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Proposed Interpretive Notice
NFA COMPLIANCE RULE 2-37: FAIR COMMISSIONS
Under Section 15A(k) of the Securities and Exchange Act of 1934 (Exchange Act), NFA is a national securities association for the limited purpose of regulating the activities of Members who are registered as brokers and dealers in security futures products under Section 15(b)(11) of the Exchange Act (i.e., FCMs and IBs who "passport" in to broker-dealer registration because they limit their securities activities to security futures products). Section 15A(k) also requires NFA to impose customer protection requirements reasonably comparable to those of national securities associations registered under Section 15A(a) of the Exchange Act. One of these requirements relates to the amount of commissions these Members may charge for security futures transactions.
NFA Compliance Rule 2-37(g) prohibits Members registered as broker-dealers under Section 15(b)(11) of the Exchange Act from charging more than a fair commission for security futures transactions. That rule also provides that what is a fair commission depends on all of the relevant circumstances, including the expense of executing the order and the value of any service the Member may have rendered based on its experience and knowledge.
The vast majority of NFA Members charge fair commissions, and Compliance Rule 2-37(g) will not require them to make any changes to their commission practices for security futures products. Commissions for futures transactions have been set competitively since the 1970s. They are usually based on the Member's costs plus a reasonable profit. Commission rates also vary based on the services provided by the Member. Additionally, Members who deal with institutional customers often negotiate commissions based on volume or similar measures. All of these practices continue to be acceptable for security futures products.1
NFA has occasionally encountered retail firms that have charged fees significantly out-of-line with the Member's costs and services and the industry norm. In most of these cases, customers have been misled as to either the amount of the commission, the effect of the commission on profitability, or how the commission rate compares with other firms in light of the services offered. High commissions also have a significant effect on commission-to-equity ratios and increase the likelihood that the Member will churn accounts over which they or their Associates have discretionary authority or de facto control. As a result, NFA has consistently responded to unreasonably high commission rates by charging the firms and their Associates with violating NFA Compliance Rule 2-2(a) and/or NFA Compliance Rule 2-29, and NFA will continue to do so. 2
NFA Compliance Rule 2-37(g) and this interpretive notice do not relieve Members of their obligation to make the applicable per trade or round-term commission charges available to customers prior to the commencement of trading and to fully explain any fees and charges that are not determined on a per trade or round-turn basis. 3
1 NFA does not believe it is appropriate to apply a guideline similar to NASD's 5% guideline for securities mark-ups. The cost of executing orders in the futures markets tends to have little correlation with either the notional value of the contract or the amount of margin. Although nothing prohibits NFA Members from setting commissions for security futures contracts based on the notional value of the contract or the amount of margin, those commissions must be reasonable in light of all of the circumstances, including the Member's expenses and the value of the Member's services.
2 See, e.g., In re Bachus & Stratton Commodities, Inc., NFA Case No. 92-BCC-15 (Hearing Panel, Feb. 18, 1993), aff'd, NFA Case No. 93-APP-2 (App. Comm., Nov. 11, 1993); In re Churchill Group, Inc., NFA Case No. 90-BCC-12 (BCC, Sep. 5, 1990) (settlement); In re The Siegel Trading Co., Inc., NFA Case No. 97-BCC-7 (Hearing Panel, Jan. 4, 1999) (settlement).
3 See Interpretation of NFA Compliance Rule 2-4: Guideline for the Disclosure by FCMs and IBs of Costs Associated With Futures Transactions, 9005, NATIONAL FUTURES ASSOCIATION MANUAL.