TRADE PRACTICE 

RULE ENFORCEMENT REVIEW 

NORTH AMERICAN 

DERIVATIVES EXCHANGE 

Division of Market Oversight 

July 28, 2017 
1

RULE ENFORCEMENT REVIEW OF 

NORTH AMERICAN DERIVATIVES EXCHANGE (NADEX) 

TRADE PRACTICE SURVEILLANCE 

Commodity Futures Trading Commission – Division of Market Oversight 

Contents

I. Rule Enforcement Review Scope ............................................................................................ 2

II. Summary of Findings, Recommendations, and Deficiencies .................................................. 5

A. Findings without Recommendations or Deficiencies ................................................... 5

B. Findings with Recommendations ................................................................................. 7

C. Findings with a Deficiency Requiring Corrective Action ............................................ 9

III. Nadex Operations............................................................................................................... 13

A. Nadex Governance ..................................................................................................... 13

B. Current Products ......................................................................................................... 14

C. Market Makers ............................................................................................................ 16

IV. Trading Volume During the Target Period ........................................................................ 17

Appendix A ................................................................................................................................... 19

Appendix B ................................................................................................................................... 43
2

I. Rule Enforcement Review Scope

The Division of Market Oversight (“Division”) has completed a rule enforcement review 

of the trade practice surveillance program of North American Derivatives Exchange Inc. 

(“Nadex” or “Exchange”).1

 The review focused on the Exchange’s compliance with two core 

principles under Section 5(d) of the Commodity Exchange Act (“Act” or “CEA”) (Core 

Principles 2 (Compliance With Rules) and 12 (Protection of Markets and Market Participants)),2

and with several rules under Part 38 of the Commission’s regulations (§§ 38.150, 38.152–153, 

38.155–159, and 38.650–651).3 The Division’s review of the Exchange’s trade practice 

surveillance program covered the period from December 12, 2014 to December 11, 2015 (“target 

period”).4

In conducting this review, Division staff interviewed Exchange officials and staff. Nadex 

provided a demonstration of the electronic systems that it uses to perform trade practice 

surveillance. The Division also reviewed numerous documents produced by Exchange staff, 

including the following: 

 

1 The Division’s rule enforcement reviews seek 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 investigations 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. 

The findings and recommendations in this rule enforcement review are limited to the Exchange and its products. 

This rule enforcement review, and 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 Appendix B for a table of Core Principles and Regulations reviewed. Because the substantive requirements of 

Core Principle 12 that relate to trade practice surveillance are similar to those of Core Principle 2, the Division has 

evaluated compliance with Core Principle 2 and the selected regulations listed herein rather than conduct a separate 

review of Core Principle 12 and its associated regulations, Commission regulations 38.650-651.

4 The Division previously reviewed the Exchange’s trade practice surveillance program in its November 15, 2013 

rule enforcement review, which covered the period from June 15, 2011 through June 15, 2012. 
3

 policies and procedures for conducting trade practice surveillance, including the 

Nadex Compliance Procedures Manual (“Compliance Manual”);

 organizational charts and summaries of personnel and staffing; 

 investigation documents and associated work product for a sample of the trade 

practice preliminary reviews and the one investigation related to potential trade 

practice violations that was closed during the target period;

 minutes of meetings held during the target period of the Regulatory Oversight 

Committee (“ROC”) of the Nadex Board of Directors;

 the market maker agreements between the Exchange and the two market makers 

active on the Exchange platform during the target period; and 

 logs tracking the disposition of preliminary reviews and investigations relating to 

trade practice surveillance matters. 

The Division analyzed Nadex’s trade practice surveillance program to determine whether 

it complied with the core principles and Commission regulations set forth above, and whether 

there were any deficiencies with, or recommendations for, the program. For purposes of this 

report, a deficiency is an area where the Division believes that the Exchange is not in compliance 

with a Commission regulation and must take corrective action, and a recommendation concerns 

an area where the Division believes that the Exchange should improve its compliance program. 

Positively, the Division found that Nadex allocates staff, information technology, and other 

resources to comply with Core Principles 2 and 12. The Exchange also maintains a rulebook for 

market participants and policies and procedures for Exchange staff relevant to Core Principles 2 

and 12. However, the Division also identified certain shortcomings that raise concerns about the 

Exchange’s trade practice surveillance program. The Division made three separate 
4

recommendations relating to compliance with Commission regulations 38.153 (Capacity to 

detect and investigate rule violations) and 38.155 (Compliance staff and resources). The 

Division also found three deficiencies pursuant to Commission regulation 38.158 (Investigations 

and investigation reports). 

In addition, although Core Principle 7 (Availability of General Information) was not a 

focus of this review, the Division identified one compliance issue under this core principle 

during the course of its examination. Material terms of Nadex’s Market Maker Agreements were 

not readily available on the Exchange’s website during the target period, pursuant to 

Commission regulation 38.401(a). Accordingly, the Division found one deficiency relating to 

compliance with Commission regulation 38.401. 

The Division provided the Exchange an opportunity to review and comment on a draft of 

this report on June 5, 2017. On June 13, 2017, Division staff conducted an exit conference with 

officials from the Exchange to discuss the findings, recommendations, and deficiencies set forth 

in the report. 
5

II. Summary of Findings, Recommendations, and Deficiencies

A. Findings without Recommendations or Deficiencies

1. Rulebook (Core Principle 2, Commission regulations 38.150) 

 The Nadex Rulebook (“Rulebook” or “Exchange Rules”) sets forth 

access requirements, terms and conditions of contracts to be traded on 

the Exchange, and rules prohibiting abusive trading practices on the 

Exchange. 

2. Automated trade surveillance system (Core Principle 2, Commission 

regulation 38.156)

 The Division found that Nadex’s automated trade practice surveillance 

tools comply with Commission regulation 38.156. The Exchange uses 

the Securities Markets Automated Research Trading and Surveillance 

System (“SMARTS”), a third-party automated trade practice 

surveillance database / analytic tool with alert functionality, for realtime monitoring and reconstruction of trading activity. 

 SMARTS provides a graphical view of trading in a specific market at a 

specific time. For order, trade, and clearing information, SMARTS 

provides compilation, retrieval, sorting, filtering, and analysis 

functionality. 

 SMARTS includes reports from the Almas real-time alert generator. 

The system also includes ARC, which contains a group of report 

templates with ad hoc customizable parameters and filter rules for each 

report. 

 Nadex staff reviews Almas alerts on a daily basis, and usually closes 

alerts by the end of the day on which they were generated.

3. Abusive trading practices prohibited (Core Principle 2, Commission 

regulation 38.152) 

 Chapter 5 of the Rulebook prohibits the trade practice violations 

enumerated in Commission regulation 38.152. See Nadex Rule 5.19 

(Prohibited Transactions and Activities); Nadex Rule 5.7 (Handling of 

Customer Orders). 

 The Exchange’s Rulebook in effect during the target period did not 

specifically prohibit conduct that violates bids or offers or 

demonstrates intentional or reckless disregard for the orderly execution 

during the closing period. However, after the target period, the 

Exchange filed a certification revising section (w) of its Rule 5.19 to 
6

prohibit market participants from engaging in any activity that 

constitutes fraudulent or abusive trading, including but not limited to 

violating bids or offers; demonstrating intentional or reckless disregard 

for the orderly execution of transactions during the closing period; or 

spoofing.5

 

4. Real-time market monitoring (Core Principle 2, Commission regulation 

38.157) 

 The Division found that the Exchange’s Compliance Department is 

responsible for real-time market monitoring. 

 During the target period, Nadex Rule 5.14 provided that the Exchange, 

in its discretion, may cancel a trade in a spread contract that has been 

executed on the market at a price that is inconsistent with prevailing 

market conditions due to improper or erroneous orders or quotes being 

matched on the Market (“Erroneous Trade”). The Rulebook was silent 

regarding whether binary option trades may be cancelled. After the 

target period, the Exchange revised Exchange Rule 5.14(a) to provide 

that, with respect to binary option contracts, Nadex will generally not 

cancel or adjust an Erroneous Trade except in extraordinary 

circumstances as determined by the Exchange.6

5. Ability to obtain information (Core Principle 2, Commission regulation 

38.159) 

 The Nadex Rulebook provides compliance staff with the ability to 

obtain testimony and books and records from Exchange members in 

investigations and hearings. 

 

5

 The Exchange filed its certification revising section (w) of Exchange Rule 5.19 on June 16, 2017, with an effective 

date of July 3, 2017. The Exchange also made two changes to its Rulebook regarding abusive trading practices on 

January 20, 2017 (after the target period), with an effective date of February 6, 2017. First, the Rulebook in effect 

during the target period prohibited “knowingly” trading against customer orders, but did not address “unknowingly” 

trading against customer orders. The Exchange revised section (c)(i) of Exchange Rule 5.7 to prohibit trading 

against customer orders. Second, the Rulebook in effect during the target period did not specifically reference front 

running, and the Exchange revised section (d) of Exchange Rule 5.7 to prohibit front running. The Exchange’s rule 

changes address the Division’s concerns during the target period relating to Commission regulation 38.152. 

