public Reporting of Swap Transaction Data, 77 Fed. Reg. 1182 Jan. 9, 2012) (“Part 43”); Swap Data 

Recordkeeping and Reporting Requirements, 77 Fed. Reg. 2136 (Jan. 13, 2012) (“Part 45”); Swap Data 

Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps, 77 Fed. Reg. 35200 (Jun. 12, 

2012) (“Part 46”). 

15 See Section VII(A) for a discussion of the automated trade practice surveillance system used by Nadex to generate 

trade practice alerts (“ALMAS”). 
11 

during the month. Nadex has not implemented any ALMAS alerts or other types of alerts 

specifically designed for surveillance of the market maker. 

D. Nadex Governance 

1. Ownership and Board of Directors 

Nadex is wholly-owned by IG Group. A UK-based company, IG Group offers a variety 

of “speculative products” to retail and professional customers.16 In addition to Nadex, IG 

Group's operating companies include: IG Index, a financial spread betting business regulated by 

the UK Financial Services Authority (“FSA”) and the UK Gambling Commission;17 and IG 

Markets, offering derivative contracts including Contracts for Difference (“CFDs”), which is 

regulated by the FSA and is a member of the London Stock Exchange. 

The Exchange’s Board of Directors (“Board”) is composed of five directors. Three 

directors are affiliated with IG Group: the CEO of Nadex and two representatives of IG Group. 

Two members of the board, who serve on the Regulatory Oversight Committee (“ROC”), are 

self-certified as public directors. As Nadex’s sole shareholder, IG US Holdings has the direct 

authority to select and remove Board members, including public directors. 

2. Regulatory Oversight Committee 

A ROC oversees the Exchange’s regulatory program. ROC committee members are 

appointed by the Board, according to the ROC charter, but the Chief Regulatory Officer 

(“CRO”) is also involved in the selection process. Among the responsibilities of the ROC, as 

listed in its charter, are to: (i) “oversee all facets of Nadex’s regulatory program, including trade 

 

16 http://www.iggroup.com/corporate/brands.html. 

17 The UK Gambling Commission regulates IG Index's offering of “Binary Bets,” which IG Index describes as “fastmoving 'yes/no' bets that provide dealing opportunities in volatile markets.” http://www.igindex.co.uk/spreadbetting/binary-bets.html. 
12 

practice and market surveillance; audits, examinations, and other regulatory responsibilities; and 

the conduct of investigations;” (ii) “review the size and allocation of the regulatory budget and 

resources; and the number hiring and termination, and compensation of regulatory personnel;” 

(iii) oversee Nadex’s chief regulatory officer, who will report directly to the ROC;” and (iv) 

“prepare an annual report assessing Nadex’s self-regulatory program for the Board and the 

Commission.” The ROC Charter also provides that the ROC shall (i) “meet quarterly and keep 

minutes of its meetings;” (ii) “recommend changes that would ensure fair, vigorous, and 

effective regulation;” and (iv) “[r]eview significant regulatory proposals and advise the Board as 

to whether and how such changes impact regulation.” In addition, the ROC is also authorized to 

address issues that potentially cannot be resolved through standard reporting channels. For 

example, if a Nadex employee perceives that the Compliance Department is not properly 

monitoring or regulating the Nadex marketplace, or that the department has failed to address or 

investigate a matter within a reasonable period of time, the employee can escalate issues to the 

CRO or the ROC. 

ROC meetings are held quarterly. During meetings, the CRO and other Compliance 

employees present information relating to notable cases, Exchange operation, and regulatory 

developments, including Dodd-Frank compliance, internal audits, and Commission audits. The 

CRO serves as the meeting secretary. Outside of formal meetings, the CRO interacts with the 

ROC mainly by phone and e-mail. Through these informal interactions, the CRO keeps the ROC 

informed of important issues, such as new rules that apply to the Exchange. 

The Exchange’s ROC charter requires a minimum membership of two individuals, both 

of whom must be public directors. Currently, the committee is composed of two Board members 

who have self-certified themselves as public directors. No tie-breaking procedures are in place 
13 

to resolve differences between the two members if a conflict were to arise. The Division is 

concerned that with two members and no tie-breaking procedures, the ROC may be confronted 

with irreconcilable conflicts in the event of a difference of opinion between ROC members. 

Accordingly, the Division recommends that: 

 The Exchange should implement tie-breaking procedures to resolve tie votes of the 

ROC, or alternatively, the Exchange should ensure that the committee is composed 

of an odd number of members greater than one. 

V. Trading Volume during the Target Period 

Total trading volume at Nadex during the target period was 987,153 contracts. The 

Exchange offered 50 different products (27 binary options and 23 bull spreads) for trading.18 

Binary option products accounted for approximately 89.5 percent of total volume, with five 

binary options accounting for approximately 51.45 percent of total exchange volume: US 500 

accounted for 20.4 percent; Wall St. 30 accounted for 10.7 percent; EUR-USD accounted for 9.1 

percent; Gold accounted for 6.4 percent; US SmallCap accounted for 4.8 percent.19 Bull spreads 

accounted for approximately 10.5 percent of total volume, with five bull spreads accounting for 

approximately 7.05 percent of total exchange volume: EUR-USD accounted for 3.18 percent; 

AUD-USD accounted for 1.42 percent; US 500 accounted for 1.01 percent; GBP-USD accounted 

for 0.76 percent; Crude Oil accounted for 0.68 percent. All trades are placed electronically by 

one of two methods: (1) Nadex’s proprietary web portal or (2) Financial Information eXchange 

(“FIX”) electronic communication protocol. Only Nadex’s market maker, Market Risk 

 

18 See Section IV(B) for a description of Nadex’s products, binary options and bull spreads. 

19 Nadex calculates the expiration values of its contracts based on contracts at other exchanges and data providers. 

The US 500 binary option is based on CME E-mini S&P 500 Index Futures. The Wall St. 30 binary option is based 

on CBOT E-mini Dow Futures. The EUR-USD binary option is based on data from Reuters. If Reuters is 

unavailable, Nadex would obtain the data from Bloomberg or another data provider deemed appropriate by the 

Exchange under the circumstances. The Gold binary option is based on COMEX/NYMEX Gold Futures. The US 

SmallCap binary option is based on ICE Mini Russell 2000 Index Futures. 
14 

Management, enters trades through FIX; all other Nadex members trade through the web portal. 

