The Financial Conduct Authority (FCA) has fined Forex Capital Markets and FXCM Securities (FXCM UK) £4m for allowing the US-based FXCM Group to withhold profits worth £6m that should have been passed on to the UK business' clients.
FXCM UK also failed to tell the FCA that the US authorities were investigating another part of the FXCM Group for the same misconduct, the regulator said.
The FCA has now ensured that FXCM UK's clients will be fully compensated and credit automatically paid to their accounts.
FCA director of markets David Lawton said the practice undermined confidence in the integrity of the foreign exchange markets.
"The FCA will use all the tools at its disposal - supervision, rule-making and enforcement - to ensure that firms do not exploit conflicts of interest or the trust placed in them by their clients."
Director of enforcement and financial crime Tracey McDermott added: "Not only did FXCM UK fail to treat its customers fairly or correctly apply our rules, I am particularly disappointed that it was not transparent in its dealings with the FCA.
"We expect all firms to put customers at the heart of their business, and we have taken action to ensure clients of FXCM UK will get redress."
FXCM UK placed over the counter foreign exchange transactions known as rolling spot forex contracts on behalf of retail clients, which were then executed by another part of the FXCM Group.
Such transactions are contracts to buy or sell foreign exchange where prices are agreed but payment is made later and contracts where the profit depends on changes in the exchange rate.
Pocketing the profits
Between August 2006 and December 2010, the FXCM Group kept profits from favourable market movements between the time the orders were placed by FXCM UK and executed by the FXCM Group, while any losses were passed on to clients in full.
FXCM UK also failed to check that its order systems were effective, and whether its order polices complied with the FCA's rules on best execution, which require firms to try to secure the best possible deal for their clients.
In July 2010, the US authorities launched an investigation into FXCM's business in the US but its senior managers failed to alert the FCA despite sitting on the UK company's board.
Once it became aware of the investigation in August 2011, the FCA stepped in to review FXCM UK and secure redress for affected consumers, it said.
Although unrelated to this enforcement case, the FCA is currently conducting a thematic review into trading on the foreign exchange market.
It is examining firms' execution practices, including the way services are described to clients and arrangements for order execution and review.
Last November the Royal Bank of Scotland (RBS) suspended two traders in connection with an investigation surrounding the manipulation of forex rates.
The FCA expects to publish the results by the end of Q2 2014.
Find more enforcement actions HERE.
Two global vehicles
'Further plug advice gap'
Must appoint separate CEOs and boards
Advisers do come out well
Will report to Mark Till