6

 The Exchange filed a certification revising section (a) of Exchange Rule 5.14 on June 16, 2017, with an effective 

date of July 3, 2017. The revision addresses the Division’s concerns with respect to the version of Exchange Rule 

5.14 in effect during the target period. 
7

B. Findings with Recommendations

1. Capacity to detect and investigate rule violations (Core Principle 2, 

Commission regulation 38.153) 

 Section 4c(a)(5)(C) of the CEA prohibits spoofing, as do Nadex’s 

rules. Nadex represented that it has the ability to use deleted order 

reports in ARC to detect spoofing by Exchange members. However, 

the Exchange explained that it reviewed ARC reports for spoofing 

only on an infrequent, ad hoc basis during the target period. It asserted 

that it would be impracticable for any Nadex member to engage in 

spoofing, given that members enter trades manually on the Exchange 

platform. The Division believes that Nadex did not adequately support 

this assertion, and that the Exchange’s policy during the target period 

of infrequent monitoring could potentially have resulted in undetected 

spoofing.7

 After the target period, on June 13, 2017, Nadex acknowledged to the 

Division that spoofing can in fact occur on its markets, and informed 

the Division that the Exchange had opened two investigations relating 

to potential spoofing in January 2017. Nadex represented that it has 

begun reviewing a manual report on a daily basis to detect potential 

spoofing, and that it is also working on an automated SMARTS alert 

for spoofing. 

 Recommendation: Nadex should promptly complete its 

development of a surveillance program to detect spoofing on its 

markets. Nadex should provide the Division with a written 

description of the Exchange’s spoofing detection program once 

it has completed its development of such program. 

2. Compliance staff and resources (Core Principle 2, Commission regulation 

38.155) 

 Nadex’s regulatory structure includes the Chief Regulatory Officer 

(“CRO”), Regulatory Officer, Compliance Associate, and Legal 

Counsel. The Regulatory Officer and the Compliance Associate 

 

7

 The Division notes that, as a general matter, spoofing can occur through manual trading. See CFTC Press Release 

No. 7486-16, “Federal Court in Chicago Orders U.K. Resident Navinder Singh Sarao to Pay More than $38 Million 

in Monetary Sanctions for Price Manipulation and Spoofing” (Nov. 17, 2016), available at 

http://www.cftc.gov/PressRoom/PressReleases/pr7486-16 (“Defendants utilized manual spoofing techniques to 

place and cancel large orders with no intention of execution.”); CFTC Press Release No. 7504-16, “Federal Court 

Orders Chicago Trader Igor B. Oystacher and 3Red Trading LLC to Pay $2.5 Million Penalty for Spoofing and 

Employment of a Manipulative and Deceptive Device, while Trading Futures Contracts on Multiple Futures 

Exchanges” (Dec. 20, 2016), available at http://www.cftc.gov/PressRoom/PressReleases/pr7504-16 (spoofing 

scheme involved “manually” placing orders).
8

together comprise the Exchange’s Compliance Department. The 

regulatory personnel (other than the Regulatory Officer) have a variety 

of duties at the Exchange unrelated to trade practice surveillance. For 

example, the CRO also serves as the Chief Compliance Officer 

(“CCO”) of the Nadex derivatives clearing organization (“DCO”), and 

the Legal Counsel serves as the Exchange’s corporate secretary. 

 The documentation that the Division received from the Exchange 

indicates that one member of the Compliance Department – i.e., the 

Regulatory Officer – conducted substantially all trade practice 

surveillance during the target period. 

 The Exchange’s trading volume has increased substantially in recent 

years, including a nearly six-fold increase from the 2011-2012 target 

period of the Division’s prior Nadex Rule Enforcement Review to the 

target period for this Rule Enforcement Review, without an increase in 

Compliance Department staff or resources. 

 During the target period, Nadex’s SMARTS system generated 8,677 

automated Almas alerts. The alerts led to only one formal 

investigation regarding potential trade practice violations. 

 The Division is concerned that Nadex may have insufficient staff 

dedicated to adequately investigate potential trade practice violations, 

especially because the Exchange closed certain Almas alerts without 

investigating potential trade practice violations, where such 

investigations appear to have been warranted. The lack of trade 

practice investigations could suggest that Nadex’s trade practice 

surveillance program is not detecting violations occurring on the 

Exchange. For example, the Exchange stated that it did not regularly 

conduct trade practice surveillance during the target period to detect 

potential spoofing. 

 Recommendation: Nadex should consider whether its staff and 

resources are sufficient or properly allocated to detect and 

investigate potential trade practice violations. To that end, the 

Exchange should: 

o Perform an evaluation to determine if Nadex’s current 

staffing levels or allocation of staffing levels allow it to 

adequately investigate potential trade practice 

violations (especially given that the Exchange closed 

certain Almas alerts without investigating potential 
9

trade practice violations, where such investigations 

appear to have been warranted).8 

o Perform an evaluation to determine if Nadex’s trade 

practice surveillance program is detecting all types of 

trade practice violations that can occur on the 

Exchange, including violations that may currently go 

undetected or that may be unique to a nonintermediated exchange, and whether Nadex’s current 

staffing levels or allocation of staffing levels allow it to 

perform such detection. 

 The Exchange should provide the Division with a copy of its 

evaluation and any changes the Exchange plans to make based 

on the evaluation’s findings. 

3. Compliance staff and resources (Core Principle 2, Commission regulation 

38.155) 

 Nadex’s Regulatory Officer is primarily responsible for providing one-onone training to new Compliance Department staff. Documentation that the 

Exchange provided indicates that the one-on-one training sessions include 

material that is not included in the Exchange’s Compliance Manual. 

 Recommendation: Nadex should revise its Compliance 

Manual to incorporate the material covered in one-on-one 

training sessions with the Regulatory Officer. 

C. Findings with a Deficiency Requiring Corrective Action

1. Investigations and investigation reports (Core Principle 2, Commission 

regulation 38.158) 

 In several instances, Nadex failed to adequately investigate or document 

potential rule violations. Specifically, Nadex did not further investigate 

after conducting preliminary reviews based on Pre-Arranged, Money 

Passing, and Futures Price Divergence Almas alerts. Rather than 

investigating members for possible trade practice violations, Nadex 

suspended the members’ accounts and subsequently terminated the 

members for inactivity. 

 

8

 See the discussion below under Commission regulation 38.158 regarding matters that were closed after preliminary 

reviews, where the Division believes trade practice investigations may have been warranted under the 

circumstances.
10

 By terminating members for inactivity rather than conducting a thorough 

investigation, Nadex did not conduct substantive trade practice 

investigations when warranted. Further, terminated members could 

reapply for Exchange membership years later and there would be an 

unresolved matter that would be too late to fully investigate. 

 Deficiency: Pursuant to Commission regulation 38.158, the 

Exchange must conduct investigations upon the discovery or 

receipt of information that indicates a reasonable basis for 

finding that a violation may have occurred. After conducting 

an investigation, the Exchange must create an investigation 

report in accordance with Commission regulations 38.158(c) 

and 38.158(d). 

2. Investigations and investigation reports (Core Principle 2, Commission 

regulation 38.158) 

 The Exchange suspended certain members’ accounts based on possible 

trade practice violations, and requested information from the members in 

connection with preliminary reviews. In two matters where members 

cooperated in preliminary reviews, the Exchange reinstated the members 

without completing trade practice investigations. However, the members’ 

responses to the Exchange during the course of the preliminary reviews 

indicated that rule violations may have occurred. Given the facts and 

circumstances of these matters, the Division believes that the Exchange 

should have elevated its preliminary reviews to investigations. 

 Deficiency: Rather than closing a matter and reinstating a 

suspended member after a preliminary review, Nadex must 

conduct an investigation upon receipt of information indicating 

that a violation may have occurred. Nadex must also create an 

investigation report in accordance with Commission 

regulations 38.158(c) and 38.158(d). 

3. Investigations and investigation reports (Core Principle 2, Commission 

regulation 38.158) 

 The Exchange closed 268 Almas alerts relating to its two market makers, 

without opening investigations into potential violations of Exchange rules. 

 Exchange Rule 4.4(a) (Obligations of Market Makers) provides that 

“[t]ransactions of Market Makers should constitute a course of dealings 

reasonably calculated to contribute to the maintenance of a fair and 

orderly market, and Market Makers shall not make bids or offers or enter 

into transactions that are inconsistent with such a course of dealings.” 

However, on 268 occasions during the target period, the market makers 
11

quoted prices that resulted in trades that were not priced consistently with 

the underlying market at the time of the trades. 

 Exchange Rule 4.4(a) also requires market makers to “maintain two-sided 

displayed quotes” and “comply with all other terms of the applicable 

Market Maker Agreement.” However, on 137 out of the 268 occasions 

discussed above, the market makers failed to maintain both sides of the 

market. 