The Exchange does not offer open outcry trading or off-exchange trading (EFPs, EFSs, EOOs, or 

block trades). Additional trading volume, open interest, and product information is provided in 

Tables 1, 2, and 3, below. 

Table 1 below lists the total Exchange volume and total number of products listed during 

the target period and during the 12 months prior to the target period (June 15, 2010 to June 15, 

2011). Exchange volume is subdivided by trading in binary options and trading in bull spreads. 

As indicated below, during this two-year period, the number of products decreased from 56 to 50 

(10 percent), but the Exchange experienced significant growth, with volume increasing by more 

than 100 percent (from a total volume of 472,266 to 987,153 contracts). Compliance stated that 

the primary driver for the increase in volume was an increase in the number of Exchange 

members. 

Table 1. Volume by product type. 

 Time period 

Volume 

(in contracts) 

Percentage 

of total 

volume 

No. of 

Products 

Traded 

Binary 

Options 

6/15/10 to 6/15/11 

 

395,739 83.80% 31 

6/15/11 to 6/15/12 

 

883,477 89.50% 27 

 

Bull 

Spreads 

6/15/10 to 6/15/11 

 

76,527 16.20% 25 

6/15/11 to 6/15/12 

 

103,676 10.50% 23 

 

Total 

6/15/10 to 6/15/11 

 

472,266 N/A 56 

6/15/11 to 6/15/12 

 

987,153 N/A 50 
15 

 Table 2 below lists the total Exchange trading volume by year from 2009 to 2012. Total 

Exchange volume grew every year during this period. Volume increased by 116% from 2009 to 

2010, by 357% from 2010 to 2011, and by 79% from 2011 to 2012. 

Table 2. Volume by year. 

Year Total volume 

2009 94,844 

2010 204,414 

2011 934,643 

2012 1,677,035 

 Table 3 below lists the names, total trading volumes, and average monthly open interest 

for the Exchange’s five primary binary option products (ranked by trading volume) during the 

target period. Trading in the US 500, the Exchange’s most heavily traded product, represented 

20.42% percent of total Exchange volume during the target period. 

Table 3. Volume for primary binary option products. 

Binary 

Option 

Product 

Volume 

(in 

contracts) 

Percentage 

of Total 

Exchange 

Volume 

Avg. 

Month-End 

Open 

Interest 

US 500 201,580 20.42% 250.7

Wall St. 30 105,202 10.66% 21.7

EUR-USD 89,840 9.10% 39.1

Gold 63,385 6.42% 233.1

US SmallCap 47,835 4.85% 4.7

 Table 4 below lists the names, total trading volume, and average monthly open interest 

for the Exchange’s five primary bull spread products (ranked by trading volume) during the 
16 

target period. Trading in the EUR-USD spread, the Exchange’s most heavily traded bull spread, 

represented 3.18 percent of total Exchange volume during the target period. 

 Table 4. Volume for primary spread option products. 

Spread 

Option 

Product 

Volume (in 

contracts) 

Percentage 

of Total 

Exchange 

Volume 

Avg. 

Month-End 

Open 

Interest 

EUR-USD 31,401 3.18% 0

AUD-USD 14,027 1.42% 0

US 500 9,984 1.01% 0

GBP-USD 7,520 0.76% 0

Crude Oil 6,683 0.68% 0

VI. Staffing, Organization and Training 

During the Division’s last rule enforcement review of the Exchange (which was prior to 

the purchase by IG US), NFA was contractually responsible for performing many of the 

Exchange’s self-regulatory functions, including trade practice surveillance. That report, which 

was published in March 2008, covered the target period April 1, 2005, through December 31, 

2006. During that target period, the Exchange’s Compliance Department was comprised of two 

people. In May 2009, Nadex terminated its regulatory services agreement with NFA, hired 

additional compliance staff, and assumed the functions previously delegated to NFA. 

 Nadex’s Compliance Department now consists of four staff members. The Compliance 

Department is led by a highly experienced CRO who also serves as the General Counsel and 

Corporate Secretary for the Exchange, and who, during the target period, served as the Chief 
17 

Compliance Officer for Nadex operating as a DCO.20 The CRO’s regulatory responsibilities 

include managing the Compliance Department budget, approving the opening of investigations, 

approving rules to be filed with the Commission, and discussing investigations with Compliance 

staff. Non-regulatory responsibilities account for approximately half of the CRO’s time. During 

the target period, the CRO was assisted by the following individuals: 

 Regulatory Officer, whose responsibilities include analyzing and reviewing trade practice 

alerts generated by the Securities Markets Automated Research Trading and Surveillance 

System (“SMARTS”), and participating in investigative interviews.21

 Compliance Officer, whose responsibilities include facilitating the opening of new 

member accounts, verifying customer identities, reviewing the Exchange’s promotional 

materials, and assisting with on-boarding and reviewing FCM members.22

 Legal Counsel / Compliance Associate, whose regulatory responsibilities include drafting 

rule filings and investigative reports, tracking customer complaints and reminders issued 

to members.23 This individual also assists the Regulatory Officer in conducting trade 

practice surveillance and assists the Chief Compliance Officer in account opening and 

 

20 The CRO joined the Exchange’s staff in January 2009. His 17 years of experience in financial compliance and 

litigation include four years with CME and seven years in private practice. On November 1, 2012, a new individual 

was appointed to the position of Chief Compliance Officer. See note 22. 

