GENESIS OF THE NFA CONCEPT
Initial Industry Concerns.
Section 17 of the Commodity Exchange Act, creating the possibility of a "futures association" within the futures industry, was originally known as Title III of the Commodity Futures Trading Commission Act of 1974. Like most other provisions of the CFTC Act, Section 17 became effective in April of 1975. For more than a year after that date, however, no effort was made within the futures industry to make use of Section 17 to form a futures association.
A principal concern of futures industry leaders was that a futures association might simply add a new regulator with new requirements. Already, many futures professionals were confronted with multiple regulators. While increasing the cost of doing business, this new regulator might serve no useful purpose for either the industry or the public.
Also, Section 17 clearly contemplated an organization akin to the Financial Industry Regulatory Authority ("FINRA"), originally established as the National Association of Securities Dealers, Inc. ("NASD"). FINRA, however, was formed to regulate the over-the-counter securities business that operates outside of the system of stock exchange self-regulation. There is no "over-the-counter" futures business. In fact, the Commodity Exchange Act prohibits it; all futures trading must take place on organized futures exchanges, through exchange members and under self-regulatory oversight.
A further concern, particularly within the exchange community, was whether a futures association would set standards or impose requirements in conflict with the rules of the exchanges, so that the members of both entities would face incompatible duties. Frequently, the members of a futures association would also belong to one or more exchanges, and all of their futures transactions would pass through the exchanges. Obviously, the futures association and the exchanges would have to work closely together if conflicts were to be avoided.
While these issues were still under debate within the industry, a proposal was submitted in August 1976 by the Futures Industry Association ("FIA") to the CFTC. The FIA proposal called for the formation of a futures association limited initially to the screening of associated persons, but with the potential eventually to set a wide variety of standards governing the relationship between futures firms and their customers. Because FIA is not organized as a self-regulatory organization, however, it advised the CFTC that it would be necessary to make major changes in FIA bylaws and devote considerable time and effort to develop a funding plan.
FIA's proposal had two principal features. First, its regulatory program applied only to FCMs, CPOs and CTAs. (Thus, it focused on those firms dealing directly with the trading public.) Second, its regulatory efforts were to be limited to "off-exchange" activities such as customer relations, advertising and the financial strength of firms doing business with the public. According to the proposal, FIA would not become involved "with other aspects of regulation which would relate to the workings of the market place, such as floor operations, contract details, prevention of manipulations and financial integrity of clearinghouses, etc."
Thus, the earliest proposal for a registered futures association recognized two essential features of any futures association: membership must be defined along functional lines — doing business with the public, regardless of statutory label — and conflicts with the self-regulatory programs of the exchanges must be avoided.
One month after the FIA proposal reached the CFTC, Leo Melamed of the Chicago Mercantile Exchange met with the chairman of the Chicago Board of Trade, Paul McGuire, to discuss this development and to exchange views on whether the exchanges should take an active part in the development of a futures association. As a result of conversations with FIA officials, they were aware that FIA preferred that a separate, distinct entity act as the Title III Organization (rather than FIA) and that FIA's proposal primarily was made to draw industry support for the concept of a national futures association and to spur others within the industry into action.
After careful analysis (See Motivating Factors below.), Mr. Melamed and Mr. McGuire concluded that a Title III organization would unquestionably benefit the legitimate interests of the futures industry and the public it serves, but that such an organization must be broadly based and provide for participation by the exchanges. They agreed to proceed on that basis. FIA, when advised of that decision, immediately concurred and offered its support.
In September 1976, articles of incorporation were developed under the direction of Mr. Melamed and Mr. McGuire, and National Futures Association was chartered in the state of Delaware. The purposes of NFA were defined generally at the time, but with the realization that the Articles of Incorporation as originally written would serve principally as a basis for negotiation within the industry and with the CFTC.
Several industry developments gave momentum to the idea of a futures association and motivated both FIA and the NFA incorporators. First, the 1974 amendments to the Commodity Exchange Act expressly recognized the existence of futures industry professionals operating largely beyond exchange supervision-CPOs and CTAs, for example. The CFTC had found through its registration process that these persons numbered in the many hundreds.
Second, each month brought the futures industry closer to fully negotiated commission rates which, in turn, would reduce the economic incentive for commercial firms and some FCMs to belong to exchanges (where, previously, members alone received discounts on commission rates). This meant that, as the futures industry grew, many new FCMs might choose not to join an exchange, in order to avoid complying with rigorous exchange financial and ethical requirements and scrutiny.
In fact, the number of industry participants operating without exchange supervision was already higher than expected and was certain to increase in the years to come. This could prove to be a danger to the proven financial integrity of the futures market system. And while the CFTC could expand in dollars and staff to meet this challenge, a self-regulatory association was the better answer. The self-regulatory philosophy was strong in the futures industry and had a long history, beginning with the founding of the Chicago Board of Trade in 1848.