 After conducting preliminary reviews of the 268 alerts relating to market 

makers, the Exchange closed the alerts without further investigation. The 

closing narratives for the alerts did not provide sufficient detail for the 

Division to understand why the Exchange closed the alerts without further 

investigation. Thus, the Division is concerned that the Exchange did not 

adequately address potential Exchange Rule 4.4 violations. 

 Deficiency: Pursuant to Commission regulation 38.158, the 

Exchange must conduct investigations upon the discovery or 

receipt of information that indicates a reasonable basis for 

finding that a violation by a market maker may have occurred. 

If, after conducting a preliminary review, the Exchange 

determines that an alert regarding a market maker does not 

warrant an investigation, the Exchange must include sufficient 

detail in the closing narrative to explain why the alert was 

closed. 

4. Availability of General Information (Core Principle 7, Commission regulation 

38.401) 

 Commission regulation 38.401(a)(1) provides that a DCM “must have 

procedures, arrangements and resources for disclosing to the Commission, 

market participants and the public accurate information pertaining to: (i) 

Contract terms and conditions; (ii) Rules and regulations pertaining to the 

trading mechanisms; and (iii) Rules and specifications pertaining to 

operation of the electronic matching platform or trade execution facility.” 

A DCM must place such information on its website pursuant to 

Commission regulation 38.401(a)(3). 

 The Exchange’s market maker program constitutes a “rule” subject to the 

9

public disclosure requirements of Commission regulation 38.401(a). 

 

9 The Commission has stated its view that a market maker program is an “agreement” corresponding to a “trading 

protocol” as such terms are used in the definition of “rule” under Commission regulation 40.1(i). See Final Rule, 

Provisions Common to Registered Entities, 76 FR 44776, 44778 (July 27, 2011), where the Commission stated that 

“[a] DCM’s rules implementing market maker and trading incentive programs fall within the Commission’s 

oversight authority.”
12

 The Division notes that the Exchange has posted a form of Market Maker 

Agreement on its website,10 but the Exchange has not posted the specific 

agreements to which its two market makers are parties. Those agreements 

permit the market makers to withdraw from a market between one and five 

minutes before the expiration of a given contract, depending on the type of 

contract. 

 Given that market makers are on one side of approximately 99 percent of 

all trades, the withdrawal of a market maker could effectively eliminate 

the liquidity that otherwise appears to be present in a contract. 

 After the target period, on June 16, 2017, Nadex filed a certification 

revising the form of Market Maker Agreement publicly available on the 

Exchange’s website. The revisions provide that a market maker is 

permitted to withdraw from a market during (a) the 5 minute period just 

prior to expiry of any event contract; (b) the 2 minute period just prior to 

expiry of any intraday, daily, or weekly contract, with the exception of 

intraday 5-minute and 20-minute contracts; and (c) the 1 minute period 

just prior to the expiry of any intraday 5-minute or 20-minute contract. 

The revisions were effective as of July 3, 2017. They address the 

Division’s concerns during the target period regarding the availability of 

information regarding the material terms of the Market Maker 

Agreements. 

 Deficiency: During the target period, Nadex did not make the 

material terms of the Market Maker Agreements with its two 

market makers readily available on the Exchange’s website, in 

accordance with Commission regulation 38.401. The Exchange 

has since cured this deficiency pursuant to the rule filing 

described above.

Additional details regarding the facts and analysis relevant to the Division’s review are 

contained in the Compliance Matrix in Appendix A. 

 

10 See Market Maker Agreement, available at www.nadex.com/sites/default/files/pdf/nadex-market-makeragreement.pdf. 
13

III. Nadex Operations

A. Nadex Governance 

Ownership and Board of Directors 

IG Group Holdings PLC (“IG Group”), a UK-based company, is the ultimate parent 

company of Nadex. The IG Group was established in 1974 as a “spread betting firm” and now 

offers online trading services in numerous countries.11 

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, 

one of whom is a chief analytics officer and the other a chief information officer of IG Group. 

The Exchange’s Board also includes two public directors.12

 Nadex’s sole shareholder, IG US 

Holdings Inc., a wholly-owned subsidiary of IG Group, has the authority to select and remove 

Board members, including public directors. 

Regulatory Oversight Committee

The ROC oversees the Exchange’s self-regulatory program. The ROC’s responsibilities, 

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

trade 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 

 

11 See IG Group, “What we do,” available at www.iggroup.com/about-ig-group/what-we-do. 

12

 The Exchange provided the Division with Board certifications stating that the Exchange’s public directors meet 

the definition of “public director” contained in the Commission’s regulations.
14

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

vigorous, and effective regulation;” and (iii) “[r]eview significant regulatory proposals and 

advise the Board as to whether and how such changes impact regulation.” 

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

of whom must be public directors. Currently, the ROC is composed of the two Nadex Board 

members who have self-certified themselves as public directors and have served in this capacity 

since 2010. One of the ROC members serves as Chairman and has the final decision in the event 

of a tie vote. The ROC alternates on an annual basis which of its members serves as Chairman. 

The ROC holds meetings quarterly. During meetings, the CRO and other regulatory 

personnel present information relating to investigations, regulatory developments, and Exchange 

operations. Between the quarterly meetings, the CRO communicates with the ROC regarding 

regulatory and other matters material to the Exchange’s business. 

B. Current Products

Nadex offers two types of products: binary options and spreads. Binary options, which 

accounted for 92.2 percent of Exchange trading during the target period, allow members to take 

risks based on the occurrence or non-occurrence of an event or condition.13 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 

 

13 See Section IV below for detailed product volume information. 
15

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 zero. A seller’s profit is limited 

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

between the purchase price and 100.14

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.15

 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 crude oil binary option contract is based on the price of NYMEX crude oil futures. A 

corresponding binary option on Nadex may offer, for example, a chance to bid on whether the 

price of crude oil futures will be above $48.50 per barrel at 2:30 p.m. on a certain date. Eventbased binary options allow Nadex members to take risks on the value of the fed funds rate set by 

the Federal Open Market Committee, jobless claims figures released by the Department of 

Labor, and nonfarm payroll statistics released by the Bureau of Labor Statistics. 

Like binary options, Nadex’s spread products 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. As with binary options, the maximum potential gains and losses of buyers and sellers 

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

 

14 See Nadex, “The Risk and Reward Profile of Binary Options,” available at www.nadex.com/learningcenter/courses/binary-options/risk-and-reward-profile-binary-options. 

15 During the target period, Nadex also offered binary options based on the TeraBit Bitcoin price index. The 

Exchange delisted its Bitcoin binary option product after the target period, on December 16, 2016. 
16

spot rate. For example, the spread contract euro / U.S. dollar (“EUR/USD”) 1.1000-1.1250 

(3pm) would settle at: 

 the spot rate, if the spot rate is within the 1.1000-1.1250 range at 3 p.m.; 

 1.1000, if the spot rate is below 1.1000; or

 1.1250, if the spot rate is above 1.1250. 

During the target period, Nadex introduced contracts with shorter durations than those 

previously offered by the Exchange. These shorter duration products include 20-minute 

contracts on U.S. equity index products, as well as five-minute contracts on forex products. 

The Exchange has at times halted trading in a product, generally as a result of technology 

issues that prevent the Exchange from receiving data from the underlying market for the product. 

During the target period, the Exchange halted trading once, on August 24, 2015, as a result of a 

halt in underlying equity index products.16

 

C. Market Makers

Nadex had Market Maker Agreements with two entities during the target period, Market 

Risk Management (“MRM”) and Group One Futures Trading LLC (“Group One”). MRM is an 

Exchange affiliate. Market makers provided a significant source of liquidity to the Exchange by 

taking one side of almost every trade during the target period. MRM was on one side of 

approximately 70 percent of trades, while Group One was on one side of approximately 29 

percent. Taken together, the two market makers were on one side of approximately 99 percent of 

all trades during the target period. 

 

16 The Exchange also described to the Division three trading halts that took place after the target period, involving 

the TeraBit, FTSE, and Nikkei 225 underlying markets. 
17

Nadex market makers are not required to quote bids and offers for a contract for a 

specified period of time before the expiration of the contract.17 Further, Appendix A of Nadex’s 

Market Maker Agreement permits market makers to withdraw from a market between one and 

five minutes before the expiration of a given contract. 

IV. Trading Volume During the Target Period

Total trading volume at Nadex during the target period was 5,713,929 contracts. 