21 The Regulatory Officer has 25 years of futures compliance experience, including 22 years at CME. 

22 At the time of the Division’s on-site visit, the Compliance Officer position had been vacant since August 31, 

2012; during the vacancy, other Compliance Department personnel temporarily took over responsibility for the 

duties of this position. On October 8, 2012, a new Compliance Officer was hired. On November 1, 2012, the new 

Compliance Officer was appointed to the position of Chief Compliance Officer. The Chief Compliance Officer is a 

statutorily required position with DCOs; conversely, the Compliance Officer is a front-line employee of the DCM’s 

Compliance Department. 

23 The Legal Counsel / Compliance Associate has three years of futures compliance experience. 
18 

promotional review.24 The employee also assists the CRO with General Counsel and 

Corporate Secretary responsibilities, including maintaining records of meetings of the 

Board of Directors and the ROC and reviewing contracts. 

During the target period, the Regulatory Officer, Compliance Officer, and Compliance 

Associate interacted regularly to discuss compliance issues and concerns, and occasionally, the 

whole Compliance Department met with the CRO on an ad-hoc basis. The CRO explained that 

such department-wide meetings often occur before or after the weekly meeting of the 

Exchange’s Management Team. The CRO also met separately with the Compliance Associate as 

needed to discuss the status of investigations, the steps needed to be taken in investigations, and 

the potential resolution of investigations. 

The Exchange does not have mandatory training for Compliance staff. However, when 

new employees are hired, they receive on-the-job training regarding the Exchange’s automated 

trade practice surveillance tools, the Compliance Manual, and Nadex rules. All members of the 

Compliance Department participate in anti-money laundering training. In addition, various 

members of the Compliance Department attend conferences sponsored by the American Bar 

Association and the Futures Industry Association. 

 IG Group provides information technology support services to Nadex.25 In particular, IG 

Group provides support for the Exchange’s desktop computers and IT network.26 The group also 

 

24 The Compliance Department’s promotional review includes a review of informational brochures and other sales 

or educational documents, including reports, letters, circulars, memoranda, or publications disseminated to or 

directed to the public. 

25 IG Group also provides human resources and marketing services to the Exchange. IG Group provides the 

following human resource services: recruiting, background checks, terminations, accounts payable processing, data 

entry and coding for the Exchange’s Treasury Department. The following services related to marketing are 

provided: marketing implementation, media buys and reporting for online marketing, paid search and search engine 

optimization, support for email marketing campaigns, support and development for the Exchange’s customer 

relationship management system. 
19 

provides support for Nadex’s bespoke applications, such as the Exchange’s back-end systems 

and the Exchange’s administrative user interface, and for third party tools, such as website 

content management systems and online marketing analytic systems.27 Although IG Group does 

not conduct trade practice surveillance or have any compliance responsibilities, it is responsible 

for ensuring that the Exchange’s data properly interfaces with SMARTS, the Exchange’s trade 

practice surveillance system. Other than the aforementioned support, there are no other IG 

divisions or departments that collect, maintain, or disseminate information critical to compliance 

or trade practice activities at the Exchange. 

The Division believes that the Compliance Department personnel are qualified and 

experienced, and that the number of personnel was sufficient for trade practice purposes during 

the target period. However, Nadex’s volume has increased dramatically since 2010. The 

Division reminds Nadex that if this growth continues, the Exchange should reassess its staffing 

needs to ensure that the number of Compliance Department personnel is sufficient to effectively 

conduct trade practice surveillance.28 

VII. Trade Practice Surveillance Program 

New Core Principle 2 – Compliance with Rules 

A. IN GENERAL – The board of trade shall establish, monitor, and enforce compliance 

with the rules of the contract market, includingi. access requirements 

 26 For desktop issues, Nadex is responsible for attempting to resolve problems before reaching out to IG Group. 

With respect to network support, Nadex submits requests to IG Group to make changes to network settings. In 

addition, IG Group may recommend that Nadex’s network settings be changed. In such a circumstance, IG Group 

provides Nadex with a change request form in advance of the change. 

27 Nadex is responsible for the day to day operation of bespoke applications in use at the Exchange. 

28 The Division notes that DCMs have been required to comply with Commission Regulation 38.155 since October 

17, 2012. Regulation 38.155 requires that a DCM monitor the size and workload of its compliance staff annually 

and ensure that its compliance resources are at appropriate levels. A review of the appropriate level of compliance 

resources and staff should consider trading volume increases. 
20 

ii. the terms and conditions of any contracts to be traded on the contract market; 

and 

iii. rules prohibiting abusive trade practices on the contract market. 

B. CAPACITY OF CONTRACT MARKET – The board of trade shall have the capacity to 

detect, investigate, and apply appropriate sanctions to any person that violates any 

rule of the contract market. 

C. REQUIREMENT OF RULES – The rules of the contract market shall provide the board of 

trade with the ability and authority to obtain any necessary information to perform 

any function described in this subsection, including the capacity to carry out such 

international information-sharing agreements as the Commission may require. 

New Core Principle 12 – Protection of Market Participants: 

The board of trade shall establish and enforce rules 

A. to protect markets and market participants from abusive practices committed by 

any party, including abusive practices committed by a party acting as an agent for 

a participant; and 

B. to promote fair and equitable trading on the contract market. 

During the entirety of the target period, Appendix B to Part 38 of the Commission’s 

regulations provided that a contract market’s trade practice surveillance program should have the 

arrangements, resources, and authority necessary to perform effective rule enforcement.29 The 

arrangements and resources attendant to the program should facilitate the direct supervision of 

the contract market, including analysis of relevant data. Trade practice surveillance programs 

can be carried out by the contract market itself or through delegation to a third party. 