Additionally, the futures association concept received support from within the industry because it offered the promise of greater efficiency in the self-regulatory process. Self-regulation in the futures industry had become complex. A number of autonomous exchanges existed, each with its own rulebook, its own surveillance staff and its own disciplinary system. Any brokerage firm belonging to more than one exchange sometimes faced duplicative self-regulatory programs at a minimum, and many also confronted conflicting exchange requirements. Therefore, a national self-regulatory association like NFA offered the hope that some of these piecemeal functions over time could be coordinated and even consolidated.
Finally, a futures association was regarded by many futures industry leaders as the next and necessary step in the evolution of the futures markets. The U.S. futures industry had reached a level of national and international visibility and participation that demanded a unified national association which, for certain specific purposes, could bring within its fold all the different exchanges, diverse interests and a multitude of market users. Logic dictated the creation of a national association which could act as the coordinated self-regulatory body for the entire industry in specific areas critical to the continued growth, viability and well-being of futures markets and the business communities which they serve.
In October of 1976, Mr. Melamed and Mr. McGuire extended invitations to five other industry leaders to form an NFA organizing committee reflecting regional considerations as well as differences in business activities. To reflect regional considerations, three invitees were from New York City and two were from Chicago. To accommodate differences in types of businesses, three invitees were officials of major brokerage houses, while firms specializing in commodities were represented also. The exchange community was represented through Mr. Melamed and Mr. McGuire and by the president of the Chicago Board of Trade. Other invitees had occupied leadership roles at the New York markets. Three of the invitees, moreover, had been leaders of FIA at the time of its original proposal to the CFTC. All accepted.
In December of 1976, the organizing committee met in New York with representatives of the various exchanges and FIA to outline its proposal. From that meeting came a consensus that the NFA organizing committee should continue to work toward a futures association utilizing the concepts discussed at the meeting.
On February 10, 1977, the CFTC heard the proposal of the NFA organizing committee and, five days later, announced that it "endorses this concept of cooperative regulation and considers the NFA proposal to be a valuable first step toward implementing the purposes of Title III."
In June of 1977, the NFA organizing committee returned to the CFTC with the view that neither NFA nor any other futures association would be an effective self-regulator if eligible industry participants could refuse to join or, once members, could resign at the first sign of disciplinary action. The organizing committee urged that it have the tools to avoid such a "revolving-door" syndrome. On June 7, 1977, the CFTC agreed: "The Commission, as a matter of policy, approves the concept of 'Uniform Required Membership' as proposed by the N.F.A. organizing committee."
Antitrust Division Objections.
In October of 1977, however, without any contact whatsoever with NFA, staff members of the antitrust division of the U.S. Department of Justice released to the media and the CFTC a lengthy legal memorandum attacking the proposal and, in particular, the concept of mandatory membership. The antitrust division authors raised constitutional questions, argued that Congress had not "intended" that membership in a futures association be compulsory, and expressed the view that there should be many competing futures associations.
After carefully reviewing the antitrust memorandum, the NFA organizing committee filed a detailed reply with the CFTC in January 1978 addressing each of the arguments made. The issue was not resolved, however, until completion later that year of the 1978 CFTC reauthorization process. Section 17 of the Commodity Exchange Act was amended expressly to sanction NFA's proposed mandatory membership concept, and to otherwise perfect Section 17. The message was unmistakable: Congress wanted NFA.
The Registration Process.
During 1979 and 1980 many additional meetings were held to develop the details of NFA's formal submission to the CFTC; comments were prepared in response to the CFTC's proposed Part 170 rules governing futures associations; and extensive drafting was undertaken to develop NFA's application papers-a 300-page legal document filed with the CFTC on March 16, 1981. The actual filing followed extensive industry briefings in February and early March of 1981, which resulted in even more fine-tuning.
NFA's application consisted of a detailed registration statement, as required by CFTC rules, and the following documents:
- Articles of Incorporation-NFA's "constitution"-which contain a number of carefully drawn protections essential to a viable, effective Title III organization.
- NFA Bylaws-which provide the organizational and operational details.
- NFA Compliance Rules-which contain NFA's code of conduct, as well as the procedures for Member/Associate discipline.
- NFA Code of Arbitration-which provides for a system of customer-initiated arbitration.
- NFA Financial Requirements-applicable to Member FCMs.
In addition, in a "preliminary statement" to the application, the organizers summarized their principal motivations in proceeding with the ambitious NFA plan. (See Preliminary Statement to NFA's March 16, 1981 Application for Registration Under Section 17 of the Commodity Exchange Act.)