5,269,006 (92.2 percent) of the contracts were binary options and 444,923 (7.8 percent) of the 

contracts were spreads. The total trading volume for the year preceding the target period (i.e., 

December 12, 2013 to December 11, 2014) was 3,622,779 contracts.18

The five products with the highest trading volume during the target period were EURUSD, US 500, USD-JPY, AUD-USD, and GBP-USD. The volume for these contracts is 

summarized in Table 1 below: 

Table 1. Volume for five most traded products 

Product Total Volume (in 

contracts)

Binary 

Option 

Volume

Spread Volume

EURUSD923,611 873,482 50,129

US 500 895,802 824,468 71,334

USDJPY623,924 597,833 26,091

AUDUSD514,336 471,590 42,746

GBPUSD487,094 470,359 16,735

 

17 See section 3(c) of Nadex’s Market Maker Agreement.

18 The Exchange had total trading volume of 987,153 contracts during the target period for the Division’s previous 

Rule Enforcement Review for Nadex, which covered the period from June 15, 2011 through June 15, 2012. See 

Rule Enforcement Review of Nadex, dated November 15, 2013, available at 

www.cftc.gov/idc/groups/public/@iodcms/documents/file/rernadex11152013.pdf. 
18

Table 2 below lists the five contracts among the Exchange’s products with the highest monthly 

open interest during the target period: 

Table 2. Contracts with highest monthly open interest 

Product Average 

Monthly Open 

Interest 

Total

Average 

Monthly 

Open Interest

Weekly 

Expiration

Average 

Monthly Open 

Interest 

Daily 

Expiration

US 500 491 491 0

GBP-USD 164 14 149

EUR-USD 114 57 58

GBP-JPY 70 2 68

Crude Oil 65 65 0
19

Appendix A 

Compliance Matrix

CFTC Regulation Findings Regarding Exchange’s Compliance Deficiencies and Recommendations

Core Principle 2 – Compliance with Rules

§ 38.150

Core Principle 2

The Exchange’s Rulebook sets forth access requirements, terms and 

conditions of contracts to be traded on the Exchange, and rules 

prohibiting abusive trading practices on the Exchange.

No deficiencies or recommendations.

§ 38.152

Abusive trading 

practices 

prohibited

Chapter 5 of the Rulebook prohibits the trade practice violations 

enumerated in Commission regulation 38.152. See Nadex Rule 5.19 

(Prohibited Transactions and Activities); Nadex Rule 5.7 (Handling of 

Customer Orders.

19

 

No deficiencies or recommendations.

§ 38.155

Compliance staff 

and resources

The regulatory personnel at the Exchange consist of the Regulatory 

Officer, Compliance Associate, CRO, and Legal Counsel. The

Regulatory Officer and Compliance Associate together comprise the 

Exchange’s Compliance Department, which reports to the CRO.

Regulatory Personnel Responsibilities

The Exchange described the responsibilities of its regulatory personnel 

as follows:

 CRO

o Responsibilities: The CRO is responsible for handling the 

day-to-day regulatory functions of the Exchange. The CRO 

oversees trade practice surveillance, market oversight, and 

investigations that the other regulatory personnel conduct. 

The CRO also reviews monthly statistics regarding trade 

See recommendations below.

 

19 The Exchange revised Exchange Rules 5.7 and 5.19 after the target period. See supra note 5. 
20

§ 38.155

Compliance staff 

and resources

(continued)

practice alerts. At the conclusion of an investigation, the 

CRO reviews and signs off on an investigation 

memorandum, and authorizes any action that the Exchange 

has determined to take against the subject of the 

investigation. The CRO reports to the ROC.

 Regulatory Officer

o Responsibilities: The Regulatory Officer is responsible for 

conducting market surveillance on a day-to-day basis. The 

Regulatory Officer generally reviews and closes all Almas 

alerts generated by the SMARTS system by the end of the 

day on which the alerts were generated. For alerts generated 

at night, the Regulatory Officer generally reviews and closes 

the alerts the following business day. The Regulatory 

Officer also drafts closing narratives for alerts closed after a 

preliminary review. When a matter is elevated from a 

preliminary review to an investigation, the Regulatory 

Officer conducts the investigation in consultation with the 

other regulatory personnel, and reviews the draft

investigation memorandum that the Legal Counsel prepares.

The Regulatory Officer is also responsible for providing 

one-on-one training to new Compliance Department

employees, as discussed below. The Regulatory Officer 

reports to the CRO.

 Compliance Associate20

o Responsibilities: The Compliance Associate is responsible 

for monitoring membership applications for responses 

 

20 The Exchange experienced a personnel change in the Compliance Associate position during the target period. The current Compliance Associate (as of the 

date of this report) started in that role as of October 5, 2015, after the prior Compliance Associate left the Exchange. 
21

§ 38.155

Compliance staff 

and resources

(continued)

concerning criminal background history, and monitoring the 

MIS system21 for potential alerts on applicants. In addition, 

the Compliance Associate reviews marketing materials, 

provides monthly activity statements to members upon 

request, and works with the customer service and account 

opening teams on issues relating to Exchange members. The 

Compliance Associate is trained to act as a backup for the 

Regulatory Officer. The Compliance Associate reports to 

the CRO.

o The Exchange represented to the Division that the 

Regulatory Officer and the Compliance Associate both work 

on trade practice surveillance matters. However, the 

documentation the Division received from the Exchange 

indicates that the Regulatory Officer conducted substantially 

all trade practice surveillance during the target period, 

including the review and closure of Almas alerts in the 

SMARTS system. 

 Legal Counsel

o Responsibilities: The Legal Counsel works with the 

Compliance Department on investigations, including 

drafting investigation memoranda for CRO approval. The 

Legal Counsel also serves as the Exchange’s corporate 

secretary and handles a variety of legal matters, including 

rule filings the Exchange submits to the Commission. The 

Legal Counsel reports to the CEO of the Exchange. 

At the start of the target period, one individual held the titles of CRO 

and general counsel of the Exchange. After he stepped down from those 

 

21 The Exchange utilizes the third-party “McDonald Information Services” (“MIS”) as a background screening service. 
22

§ 38.155

Compliance staff 

and resources

(continued)

positions as of March 20, 2015, two Exchange staff members took over 

as CRO and Legal Counsel, respectively, as of March 23, 2015. The

CRO who started on March 23, 2015 also served in a dual capacity as

the CCO of the Nadex DCO.22 The Exchange represented that the 

combined CRO / CCO reported (a) to the ROC, in his capacity as CRO 

of the DCM, and (b) to the CEO of Nadex, in his capacity as CCO of the 

DCO.23 

Training

The Regulatory Officer provides one-on-one training to new 

Compliance Department staff, including training on the functionality 

and review process of the SMARTS system and alerts. In particular, the 

Regulatory Officer trains the Compliance Associate to act as back-up in 

the event that the Regulatory Officer is out of the office. In addition, the 

Exchange participates in external trainings and seminars through the 

FIA Law and Compliance Division.

The documentation the Division received from the Exchange indicates 

that the one-on-one training sessions with the Regulatory Officer include 

material that is not set forth in the Exchange’s Compliance Manual. 

Given that a single Regulatory Officer is primarily responsible for 

providing training regarding trade practice surveillance, the Division 

recommends that the Exchange include in its Compliance Manual the 

material covered in such training sessions.

Recommendation 

Nadex should revise its Compliance 

Manual to incorporate the material 

covered in one-on-one training 

sessions with the Regulatory Officer.

 

22 Nadex is registered with the Commission as both a DCM and a DCO. Nadex represented to the Division that its DCM and DCO share a common staff. 

23 After the target period, on or about August 3, 2016, the combined CRO / CCO who started in March 2015 left the Exchange. Approximately eight weeks later, 

on September 26, 2016, the Exchange appointed a new CRO / CCO. The Exchange’s Legal Counsel served as interim CRO / CCO between August 3 and 

September 26, 2016. 
23

§ 38.155

Compliance staff 

and resources

(continued)

Sufficiency of Compliance Staff and Resources

The Division notes that the Exchange’s regulatory personnel (other than 

the Regulatory Officer) have a variety of duties at the Exchange 

unrelated to trade practice surveillance. For example, the CRO also 

serves as the CCO of the Nadex DCO, and the Legal Counsel serves as 

the Exchange’s corporate secretary and handles both compliance and 

non-compliance related matters.

The documentation that the Division received from the Exchange 

indicates that one member of the Compliance Department – i.e., the 

Regulatory Officer – conducted substantially all trade practice 

surveillance during the target period.

The Exchange’s trading volume has increased substantially in recent 

years, including a nearly six-fold increase from the 2011-2012 target 

period of the Division’s prior Nadex Rule Enforcement Review to the 

target period for this Rule Enforcement Review, without an increase in 

Compliance Department staff. 

The Exchange’s SMARTS system generated 8,677 automated Almas

alerts during the target period. Of those alerts, the Exchange conducted

only one formal investigation into a potential trade practice violation. 