 An acceptable program should have systems that maintain all data reflecting the details of 

each transaction executed on the contract market. In this regard, the program should include 

routine electronic analysis of transaction data to detect potential trading violations. The program 

should also provide for appropriate and thorough investigation of potential trading violations 

 

29 On May 10, 2012, the Commission issued its Final Rules, Core Principles and Other Requirements for 

Designated Contract Markets, 77 Fed. Reg. 36612 (June 19, 2012), which became effective on October 17, 2012, 

after the target period. Among other things, this rulemaking revised guidance and acceptable practices for some 

core principles and, for several core principles such as Core Principles 2 and 12, adopted rules, some of which 

codified previous guidance and acceptable practices. Because these rules were not effective during the target period, 

the Division evaluated the Exchanges’ trade practice surveillance program pursuant to the substantive standards 

contained in the pre-existing guidance and acceptable practices. 
21 

brought to the contract market’s attention, including member and Commission referrals and 

customer complaints. 

A. Automated Surveillance System 

Nadex’s primary trade practice surveillance tool is SMARTS, an alert and analysis 

program. A subcomponent of the SMARTS system, the ALMAS tool, generates real-time trade 

practice alerts. Parameters for the alerts are set by Compliance. The system is programmed to 

produce alerts based on the following trade practice issues: (a) money-pass, (b) pre-arranged 

trading, (c) position limits, (d) daily settlement price manipulation, (d) trading ahead, (e) taking 

the other side of a customer order, (f) futures price divergence, and (g) wash trading.30 These 

alerts can be triggered by the behavior of any market participant, including the market maker. 

During the target period, 1,149 ALMAS alerts were generated, including 370 alerts (32 percent) 

triggered by Nadex’s market maker. All alerts triggered by Nadex’s market maker were either 

daily settlement price manipulation alerts or futures price divergence alerts. For all market 

participants other than Nadex’s market maker, the most common alert was money pass, which 

generated 305 alerts (39 percent of all alerts). Four additional categories of alerts were triggered 

by market participants other than the market maker: 212 daily settlement price manipulation 

alerts (27 percent of non-market maker alerts), 175 pre-arranged trading alerts (22 percent of 

non-market maker alerts), 86 futures price divergence alerts (11 percent of non-market maker 

alerts), and 1 trading ahead alert (less than 1 percent of non-market maker alerts). 

 

30 The futures price divergence alert is triggered when the price of a trade differs significantly from the value of the 

underlying instrument. 

The wash trading alert is triggered when the same account trades opposite itself. Nadex’s matching system currently 

prevents the same account from trading opposite itself. As a result, the wash trading alert system does not generate 

any alerts. 
22 

ALMAS alerts are monitored on a real-time basis by Compliance throughout the business 

day. Alerts generated during overnight trading are reviewed the following day.31 In reviewing 

the alerts, Compliance may conduct additional review regarding the trade(s) or trader(s) in 

question to determine if a rule violation has occurred. In particular, the following information 

may be reviewed: the activity level of the traders in question, the size of the trade, the timing of 

the orders, whether the orders liquidated into an open position, the relationship between the trade 

price and the market price, the overall activity of the contract. In addition, Compliance may use 

the SMARTS Replay tool, which displays the complete market depth and all active bids and 

offers. Each alert is either dismissed or elevated to an investigation.32 In either case, 

Compliance adds a short paragraph into the system explaining the basis for the decision. Based 

on a review of approximately half of the notes for the ALMAS alerts generated during the target 

period, including all of the alerts triggered by the market maker, the Division believes that the 

notes provide an adequate justification for dismissed alerts. 

Several other SMARTS components enable Compliance to detect potential rule 

violations. ARC, a research and profiling tool, generates ad-hoc reports based on queries run by 

Compliance staff. On a monthly basis, Compliance staff runs the following ARC reports: Client 

Product Report, Client Counterparties Report, Prearranged Trading Report, and Collusion 

Report. These reports are used to detect a number of rule violations, including spoofing and prearranged trading.33

 

31 Nadex’s hours of trading are 6 pm ET Sunday to 4:15 pm ET Friday, excluding the hour between 5 pm and 6 pm 

Monday through Thursday. 

32 See Section VII(B) for a description of how Nadex tracks investigations. 

33 The Prearranged Trading Report lists the occasions where two members trade opposite one another with less than 

a specified time limit between the bid and offer. Because Nadex’s market maker is a party to the vast majority of 

trades, it is noteworthy when two Nadex members engage in a trade opposite one another instead of opposite the 

market maker. Compliance explained that such trades raise the possibility of pre-arranged trading. 
23 

In addition, ARC enables Compliance to identify a market participant’s overall trading 

profile by running target searches of the participant’s activity. For example, using this tool, 

Compliance can query which counterparties have traded opposite a specific participant, or the 

typical hours of a participant’s trading activity. Spread User, a graphical research tool, provides 

a visual representation of market activity at the time of a trade. The tool enables Compliance to, 

among other things, determine the depth of the market connected to a particular trade, identify 

which side of the market placed an aggressive order that ultimately led to a trade, and visualize 

the trading price of an option during a particular time period. 

Compliance also conducts market profiling and generates ad-hoc reports through 

Dashboard, a front-end system that provides access directly into Nadex’s trading database. 

Compliance uses Dashboard to help resolve ALMAS alerts and to verify that the market maker is 

adhering to the terms of the Market Maker Agreement. In addition, Compliance staff uses a realtime market maker monitor to display the market maker’s average spread, maximum spread, 

minimum spread, average bid price, average offer price, and total number of quotes made. If the 

average market quantity for each contract does not match the requirements set forth in the 

Market Maker Agreement, the CRO is notified. In one instance during the target period, in 

November 2011, the market maker failed to meet these requirements by failing to replenish the 

offer side of a single contract. After being notified of this failure by the Exchange, the market 

maker resumed offering a two-sided market. 