Public comments were solicited by the CFTC and hearings were held before the CFTC on June 4, 1981. Speaking on behalf of NFA, organizing committee chairman Leo Melamed emphasized NFA's goal of integrated, coordinated self-regulation:
In an era of deregulation long overdue in my opinion, and essential to the long-term health and economic survival of America — it would be ironic, if not tragic, if NFA were to represent yet another layer of regulation. Duplicative, costly, inefficient, suffocating regulation. A fundamental goal of NFA organizers has been, and is, to avoid just this. We do not want NFA to become but another regulatory layer. We do not want to duplicate existing self-regulatory efforts. Rather, we want to complement and perfect existing programs. Nor do we want to precipitate useless turf battles. Rather, we want to recognize the essential, central role of the exchange community and draw upon its considerable talents and expertise. After all, they have done a remarkably fine job for over 100 years, within their area of limited jurisdiction.
Thus the NFA proposal of integrated, coordinated self-regulation is the only rational one, the only one, we submit, that Congress could have intended. Our plan fully complies with the spirit and the letter of the law. Moreover, it best reflects what is the essence of futures trading: In the words of Holbrook Working, "Futures trading is trading conducted under special regulations and conventions, more restrictive than that applied to any other class of commodity transactions, which [regulations and conventions] serve to facilitate hedging and speculation by promoting exceptional convenience and economy of transactions." Regulators — self or otherwise — must never lose sight of that.
Following extensive review, and analysis of further objections from the antitrust division and NFA's detailed response, NFA's registration was granted by the CFTC on September 22, 1981.
1982 Congressional Affirmation.
Approximately four months later, however, the future of NFA was put in serious doubt, as the CFTC urged Congress to adopt a futures transaction tax. This novel tax, if enacted, would have deprived NFA of its funding base at a critical time and would have jeopardized futures industry support for the NFA concept. Congress soundly rejected the CFTC tax proposal, however, in favor of NFA.
In this connection, Congress comprehensively reexamined and significantly amended Section 17 of the Commodity Exchange Act to enhance further the NFA role. Congress also affirmed that "every registered commodity professional, except floor brokers, must be a member of NFA in order to fulfill the 1978 congressional grant of authority to the CFTC to make membership in a registered futures association compulsory." [128 Cong. Rec. H7507 (daily ed. remarks of Rep. Wampler). Accord 128 Cong. Rec. S13097 (daily ed. remarks of Sen. Percy).] The Committee of Conference on the Futures Trading Act of 1982 emphasized explicitly that "under the Act, the Commission has the authority to adopt . . . [CFTC Rule 170.15]" H.R. Rep. No. 964, 97th Cong., 2d Sess. 50 (1982).
In short, Congress in 1982 squarely faced the question whether NFA would have a meaningful place in the Commodity Exchange Act's regulatory scheme or whether direct governmental regulation by the CFTC would be preferred. See, e.g., 128 Cong. Rec. H7517 (daily ed. remarks of Rep. Volmer). Congress selected the self-regulatory approach of NFA and Section 17 of the Act. To that end, Congress also sought to ensure that NFA would fulfill the self-regulatory mission reflected in Section 17. The 1982 Act therefore contains significant revisions to Section 17 covering the assumption by NFA of CFTC registration functions, NFA rule approval procedures, expansion of NFA arbitration remedies, the establishment of performance standards for NFA, and a broad study of NFA performance.
In the context of this vast array of amendments, Congress expressly recognized "that unless all persons covered by the regulatory program of a futures association join an association, the self-regulatory purposes of Section 17 of the Commodity Exchange Act will not be fulfilled and, in particular, the goal of new Section 17(q) may be impossible to achieve." H.R. Rep. No. 964, 97th Cong., 2d Sess. 49-50 (1982) (Report of Committee of Conference).
New Section 17(q) required NFA to develop a comprehensive program that fully implements NFA's rules approved by the CFTC. In enacting Section 17(q), Congress thus made clear its appreciation of the nexus between the provisions of that Section and mandatory NFA membership. Indeed, the Conference Committee report on Section 17(q) contained the following directive to the CFTC.
The conferees expect that the Commission will exercise . . . [its] authority and adopt such rules or take such other action as it deems to be necessary or appropriate to insure that persons eligible for membership in a registered futures association become and remain members of at least one such association.
H.R. Rep. No. 964, 97th Cong., 2d Sess. 50 (1982).
In 1982, therefore, Congress ratified the CFTC's mandatory NFA membership policy, directed in Section 17(q) that NFA self-regulatory programs and rules be fully implemented, stated explicitly that mandatory futures association membership was necessary to effectuate that directive as well as the specific purposes of Section 17, and emphasized its expectation that the CFTC would exercise its authority to accomplish fully the mandatory NFA membership objective.1
1 On June 1, 1983 the CFTC adopted Rule 170.15 (effective August 8, 1983), which provides that each FCM required to register as such must become and remain a member of at least one registered futures association.