The Division is concerned that the Exchange may have insufficient staff 

dedicated to adequately investigate potential trade practice violations 

identified in the alerts, especially because the Exchange closed certain 

Almas alerts without investigating potential trade practice violations, 

where such investigations appear to have been warranted.24 

 

24 See the discussion below under Commission regulation 38.158 regarding matters that were closed after preliminary reviews, where the Division believes trade 

practice investigations may have been warranted under the circumstances. 
24

§ 38.155

Compliance staff 

and resources

(continued)

The lack of trade practice investigations could also suggest that Nadex’s 

trade practice surveillance program is not detecting violations occurring 

on the Exchange. For example, the Exchange stated that it did not 

regularly conduct trade practice surveillance during the target period to 

detect potential spoofing. The Division is concerned that the Exchange

may have insufficient staffing levels to conduct surveillance regarding 

potential spoofing.

25

 

Recommendation 

Nadex should consider whether its 

staff and resources are sufficient or 

properly allocated to detect and 

investigate potential trade practice 

violations. To that end, the 

Exchange should:

oPerform an evaluation to 

determine if Nadex’s current 

staffing levels or allocation of 

staffing levels allow it to 

adequately investigate potential 

trade practice violations

(especially given that the 

Exchange closed certain Almas 

alerts without investigating

potential trade practice 

violations, where such 

investigations appear to have 

been warranted). 

oPerform an evaluation to 

determine if Nadex’s trade 

practice surveillance program is 

detecting all types of trade 

practice violations that can occur 

on the Exchange, including 

violations that may currently go 

 

25 See the discussion below under Commission regulation 38.153 regarding spoofing. 
25

§ 38.155

Compliance staff 

and resources

(continued)

undetected or that may be unique 

to a non-intermediated exchange, 

and whether Nadex’s current 

staffing levels or allocation of 

staffing levels allow it to perform 

such detection.

The Exchange should provide the 

Division with a copy of its evaluation

and any changes the Exchange plans 

to make based on the evaluation’s

findings. 

§ 38.156

Automated trade 

surveillance system

The Exchange uses the SMARTS system to detect and analyze possible 

market abuse. SMARTS provides a graphical view of trading in a 

specific market at a specific time. For order, trade, and clearing 

information, SMARTS provides compilation, retrieval, sorting, filtering, 

and analysis functionality. The SMARTS system is comprised of the

following surveillance tools:

 The Almas alerting tool generates automated real-time alerts, 

tracks an audit history of information recorded against each alert 

and logs who was responsible for each action.

 ARC contains a group of report templates with ad hoc 

customizable parameters and filter rules for each report.

 The replay tool is used to build and replay the order book for any 

contract. It is used to review suspicious activity and recreate 

every bid and offer that entered the market at a given time.

 Spread is a trading visualization tool that presents graphically the 

time series of trading data for a contract. The graph contains 

trade details and has the ability to overlay underlying market 

No deficiencies or recommendations.
26

§ 38.156

Automated trade 

surveillance system

(continued)

pricing.

The Exchange runs the following Almas alerts on a real-time basis: PreArranged, Money Passing, Settlement Manipulation, Futures Price 

Divergence, Position Limit Monitoring, Wash, Trading Ahead of 

Customer Orders, and Trading Against Customer Orders.26 Four types 

of Almas alerts were triggered during the target period, namely PreArranged Trading, Money Passing, Settlement Price Manipulation, and 

Futures Price Divergence. The Exchange reviews Almas alerts on a 

daily basis, and usually closes alerts by the end of the day on which they 

were generated. 

With respect to ARC, the Exchange is able to run reports for PreArranged Trading, Collusion, Order History, Deleted Orders, Trade 

Report (Fast) (showing all trades that meet user defined filter criteria),

Time Period (showing when a given trader is active), Counterparties 

(showing counterparties for a given trader), Products (showing which 

products an Exchange member trades), CTI, and P&L. During the target 

period, the Compliance Department ran ARC reports on a monthly basis 

for Trade Report (Fast), Pre-Arranged Trading, and Collusion. The 

Exchange ran the Order History and Deleted Orders reports on an asneeded, ad hoc basis.

The Exchange also accesses programs outside of the SMARTS system 

in connection with trade practice surveillance. The Nadex Dashboard is 

an internally created platform of searchable database information, which 

the Exchange uses to view historical trading and review exchange 

volume statistics on an ad hoc basis. The Nadex Admin Manager is a 

searchable database of Exchange back office functions, which is used to 

 

26 The Exchange represented that it continued to run the Almas alerts for Trading Ahead of Customer Orders and Trading Against Customer Orders during the 

target period, although the Exchange did not have any FCM members during that time. 
27

§ 38.156

Automated trade 

surveillance system

(continued)

view members’ application details, historical ledger items, and current 

ledger balances of members on an ad hoc basis. 

§ 38.157

Real-time market 

monitoring 

Real-Time Market Monitoring

The Exchange’s Compliance Department is responsible for real-time

market monitoring. The monitoring is primarily conducted by the 

Regulatory Officer using the SMARTS system. When an Almas alert is 

generated, the Regulatory Officer opens the alert and writes a summary 

in the SMARTS system based on his review of the alert and the 

circumstances surrounding the alert. The Regulatory Officer marks an 

alert as “E” for “explained” where it appears that no rule violation 

occurred. The Regulatory Officer marks certain documents “D” for 

“discard,” such as regularly generated reports that appear in Almas but 

should not be categorized as alerts. If the Regulatory Officer 

determines, after a preliminary review of an alert, that further 

investigation is warranted, he marks the alert “I” for “investigate.” 

However, marking an alert “I” does not automatically lead the 

Compliance Department to open a formal investigation into the alert. 

Instead, the Regulatory Officer conducts further review into the alert to 

determine if it merits an investigation. 

When reviewing an Almas alert, the Regulatory Officer may use the 

“replay” function in the SMARTS system to replay the order book for a 

contract on a second-by-second basis. The Regulatory Officer also uses

the “spread” function, which provides a graph of bid/ask spreads in the 

market, and dots wherever a trade occurred. The Regulatory Officer 

also runs ARC reports, which have customizable features not found in 

Almas. For example, the Regulatory Officer can adjust the parameters 

of a Pre-Arranged Trading report in ARC, whereas the corresponding 

Pre-Arranged Trading alert in Almas is hard-coded with parameters that 

No deficiencies or recommendations.
28

§ 38.157

Real-time market 

monitoring

(continued)

the Regulatory Officer cannot modify on his own.27

Emergency Suspensions or Terminations 

Exchange Rule 9.6(a) (Summary Suspension) provides that the 

Exchange “may summarily suspend or restrict a Member (or any of its 

Authorized Traders or, in the case of FCM Members, its customers) 

privileges [sic] if the Chief Regulatory Officer believes suspension or 

restriction is necessary to protect the swaps or commodity futures 

markets, Nadex, the public, or other Members.” The Exchange 

represented that it did not issue any emergency suspensions or 

terminations during the target period.

Trade adjustment and cancellation

During the target period, Nadex Rule 5.14 provided that the Exchange, 

in its discretion, may cancel a trade in a spread contract that has been 

executed on the market at a price that is inconsistent with prevailing 

market conditions due to improper or erroneous orders or quotes being 

matched on the Market (“Erroneous Trade”). However, the Rulebook 

was silent regarding whether binary option trades may be cancelled. 

After the target period, the Exchange revised Exchange Rule 5.14(a) to 

provide that, with respect to binary option contracts, Nadex will 

generally not cancel or adjust an Erroneous Trade except in 

extraordinary circumstances as determined by the Exchange.28

 

27 The Exchange stated that in order to change the hard-coded parameters in an Almas alert, the Regulatory Officer and CRO would have to present the proposed 

modification to the ROC for approval. 

28 The Exchange revised section (a) of Exchange Rule 5.14 after the target period. See supra note 6. 
29

§ 38.153

Capacity to detect 

and investigate rule 

violations

Detecting Rule Violations

The Exchange’s trade practice surveillance program is divided between 

pre-case matters (preliminary reviews) and cases (investigations). The 

Exchange maintains logs that track pre-case matters and cases.

The sanctions that the Exchange can impose include warning letters, 

fines, and suspension or termination of a member’s account. The 

Exchange’s Rulebook allows for warning letters to be issued for 

substantive trade practice violations, although the Exchange did not 

issue any warning letters during the target period. 

Collecting Information and Documents

Pursuant to Exchange Rule 3.3(a) (Member Obligations), each 

Exchange member and any authorized trader thereof must cooperate 

with the Exchange, its agents, and/or the Commission in any 

investigation, call for information, inquiry, audit, examination, or 

proceeding. Exchange Rule 3.3(a) further provides that such 

cooperation must include providing the Exchange with access to 

information on the activities of such member and/or authorized trader in 

any referenced market that provides the underlying prices for any Nadex 

market.
30

§ 38.153

Capacity to detect 

and investigate rule 

violations 

(continued)

Pre-Case

Trade Practice Reviews

Trade Practice Review Procedures

The Exchange refers to pre-investigation matters as preliminary reviews. 