Nadex also identifies trade practice issues by reviewing FCM error accounts, which 

Compliance is responsible for reviewing on a monthly basis. However, during the target period, 

there was no activity in the FCM error accounts. 

B. Investigations 
24 

1. Investigation Process 

Nadex tracks three types of investigations: Trade Practice Inquiries, Inquiries (“General 

Inquiries”), and Complaints. Trade Practice Inquiries involve trade practice issues identified 

through Nadex’s surveillance system described above, typically through ALMAS alerts or by 

customer complaints. General Inquiries involve potential problems identified by the Exchange 

that do not relate to trade practice issues. For example, the discovery of a prospective member’s 

criminal history could result in the creation of a General Inquiry.34 “Complaints” are customer 

complaints that do not relate to trade practice issues; a complaint which raised trade practice 

issues would be designated as a Trade Practice Inquiry. All three categories of investigations are 

tracked by Compliance in an investigation log. 

Compliance conducts and documents each investigation. Compliance creates an 

Investigation Origination Form to track the course of the investigation, resulting in a timeline of 

steps taken during the investigation. Ad-hoc Compliance meetings are held throughout the 

course of investigations to discuss case theories and dispositions. During investigations, 

Compliance conducts witness interviews and requests relevant documents from market 

participants. At the conclusion of each investigation classified as a Trade Practice Inquiry or a 

General Inquiry, and regardless of whether rule violations were found, a member of the 

Compliance Department drafts an Investigative Memorandum. The Investigation Memorandum 

includes the analysis used to determine whether a violation took place, facts relevant to the 

 

34 Nadex identifies problematic criminal history and other potential problems of prospective members in several 

ways. First, applicants are requested to submit criminal history information on their membership application. 

Secondly, at the time an application is submitted, Equifax identification verification is run on the individual, which 

also includes an Office of Foreign Asset Control (“OFAC”) search. Finally, shortly after an application is 

submitted, Nadex performs a criminal background check on the individual through McDonald Information Services 

(“MIS”). The MIS check also includes an identity verification component. After an application has been accepted, 

Nadex continues to monitor, through MIS, information regarding potential criminal history. On an ongoing basis, 

members are required, pursuant to Nadex Rule 3.3, to notify the Exchange regarding certain criminal actions. 
25 

investigation, which if any Exchange rules were violated, and a recommended sanction. In the 

case of Complaints, a Complaint Report Form is drafted. This form includes, among other 

things, the nature of the Complaint and the recommended action to be taken. In addition, the 

form includes a brief timeline of the events in the case. 

 In the case of Trade Practice Inquiries and General Inquiries, Compliance staff prepares 

an Investigation Memorandum upon concluding its investigatory work. Such memoranda 

include staff’s findings and recommendations, and are reviewed and approved by the CRO. If no 

rule violations were found, this conclusion is documented in the Investigation Memorandum, and 

the member is not contacted. In cases where rule violations were found, Compliance sends a 

copy of the memorandum to the subject of the investigation. The subject has 15 days to respond 

to or contest the sanction recommendation. If the subject contests the findings, the subject may 

request a formal hearing. Compliance staff determined that rule violations had been committed 

in the sole Trade Practice Inquiry and in each of the five General Inquiries conducted during the 

target period, but no formal hearings were requested. 

2. Adequacy of Investigations 

As discussed in more detail below, Nadex conducted a total of eleven investigations 

during the target period: one Trade Practice Inquiry, three Complaints, and seven General 

Inquiries.35 Because the Exchange only conducted a single Trade Practice Inquiry during the 

target period, Division staff was unable to comprehensively assess the quality of the Exchange’s 

trade practice investigation techniques. However, Division staff expanded its review of 

investigations during the target period to include all eleven investigations completed, regardless 

of whether such investigations involved trade practice matters. 

 

35 This number represents investigations which were opened, active, or closed during the target period. 
26 

a. Investigative Work and Documentation

 The Division found that Nadex generally maintains adequate documentation and files of 

its investigations. The investigation files contain relevant information, including audio 

recordings of telephone calls with market participants, emails between Nadex and market 

participants, and relevant trade records. The quality of investigative work is thorough and 

complete. Questions posed by Compliance to the subjects of investigations were targeted to 

soliciting information to determine compliance with Nadex rules. Compliance staff members 

were well informed during such conversations, basing their questions on trading data and other 

relevant data as appropriate. Division staff found that the Exchange reviewed relevant 

documents and used those documents effectively when conducting investigations; drafting 

Investigation Memoranda, Investigation Origination Forms, and Complaint Report Forms; and 

determining whether or not violations occurred. 

Complaint Report Forms contained adequate detail regarding the nature of the complaint 

and the complaint’s resolution. Investigation Origination Forms provide a comprehensive view 

of each step of an investigation, and Investigation Memoranda typically provide the facts of a 

case and a thorough analysis explaining whether or not a rule violation took place. The 

Division found, however, that some, but not all Investigation Memoranda contain a CRO 

signature and CRO approval date. Such a signature would provide certainty as to which version 

of each memorandum is final. Additionally, including the CRO approval date would enable the 

Exchange to more easily determine the source of any delays in the investigation process. 