A preliminary review may be initiated if: 

 The Compliance Department detects unusual activity (e.g., based 

on alerts generated by the SMARTS system or MIS);29

 Any Nadex employee detects unusual or suspicious activity in 

the course of his or her job; 

 A market participant submits a tip or complaint; or 

 A regulatory agency refers unusual activity to the Exchange. 

Capacity to Detect Spoofing

Section 4c(a)(5)(C) of the CEA prohibits spoofing, as do Nadex’s rules. 

Nadex represented that it has the ability to use deleted order reports in 

ARC to detect spoofing by Exchange members. However, the Exchange 

explained that it reviewed ARC reports for spoofing only on an 

infrequent, ad hoc basis during the target period. It asserted that it 

would be impracticable for any Nadex member to engage in spoofing, 

given that members enter trades manually on the Exchange platform. 

The Division believes that Nadex did not adequately support this

See recommendation below.

 

29 The Exchange screens members on an ongoing basis using MIS, the third-party background screening service. MIS screens members on an ongoing basis for 

criminal charges or fines by financial regulators. 
31

§ 38.153

Capacity to detect 

and investigate rule 

violations 

(continued)

assertion, and that the Exchange’s policy during the target period of 

infrequent monitoring could potentially have resulted in undetected 

spoofing.30

After the target period, on June 13, 2017, Nadex acknowledged to the 

Division that spoofing can in fact occur on its markets, and informed the 

Division that the Exchange had opened two investigations relating to 

potential spoofing in January 2017. Nadex represented that it has begun 

reviewing a manual report on a daily basis to detect potential spoofing, 

and that it is also working on an automated SMARTS alert for spoofing. 

Disposition of Trade Practice Reviews

Nadex documents the preliminary reviews arising from SMARTS alerts 

in the Almas section of SMARTS. 

When the Compliance Department closes an Almas alert as “explained,”

the Exchange does not create any documentation regarding the closure 

of the alert beyond the closing narrative and other information contained

in the SMARTS system. The Exchange considers the review and 

closure of Almas alerts to constitute a preliminary review. 

The SMARTS system generated a total of 8,677 Almas alerts during the 

target period. The number of alerts, broken down by category, is as 

follows:

Recommendation 

Nadex should promptly complete its 

development of a surveillance 

program to detect spoofing on its 

markets. Nadex should provide the 

Division with a written description of 

the Exchange’s spoofing detection 

program once it has completed its 

development of such program. 

 

30 See supra note 7. 
32

§ 38.153

Capacity to detect 

and investigate rule 

violations 

(continued)

 Pre-Arranged Trading Alert: 4,322

 Money Passing Alert: 979

 Settlement Price Manipulation: 371

 Futures Price Divergence: 3,005

The Division reviewed a representative sampling of the alerts, broken 

down as follows:

 Pre-Arranged Trading Alert – 1,162 of 4,322 (27 percent)

 Money Passing Alert – 264 of 979 (27 percent)

 Settlement Price Manipulation– 224 of 371 (60 percent)

 Futures Price Divergence– 2,208 of 3,005 (73 percent)

The dispositions of the Almas alerts were as follows:

Pre-Arranged Trading: 4,300 alerts were closed as “Explained,” 16 

were discarded, and six were designated for possible investigation.

Money Passing: 869 alerts were closed as “Explained,” 106 were 

discarded, and four were designated for possible investigation.

Settlement Price Manipulation: 362 alerts were closed as “Explained,” 

nine were discarded, and none was designated for possible investigation.

Futures Price Divergence: 1,287 alerts were closed as “Explained,” 

1,712 were discarded, and six were designated for possible 

investigation.
33

§ 38.153

Capacity to detect 

and investigate rule 

violations 

(continued)

Complaints

Complaint Procedures

Complaints can originate from Exchange members or non-members, and 

may be made against the Exchange, its members or third parties. 

Complaints may be submitted to the Exchange by emailing the 

Compliance Department directly, or by contacting the Exchange’s 

customer service group.

The Compliance Department completes a Complaint Report Form upon 

receipt of a complaint, documenting the allegations made. The 

Compliance Department reviews the evidence involved to determine the 

legitimacy of the allegations.

If it is determined that a complaint has merit, the Compliance 

Department will investigate the matter based on the circumstances of the 

complaint. 

Complaint Opened and Closed During Target Period

The one complaint Nadex received during the target period involved a 

corn contract being closed before its usual expiration time on the Friday 

a week after Thanksgiving. Nadex operations staff inadvertently failed 

to reset the regular closing time from the earlier close of the 

Thanksgiving holiday schedule the prior week. The complainant 

asserted that if the contract had expired at its usual time, he would be 

entitled to the full contract payout. The Exchange agreed to make an 

adjustment to the complainant’s account reflecting the amount he paid in 

fees relating to the contract.

No deficiencies or recommendations.
34

§ 38.153

Capacity to detect 

and investigate rule 

violations 

(continued)

Timeliness of Complaint

The Exchange closed the complaint submitted during the target period in 

one day.

Conduct of Complaint

No specific rules were suspected to have been violated in the complaint 

filed during the target period, and the contract posting in question did, in 

fact, list the earlier expiration time. The Division found that the 

Exchange investigated the complaint in a timely and thorough manner.

§ 38.158

Investigations and 

investigation 

reports

Investigation Procedures

The Compliance Department (i.e., the Regulatory Officer and 

Compliance Associate) will open an investigation if it reasonably

believes, based on a preliminary review, that Exchange rules have been 

violated. The Compliance Department conducts investigations in 

consultation with the Legal Counsel and CRO. For investigations

relating to trade practice, the Compliance Department may send out 

questionnaires to the Exchange members involved. Once Compliance

Department staff has collected sufficient evidence in connection with its

investigation, it relays that information (including disciplinary 

recommendations) to the Legal Counsel, who drafts an Investigative 

Report. The Compliance Department reviews the Investigative Report

for accuracy, and then sends the report to the CRO for approval. 

Once a matter is elevated from a preliminary review to an investigation, 

Nadex maintains all documentation relating to the investigation in a

shared Compliance drive on the Exchange’s network. 

See deficiencies below.
35

§ 38.158

Investigations and 

investigation 

reports

(continued)

Conduct of Investigations 

The Division reviewed all documentation that the Exchange provided 

for the 16 Almas alerts generated during the target period that the 

Regulatory Officer marked “I” for further review. Of those 16 alerts, 

two alerts led to one trade practice investigation, while the Exchange 

closed the other 14 alerts after preliminary reviews. The following is a 

summary of the disposition of these alerts.

Investigation Based on Alerts Marked “I”

On October 30, 2015, the Exchange received one Pre-arranged Trading 

alert and one Futures Price Divergence alert relating to the activity of

two Canadian members of the Exchange. The members admitted to 

prearranging trades in which one member mentored the other (who was 

his nephew) on trading. The Exchange subsequently ceased doing 

business with all Canadian citizens, as a result of a cease and desist 

order from the Ontario Securities Commission stating that the Exchange

was operating without proper registration. The Exchange closed the 

matter on February 11, 2016 (after the target period), with the proviso 

that it be reopened if the Exchange resumes business in Canada or either 

member relocates to a jurisdiction from which the Exchange accepts 

registrations. 

Alerts Marked “I” with No Investigation

With respect to the 14 Almas alerts that the Exchange marked “I” but 

did not formally investigate, 11 of the alerts involved matters in which

the Exchange suspended members and subsequently terminated their

accounts for inactivity, after the members failed to respond to requests 

for information. These matters are summarized below:

 On May 11, 2015, the Exchange received three Pre-Arranged 
36

§ 38.158

Investigations and 

investigation 

reports

(continued)

Trading alerts and two Futures Price Divergence alerts relating to 

the trading activity of two members. Both members listed the 

same address in New York. The Compliance Department placed 

holds on the members’ accounts. On May 18, 2015, the 

Exchange sent an email asking the members to respond to 

investigative questions. The members responded the next day 

with an email denying any wrongdoing. One of the members 

sent a subsequent email stating that a member of his immediate 

family had accessed his account. The Exchange never received 

any further replies from the members. On November 16, 2016

(after the target period), the Exchange terminated the members

for inactivity pursuant to Exchange Rule 3.3(f).

 On June 4, 2015, the Exchange received three Money Passing

alerts and three Futures Price Divergence alerts relating to the 

trading activity of three members. The Exchange sent the 

members an email, informing them that their accounts were 

placed on hold for suspicious trading activity and asking them to 

respond to investigative questions. Two of the members never 

responded, while the third sent multiple emails but never fully 

answered the Exchange’s questions. On November 16, 2016

(after the target period), the Exchange terminated the members 

for inactivity pursuant to Exchange Rule 3.3(f).

The Division is concerned that Nadex did not further investigate these 

matters after conducting preliminary reviews based on Pre-Arranged, 

Money Passing, and Futures Price Divergence Almas alerts. 

Specifically, by terminating members for inactivity rather than 

conducting a thorough investigation, Nadex did not conduct substantive 

trade practice investigations when warranted. Further, terminated 

members could reapply for Exchange membership years later and there 

would be an unresolved matter that is now too late to fully investigate. 

Deficiency 

Pursuant to Commission regulation 

38.158, the Exchange must conduct 

investigations upon the discovery or 

receipt of information that indicates a 

reasonable basis for finding that a 

violation may have occurred. After 

conducting an investigation, the 
37

§ 38.158

Investigations and 

investigation 

reports

(continued)

In the three remaining Almas alerts that the Exchange marked “I” 

without conducting an investigation, the Exchange suspended members’ 

accounts and then reinstated the members after they responded to 

requests for information. These matters are summarized below: 

 On February 9, 2015, the Exchange received a Pre-Arranged 

Trading alert relating to the trading activity of two members. 

The Compliance Department sent the members an email the 

following day, asking them to respond to investigative questions. 

In their responses, the members (who were spouses) indicated 

that they pre-arranged trades and that the husband had logged 

into his wife’s account. Further, the members appear to have 

provided misleading information to the Exchange, since the wife 

denied that anyone else had logged into or traded for her 

account, while the husband admitted to entering orders for his 

wife’s account. The Exchange closed the wife’s account and 

reinstated the husband’s account, after the husband agreed that 

he would not allow anyone else to access, trade, inquire about or 

make deposits to his account.

 On July 25, 2015, the Exchange received two Pre-Arranged 

Trading alerts relating to the trading activity of two members. 

The Compliance Department placed holds on both members and 

sent them an email asking them to respond to investigative 

Exchange must create an 

investigation report in accordance 

with Commission regulations 

38.158(c) and 38.158(d).
38

§ 38.158

Investigations and 

investigation 

reports

(continued)

questions. In their responses to the Exchange, the members 

stated that they had placed trades opposite each other as an

experimental trading strategy. The Exchange reinstated both 

members after the members certified that they would not allow 

others to access or trade for their account, they would not access 

others’ accounts, and they would not pre-arrange trades in the 

future.

The Division is concerned that the Exchange reinstated members, and 

closed preliminary reviews, where the Exchange had information that

trade practice violations may have occurred. In fact, the Exchange did 

not conduct investigations in matters where members expressly admitted 

to activity that appears to contravene Exchange rules. For example, in 

the matter commenced on February 9, 2015, involving the spouses who 

appear to have pre-arranged trades and shared account information, the 

Exchange had a reasonable basis to investigate whether the members 

had violated various Exchange rules, including:

 Exchange Rule 3.1(f), providing that an individual member may 

not maintain or trade more than one account; 

 Exchange Rule 5.2(d), providing that a member may not share 

user IDs and passwords; 

 Exchange Rule 5.19(b), providing that a member may not enter 

into non-competitive trades; 

 Exchange Rule 5.19(g), providing that an individual member 

may not trade for any other person or entity; and 

 Exchange Rule 5.19(k), providing that no person shall 

intentionally provide misleading, erroneous, or fraudulent 

information to the Exchange. 
39

§ 38.158

Investigations and 

investigation 

reports

(continued)

Similarly, in the matter commenced on July 25, 2015, involving 

members who admitted to trading opposite one another, the Exchange 

had a reasonable basis to investigate whether the members had violated

the prohibition on pre-arranged trading under Exchange Rule 5.19(b). 

Given the facts and circumstances of these matters, the Division believes 

that the Exchange should have elevated its preliminary reviews to 

investigations. 

Market Maker Alerts with No Investigation

The Exchange closed 268 Almas alerts during the target period relating 

to its two market makers, without opening investigations into potential 

violations of Exchange rules by the market makers.

Specifically, Exchange Rule 4.4(a) (Obligations of Market Makers) 

provides that “[t]ransactions of Market Makers should constitute a 

course of dealings reasonably calculated to contribute to the 

maintenance of a fair and orderly market, and Market Makers shall not 

make bids or offers or enter into transactions that are inconsistent with 

such a course of dealings.” However, on 268 occasions during the target 

period, the market makers quoted prices that resulted in trades that were 

not priced consistently with the underlying market at the time of the 

trades. 

Exchange Rule 4.4(a) also requires market makers to “maintain twosided displayed quotes” and “comply with all other terms of the 

Deficiency 

Rather than closing a matter and 

reinstating a suspended member after 

a preliminary review, Nadex must 

conduct an investigation upon receipt 

of information indicating that a 

violation may have occurred. Nadex 

must also create an investigation 

report in accordance with 

Commission regulations 38.158(c) 

and 38.158(d).
40

§ 38.158

Investigations and 

investigation 

reports

(continued)

applicable Market Maker Agreement.”31 However, on 137 out of the 

268 occasions referenced above, the market makers failed to maintain 

both sides of the market. 

After conducting preliminary reviews of the 268 alerts relating to market 

makers, the Exchange closed the alerts without further investigation. 

The Division is concerned that the Exchange did not adequately address 

potential violations of Exchange Rule 4.4. 

The closing narratives for the alerts did not provide sufficient detail for 

the Division to determine why the Exchange closed the alerts. For 

example, the Exchange stated in numerous closing narratives that 

market makers had experienced a temporary pricing malfunction, but the 

narratives did not analyze whether the market makers were in violation 

of Exchange Rule 4.4. The documentation the Division received from 

the Exchange does not explain what caused the apparent pattern of 

pricing malfunctions that the market makers experienced.

Deficiency 

Pursuant to Commission regulation 

38.158, the Exchange must conduct 

investigations upon the discovery or 

receipt of information that indicates a 

reasonable basis for finding that a 

violation by a market maker may 

have occurred. If, after conducting a 

preliminary review, the Exchange 

determines that an alert regarding a 

market maker does not warrant an 

investigation, the Exchange must

include sufficient detail in the closing 

narrative to explain why the alert was 

closed.

 

31 The Exchange filed a certification revising section (a) of Exchange Rule 4.4 after the target period, on June 16, 2017, with an effective date of July 3, 2017. 

Revised Exchange Rule 4.4 provides that market makers are required to “maintain two-sided displayed quotes, insofar as required by the Market Maker 

Agreement” (emphasis added). The certification also revised the Exchange’s form of Market Maker Agreement to provide that a market maker “will not be 

required to price a two-sided market” in certain circumstances, including “during the first 30 seconds and last 30 seconds of any Intraday 5-Minute Binary 

Contract.”
41

§ 38.158

Investigations and 

investigation 

reports

(continued)

Warning Letters

The Exchange did not issue any warning letters during the target period.

§ 38.159

Ability to obtain 

information

The Exchange’s Rulebook provides compliance staff with the ability to 

obtain testimony and books and records from Exchange members in 

investigations and hearings.32

No deficiencies or recommendations.

 Core Principle 7 – Availability of General Information . 

§ 38.401

General 

requirements

Commission regulation 38.401(a)(1) provides that a DCM “must have 

procedures, arrangements and resources for disclosing to the 

Commission, market participants and the public accurate information 

pertaining to: (i) Contract terms and conditions; (ii) Rules and 

regulations pertaining to the trading mechanisms; and (iii) Rules and 

specifications pertaining to operation of the electronic matching 

platform or trade execution facility.” A DCM must place such 

information on its website pursuant to Commission regulation 

38.401(a)(3). 

The Exchange’s market maker program constitutes a “rule” subject to 

the public disclosure requirements of Commission regulation 38.401(a). 

The Division notes that the Exchange has posted a form of Market 

Maker Agreement on its website, but the Exchange has not posted the 

specific agreements to which its two market makers are parties. Those 

agreements permit the market makers to withdraw from a market 

between one and five minutes before the expiration of a given contract, 

See deficiency below.

 

32 See Exchange Rule 3.3(a) (Member Obligations). 
42

§ 38.401

General 

requirements

(continued)

depending on the type of contract. 

Given that market makers are on one side of approximately 99 percent 

of all trades, the withdrawal of a market maker could effectively 

eliminate the liquidity that otherwise appears to be present in a contract. 

After the target period, on June 16, 2017, Nadex filed a certification 

revising the form of Market Maker Agreement publicly available on the 

Exchange’s website, to provide that a market maker is permitted to 

withdraw from a market during (a) the 5 minute period just prior to 

expiry of any event contract; (b) the 2 minute period just prior to expiry 

of any intraday, daily, or weekly contract, with the exception of intraday 

5-minute and 20-minute contracts; and (c) the 1 minute period just prior 

to the expiry of any intraday 5-minute or 20-minute contract. The

revisions were effective as of July 3, 2017. They address the Division’s 

concerns during the target period regarding the availability of 

information regarding the material terms of the Market Maker 

Agreements.

Deficiency

During the target period, Nadex did 

not make the material terms of the 

Market Maker Agreements with its 

two market makers readily available 

on the Exchange’s website, in 

accordance with Commission 

regulation 38.401. The Exchange 

has since cured this deficiency 

pursuant to the rule filing described 

above.
43

Appendix B

NORTH AMERICAN DERIVATIVES EXCHANGE

RULE ENFORCEMENT REVIEW 

TABLE OF CORE PRINCIPLES AND 

REGULATIONS REVIEWED 

§ 38.150 Core Principle 2.