Accordingly, the Division recommends that: 

 The Exchange should ensure that each Investigation Memoranda includes a CRO 

signature and a CRO approval date. 
27 

In one investigation (“Jurisdictional Fraudulent Account Investigation”), the Division 

found that the Exchange’s analysis in an Investigation Memorandum was lacking with regard to 

the issue of jurisdiction. In the Jurisdictional Fraudulent Account Investigation, the Exchange 

concluded that an account had been set up without the knowledge of the individual (“account 

holder”) in whose name the account was created. In September 2011, the account holder alleged 

that another individual (“other individual”), who had previously applied for a Nadex account in 

his own name, had fraudulently created her account. The other individual did not fund the 

account in his own name, and at the time, Nadex’s jurisdiction only extended to individuals who 

had successfully funded their Nadex accounts.36 In the investigation memorandum, Compliance 

concluded that the other individual had engaged in conduct that “would violate numerous 

Exchange rules.” As a result, in addition to closing the account holder’s account, Nadex denied 

the other individual’s account application and barred him from reapplying to the Exchange in the 

future. In a follow-up conversation after Division staff’s onsite visit, Compliance explained that 

the Exchange had considered the issue of jurisdiction and concluded it did not have jurisdiction 

over the other individual. The reasons for this conclusion were that the other individual failed to 

fund the account that he had created in his own name and that there was no “concrete proof” that 

he had control over the account holder’s account. However, the memorandum contained no 

discussion regarding whether the Exchange had jurisdiction over the other individual. 

Accordingly, the Division recommends that: 

 

36 On August 20, 2012, Nadex implemented Rule 2.10 (Consent to Jurisdiction), which provides: “Any Person 

initiating or executing a transaction on or subject to the Rules of the Exchange directly or through an intermediary, 

and any Person for whose benefit such a transaction has been initiated or executed, expressly consents to the 

jurisdiction of the Exchange and agrees to be bound by and comply with the Rules of the Exchange in relation to 

such transactions, including, but not limited to, rules requiring cooperation and participation in investigatory and 

disciplinary processes.” 
28 

 In cases where the Exchange determines that it lacks jurisdiction over persons 

subject to a disciplinary investigation, the corresponding investigation memoranda 

should include a written analysis of the reasons jurisdiction is lacking. 

b. Review of Investigations 

Division staff reviewed the steps taken by the Exchange in each investigation conducted 

during the target period as well as the disposition of each such investigation. The Division found 

that the Exchange’s actions, and the sanction imposed, were appropriate in ten of the eleven 

investigations conducted during the target period. 

All eleven investigations conducted during the target period have been closed. The sole 

Trade Practice Inquiry involved a member who engaged in pre-arranged trading in violation of 

Nadex Rule 5.19(b), (i), and (o). Because Compliance believed that the member had controlled 

and fraudulently created the accounts involved in the pre-arranged trading as well as other 

accounts, Compliance determined that the member had violated Nadex Rules 3.1, 5.19(c) and 

(k).37 Finally, by failing to cooperate in the investigation, the Exchange concluded that the 

member violated Nadex Rule 3.3.38 Nadex closed the investigation by revoking the individual’s 

Nadex membership and prohibiting him from trading Nadex products in the future. 

 

37 Nadex Rule 3.1 – Trading Members – Applications, Classifications, and Privileges 

 (f) A Trading Member that is an individual may not maintain and/or trade more than one Nadex account 

Nadex Rule 5.19 – Prohibited Transactions and Activities 

 . . . 

(c) No Person shall enter into or attempt to enter into any trade on the Market that does not result in a 

change of beneficial ownership . . . or that has some other illegitimate purpose 

. . . 

(k) No Person shall intentionally provide erroneous or fraudulent information to Nadex on a membership 

application or otherwise 

38 Nadex Rule 3.3 – Member Obligations 

(a) Each Member and any Authorized Trader(s) thereof, must comply with these Rules, applicable 

provisions of the Commodity Exchange Act, and relevant Commission regulations. Each Member and 

any Authorized Trader(s) thereof must also cooperate promptly and fully with Nadex, its agents, and/or 
29 

Of the three Complaints closed during the target period, two involved allegations that the 

settlement price was incorrect; in both instances, Nadex determined that the settlement price was 

accurate and therefore took no action with respect to the Complaints. The remaining Complaint 

involved a member alleging that his account was negative because his account had been hacked. 

As evidence, the member stated that bank accounts owned by other individuals had been added 

to his Nadex account. Nadex discovered a software bug which could have allowed certain 

members to see the bank account number and routing number of other members, though it found 

no evidence that any accounts had lost money as a result of the bug. The Exchange closed the 

investigation by resolving the bug, offering identity theft protection to the members whose 

accounts were affected, and providing a credit to the account of the member who had raised the 

issue. 

Of the seven General Inquiries, three involved accounts being opened fraudulently 

(“Fraudulent Account Investigations”). The first Fraudulent Account Investigation involved 

three Nadex accounts which had been created and funded through checks drawn on credit cards 

without the knowledge of the individuals in whose names the accounts were created. Nadex 

returned the funds to the credit card company and closed the member accounts. In the second 

such case, the Jurisdictional Fraudulent Account Investigation discussed above, Nadex closed the 

account in question, denied the application of the individual alleged to have fraudulently opened 

an account, and barred that individual from opening a Nadex account in the future.39 The third 

Fraudulent Account Investigation involved a Nadex account that was funded and traded without 

 the Commission in any investigation, call for information, inquiry, audit, examination, or proceeding . . 

.If any Member or Authorized Trader(s) thereof fail to satisfy these obligations, Nadex may revoke or 

suspend the Member's privileges in full or in part. Each Member may also be subject to civil or 

criminal prosecution.

39 See Section VII(B)(2)(a). 
30 

the knowledge of the individual in whose name the account had been created. The Exchange 

closed the account and did not hold the individual in whose name the account had been created 

responsible for an account deficit caused by the trading. 