(a) In general. The board of trade shall establish, monitor, and enforce compliance with the rules 

of the contract market, including: 

(1) Access requirements; 

(2) The terms and conditions of any contracts to be traded on the contract market; and 

(3) 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 section, including the capacity to carry out such international information-sharing 

agreements, as the Commission may require. 

§ 38.152 Abusive trading practices prohibited.

A designated contract market must prohibit abusive trading practices on its markets by members 

and market participants. Designated contract markets that permit intermediation must prohibit 

customer-related abuses including, but not limited to, trading ahead of customer orders, trading 

against customer orders, accommodation trading, and improper cross trading. Specific trading 

practices that must be prohibited by all designated contract markets include front-running, wash 

trading, pre-arranged trading (except for certain transactions specifically permitted under part 38 

of this chapter), fraudulent trading, money passes, and any other trading practices that a 

designated contract market deems to be abusive. In addition, a designated contract market also 

must prohibit any other manipulative or disruptive trading practices prohibited by the Act or by 

the Commission pursuant to Commission regulation. 

§ 38.153 Capacity to detect and investigate rule violations.

A designated contract market must have arrangements and resources for effective enforcement of 

its rules. Such arrangements must include the authority to collect information and documents on 

both a routine and non-routine basis, including the authority to examine books and records kept 

by the designated contract market's members and by persons under investigation. A designated 

contract market's arrangements and resources must also facilitate the direct supervision of the 

market and the analysis of data collected to determine whether a rule violation occurred. 
44

§ 38.155 Compliance staff and resources.

(a) Sufficient compliance staff. A designated contract market must establish and maintain 

sufficient compliance department resources and staff to ensure that it can conduct effective audit 

trail reviews, trade practice surveillance, market surveillance, and real-time market monitoring. 

The designated contract market's compliance staff also must be sufficient to address unusual 

market or trading events as they arise, and to conduct and complete investigations in a timely 

manner, as set forth in § 38.158(b) of this part. 

(b) Ongoing monitoring of compliance staff resources. A designated contract market must 

monitor the size and workload of its compliance staff annually, and ensure that its compliance 

resources and staff are at appropriate levels. In determining the appropriate level of compliance 

resources and staff, the designated contract market should consider trading volume increases, the 

number of new products or contracts to be listed for trading, any new responsibilities to be 

assigned to compliance staff, the results of any internal review demonstrating that work is not 

completed in an effective or timely manner, and any other factors suggesting the need for 

increased resources and staff. 

§ 38.156 Automated trade surveillance system.

A designated contract market must maintain an automated trade surveillance system capable of 

detecting and investigating potential trade practice violations. The automated system must load 

and process daily orders and trades no later than 24 hours after the completion of the trading day. 

In addition, the automated trade surveillance system must have the capability to detect and flag 

specific trade execution patterns and trade anomalies; compute, retain, and compare trading 

statistics; compute trade gains, losses, and futures-equivalent positions; reconstruct the sequence 

of market activity; perform market analyses; and support system users to perform in-depth 

analyses and ad hoc queries of trade-related data. 

§ 38.157 Real-time market monitoring 

A designated contract market must conduct real-time market monitoring of all trading activity on 

its electronic trading platform(s) to identify disorderly trading and any market or system 

anomalies. A designated contract market must have the authority to adjust trade prices or cancel 

trades when necessary to mitigate market disrupting events caused by malfunctions in its 

electronic trading platform(s) or errors in orders submitted by members and market participants. 

Any trade price adjustments or trade cancellations must be transparent to the market and subject 

to standards that are clear, fair, and publicly available. 

§ 38.158 Investigations and investigation reports.

(a) Procedures. A designated contract market must establish and maintain procedures that require 

its compliance staff to conduct investigations of possible rule violations. An investigation must 

be commenced upon the receipt of a request from Commission staff or upon the discovery or 

receipt of information by the designated contract market that indicates a reasonable basis for 

finding that a violation may have occurred or will occur. 

(b) Timeliness. Each compliance staff investigation must be completed in a timely manner. 

Absent mitigating factors, a timely manner is no later than 12 months after the date that an 
45

investigation is opened. Mitigating factors that may reasonably justify an investigation taking 

longer than 12 months to complete include the complexity of the investigation, the number of 

firms or individuals involved as potential wrongdoers, the number of potential violations to be 

investigated, and the volume of documents and data to be examined and analyzed by compliance 

staff. 

(c) Investigation reports when a reasonable basis exists for finding a violation. Compliance staff 

must submit a written investigation report for disciplinary action in every instance in which 

compliance staff determines from surveillance or from an investigation that a reasonable basis 

exists for finding a rule violation. The investigation report must include the reason the 

investigation was initiated; a summary of the complaint, if any; the relevant facts; compliance 

staff's analysis and conclusions; and a recommendation as to whether disciplinary action should 

be pursued. 

(d) Investigation reports when no reasonable basis exists for finding a violation. If after 

conducting an investigation, compliance staff determines that no reasonable basis exists for 

finding a violation, it must prepare a written report including the reason(s) the investigation was 

initiated; a summary of the complaint, if any; the relevant facts; and compliance staff's analysis 

and conclusions. 

(e) Warning letters. No more than one warning letter may be issued to the same person or entity 

found to have committed the same rule violation within a rolling twelve month period. 

§ 38.159 Ability to obtain information.

A designated contract market must have the ability and authority to obtain any necessary 

information to perform any function required under this subpart C of the Commission’s

regulations, including the capacity to carry out international information sharing agreements as 

the Commission may require. Appropriate information sharing agreements can be established 

with other designated contract markets and swap execution facilities, or the Commission can act 

in conjunction with the designated contract market to carry out such information sharing. 

§ 38.400 Core Principle 7.

The board of trade shall make available to market authorities, market participants, and the public 

accurate information concerning: 

(a) The terms and conditions of the contracts of the contract market; and 

(b) (1) The rules, regulations and mechanisms for executing transactions on or through the 

facilities of the contract market, and 

(2) The rules and specifications describing the operation of the contract market’s: 

(i) Electronic matching platform, or 

(ii) Trade execution facility. 

§ 38.401 General requirements.

(a) General. (1) A designated contract market must have procedures, arrangements and 

resources for disclosing to the Commission, market participants and the public accurate 

information pertaining to: 

(i) Contract terms and conditions; 
46

(ii) Rules and regulations pertaining to the trading mechanisms; and 

(iii) Rules and specifications pertaining to operation of the electronic matching 

platform or trade execution facility. 

(2) Through the procedures, arrangements and resources required in paragraph (a) of this 

section, the designated contract market must ensure public dissemination of information 

pertaining to new product listings, new rules, rule amendments or other changes to previouslydisclosed information, in accordance with the timeline provided in paragraph (c) of this section. 

(3) A designated contract market shall meet the requirements of this paragraph (a), by 

placing the information described in this paragraph (a) on the designated contract market’s Web 

site within the time prescribed in paragraph (c) of this section. 

(b) Accuracy requirement. With respect to any communication with the Commission, and any 

information required to be transmitted or made available to market participants and the public, 

including on its Web site or otherwise, a designated contract market must provide information 

that it believes, to the best of its knowledge, is accurate and complete, and must not omit material 

information. 

(c) Notice of regulatory submissions. (1) A designated contract market, in making available on 

its Web site information pertaining to new product listings, new rules, rule amendments or other 

changes to previously-disclosed information, must place such information and submissions on its 

Web site concurrent with the filing of such information or submissions with the Secretary of the 

Commission. 

(2) To the extent that a designated contract market requests confidential treatment of any 

information filed with the Secretary of the Commission, the designated contract market must 

post on its Web site the public version of such filing or submission. 

(d) Rulebook. A designated contract market must ensure that the rulebook posted on its Web site 

is accurate, complete, current and readily accessible to the public. A designated contract market 

must publish or post in its rulebook all new or amended rules, both substantive and nonsubstantive, on the date of implementation of such new or amended rule, on the date a new 

product is listed, or on the date any changes to previously-disclosed information take effect. 

§ 38.650 Core Principle 12.

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. 

§ 38.651 Protection of markets and market participants.

A designated contract market must have and enforce rules that are designed to promote fair and 

equitable trading and to protect the market and market participants from abusive practices 

including fraudulent, noncompetitive or unfair actions, committed by any party. The designated 

contract market must have methods and resources appropriate to the nature of the trading system 

and the structure of the market to detect trade practice and market abuses and to discipline such 

behavior, in accordance with Core Principles 2 and 4, and the associated regulations in subparts 

C and E of this part, respectively. The designated contract market also must provide a 
47

competitive, open and efficient market and mechanism for executing transactions in accordance 

with Core Principle 9 and the associated regulations under subpart J of this part.