The four remaining General Inquiries involved a variety of issues. The first such case 

involved a member (“sender”) who had made deposits from his bank account into the Nadex 

accounts of two other members (“recipients”). The Exchange determined that the sender and 

recipients had violated Nadex Rule 3.1 by funding Nadex accounts with a bank account in 

another individual’s name, and that the recipients had violated Nadex Rule 5.2 by allowing the 

sender to access their accounts.40 The second General Inquiry involved an applicant who owned 

two corporate entities. The applicant provided all requested identification verification 

documents and disclosed a criminal background on his application. After Compliance assessed 

the applicant’s background and determined that the nature of the disclosed criminal incidents did 

not pose a threat to Nadex, Compliance allowed the individual to become a member. After the 

member made a deposit of $15,000, Compliance requested additional information regarding one 

of the member’s corporate entities. In response, the member stated that the corporate entity 

 

40 Nadex Rule 3.1 – Trading Members – Applications, Classifications, and Privileges

(a) To be eligible to become a Trading Member: 

(i) An applicant who is an individual, must: 

. . . 

3) have an account or accounts in the Trading Member's name with a Financial Institution that the 

Trading Member will use to fund its Nadex account at the Nadex settlement bank and to receive 

funds from its Nadex account . . . . 

Nadex Rule 5.2 – Trading Member Access to Nadex 

(d) Each Trading Member will be responsible for protecting its ID and password . . . In addition, a Trading 

member may not knowingly or negligently permit any Person not authorized by Nadex and by the Trading 

Member to use the ID and password to access the secure portion of the Nadex website. Each Trading 

Member is required to immediately notify Nadex if it knows, or has reason to believe, that its ID or the ID 

and/or password of any Authorized Trader have been disclosed to any Person not authorized by Nadex and 

the Trading Member to use such ID and/or password . . . .
31 

invested in domain names, that he is not a professional trader, that he does not solicit funds, and 

that all funds in his Nadex account were solely his. Compliance determined that neither 

corporate entity owned by the member appeared to be soliciting funds for investment. In 

resolving the General Inquiry, Compliance found no evidence that the member had violated 

Nadex rules. The third General Inquiry involved a member who had failed to disclose in his 

application that he was subject to a state-issued Desist and Refrain Order (“Order”) for acting as 

a broker-dealer and trading advisor without registering with the SEC or obtaining a certificate 

from the state, and for making untrue or misleading statements to customers. Due to the nature 

of the Order and the member’s failure to disclose it, the Exchange determined that the member 

had violated Rules 3.1 and 3.3.41 The Exchange terminated the member’s account and 

 

41 Nadex Rule 3.1 – Trading Members – Applications, Classifications, and Privileges

(a) To be eligible to become a Trading Member:

 (i) An applicant who is an individual, must: 

. . . 

3) have an account or accounts in the Trading Member’s name with a Financial 

Institution that the Trading Member will use to fund its Nadex account at the Nadex 

settlement bank and to receive funds from its Nadex account. . . .”

Nadex Rule 3.3 – Member Obligations 

. . . 

(d) Each Member must immediately notify Nadex in writing upon becoming aware: 

(i) that the Member, any of the Member’s officers or any of the Member’s Authorized Traders has 

had trading privileges suspended, access to, or membership or clearing membership in, any 

Regulatory Agency denied; 

(ii) that the Member, any of the Member’s officers or any of the Member’s Authorized Traders has 

been convicted of, pled guilty or no contest to, or entered a plea agreement to, any felony in any 

domestic, foreign or military court; 

(iii) that the Member, any of the Member’s officers or any of the Member’s Authorized Traders 

has been convicted of, plead guilty or no contest to, or entered a plea agreement to a misdemeanor 

in any domestic, foreign or military court which involves: 

(1) embezzlement, theft, extortion, fraud, fraudulent conversion, forgery, counterfeiting, 

false pretenses, bribery, gambling, racketeering, or misappropriation of funds, securities 

or properties; or 
32 

membership, returned the funds therein, and barred the member from opening a new Nadex 

account for two years. 

In the final General Inquiry, the Access Sharing Investigation, a Nadex member shared 

access to his account with his son. Initially, the member was specifically reminded not to do so; 

less than a year later, the Exchange issued a warning letter for improperly sharing access to an 

account. The case first came to the attention of the Compliance Department in August 2011 

through a call with Nadex Customer Service. In the call, the member said that the member’s son 

had set up the account. The member called back and said, “we just got locked out of our new 

account,” and “well, my son was signing in.” Customer Service informed the member that 

Nadex rules only permit one person to operate an account. In reply, the member said, “I 

understand but it can’t work that way with me . . . he’s actually working for me doing all my 

trading.” The following day, Compliance emailed the member to inform him that “individual 

accounts at Nadex are not permitted to have authorized traders other than the account owner.” 

Furthermore, Compliance stated, “pursuant to Nadex Rule 5.2(d), you may not share your Nadex 

username and password with anyone not authorized by Nadex.” Compliance asked him to 

confirm that only he would access the account. The member replied in the affirmative, stating, 

“only I will be accessing the account.” In May 2012, after Nadex learned that the member had 

continued to let his son trade in the account, the Exchange issued a warning letter to the member 

 (2) any transaction in or advice concerning futures, options on futures, leveraged 

transactions or securities; 

(iv) that the Member, any of the Member’s officers or any of the Member’s Authorized Traders 

has been subject to, or associated with a firm that was subject to regulatory proceedings before any 

Regulatory Agency; 

(v) that the Member, any of the Member’s officers or any of the Member’s Authorized Traders is 

currently a party to any investigation or proceeding, the resolution of which could result in an 

event described in Rule 3.3(d)(i)-(iv)
33 

for violating Nadex Rules 3.5 and 5.2, and a warning letter to the son for violating Nadex Rules 

3.1, 3.5 and 5.2.42 

The Division notes that current Commission Regulation 38.158(e), with which DCMs 

were required to comply by October 17, 2012, after the target period, would preclude the 

Exchange from issuing a warning letter in a similar case in the future. That rule prohibits DCMs 

from issuing more than one warning letter to the same person found to have committed the same 

rule violation within a rolling twelve month period. Further, the Division has previously 

recommended in past rule enforcement review reports that exchanges not issue more than one 

warning letter to the same market participant for the same violation in a rolling twelve month 

 

42 Nadex Rule 3.5 – Authorized Traders 

(a) . . . Only those individuals authorized by the Trading Member and approved by Nadex may enter and 

execute transactions on the Market for the Trading Member's account.

Nadex Rule 5.2 – Trading Member Access to Nadex 

(d) Each Trading Member will be responsible for protecting its ID and password, and with respect to an 

entity Trading Member, the ID(s) and password(s) of its Authorized Trader(s), from improper disclosure. In 

addition, a Trading Member may not knowingly or negligently permit any Person not authorized by Nadex 

and by the Trading Member to use the ID and password to access the secure portion of the Nadex website. 

Each Trading Member is required to immediately notify Nadex if it knows, or has reason to believe, that its 

ID or the ID and/or password of any Authorized Trader have been disclosed to any Person not authorized 

by Nadex and the Trading Member to use such 10 and/or password. Under any circumstances, the Trading 

Member will be deemed to know that such ID and/or password have been disclosed to an unauthorized 

person 12 hours after any order is entered by that unauthorized person in your account. 

Nadex Rule 3.1 – Trading Members – Applications, Classifications and Privileges 

 To be eligible to become a Trading Member: 

(i) An applicant who is an individual must: 

. . . 

(4) certify that 

. . . 

(iv) the applicant will trade only for itself and will not trade as an intermediary for any 

other person or entity 

(f) A Trading Member that is an individual, may not maintain and/or trade more than one Nadex 

account . . . . 
34 

period.43 The Division expects all exchanges to take note of recommendations in its public rule 

enforcement review reports and apply such recommendations accordingly within their own 

programs. Consistent with its previous recommendations, and as is now required by 

Commission Regulation 38.158(e): 

 The Exchange may not issue more than one warning letter to the same person or 

entity found to have committed the same rule violation within a rolling twelve 

month period. 

 

3. Timeliness of Investigations 

Division staff examined all eleven investigations conducted during the target period for 

timeliness. As mentioned above, during the target period, the Exchange closed ten 

investigations. The sole investigation conducted during the target period that remained open was 

closed approximately four months after the conclusion of the period. Each of the eleven 

investigations was completed in 115 days or less, and the average length of investigation was 

approximately 46 days. Table 4 below provides the average length of investigation by 

investigation type. The Division found that all eleven investigations were conducted in a timely 

manner. 

Table 4. Length of investigations. 

Number Average length 

Trade Practice Inquiries 1 92 days 

General Inquiries 7 58 days 

Complaints 3 3 days 

4. Investigation Log 

Nadex maintains a log detailing all investigations at the Exchange (“investigation log”). 

The investigation log identifies each investigation as belonging to one of the three categories 

 

43 See “Rule Enforcement Review of the Minneapolis Grain Exchange,” (2009), at 9 and 58. See also “Rule 

Enforcement Review of the Kansas City Board of Trade,” (1998). 
35 

mentioned above:44 Trade Practice Inquiries, General Inquiries, or Complaints. The log lists for 

each matter which rules were violated, if any, and any attendant disciplinary action. The 

investigation open date and the investigation close date are listed in each instance. 

The open date corresponds to the date the activity in question is identified as potentially 

problematic after an initial review is conducted by Compliance. For Trade Practice Inquiries 

triggered by ALMAS alerts, the open date corresponds to the date on which Compliance reviews 

the alert and determines that an investigation is warranted. In most cases, the open date for these 

investigations corresponds to the date of the ALMAS alert because ALMAS alerts generated 

during the business day are reviewed during the same business day. For ALMAS alerts which 

are generated in overnight trading, which Compliance reviews on the first business day after the 

alert is generated, the start date corresponds to the first business day after the alert is generated. 

For investigations triggered by complaints, the open date corresponds to the date on which 

Compliance determines that an investigation is warranted after reviewing the complaint.45 

Typically, the open date corresponds to the same day as the complaint is made because 

Compliance reviews most complaints the day they are made. However, complaints received by 

Customer Service after work hours would be reviewed by Compliance the following business 

day. Accordingly, the open date for such complaints would correspond to the business day after 

the complaint was received. 

The close date corresponds to the date on which the case is considered final. This date 

depends on the nature of the case. In disciplinary cases in which the member does not contest 

the findings in the investigation memorandum, the close date represents the date on which the 

 

44 See Section VII(B)(1). 

45 As explained in Section VII(B)(1), complaints are designated as Trade Practice Inquiries if trade practice issues 

are involved. Customer complaints which do not involve Trade Practice Issues are designated as Complaints. 
36 

findings are deemed admitted, which occurs 15 days after the member is notified of the findings. 

In cases in which no recourse is recommended, or a member voluntarily terminates his or her 

account, or is sent a warning, the close date represents the date the matter is resolved with the 

member. Neither the close date nor any other date on the chart identifies the date when an 

investigation was completed by staff. In addition, the log does not separately identify the date of 

CRO approval. 

The Division concludes that the investigation log is not sufficiently detailed. Although 

the dates and other information on the log appear to be accurate, and the open date tracks when 

Compliance begins investigations, neither the close date nor any other date on the chart identifies 

when investigatory work ceased. Thus, the log does not track the duration of Exchange staff’s 

investigatory work. The absence of such information on the log could hinder the Exchange’s 

ability to evaluate the timeliness of an investigation. In addition, the omission of the date of 

CRO approval could prevent the Exchange from readily identifying the probable reason why an 

investigation was untimely. Accordingly, the Division recommends that: 

 The Exchange should ensure that Nadex’s investigation log contains all necessary 

information for each investigation, including the date on which each investigation 

was completed by staff and the date of CRO approval.