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NFA's Functions Explained
NFA IN BRIEF
NFA is a not-for-profit membership corporation formed in 1976 to become a futures industry's self-regulatory organization under Section 17 of the Commodity Exchange Act. Section 17 was added to the Commodity Exchange Act by Title III of the Commodity Futures Trading Commission ("CFTC") Act of 1974 and provides for the registration and CFTC oversight of self-regulatory associations of futures professionals. NFA's formal designation as a "registered futures association" was granted by the CFTC on September 22, 1981 and the first of NFA's regulatory operations began on October 1, 1982.
The final NFA plan, as approved by the CFTC in 1981 and made operational in 1982, provided for a phase-in of NFA programs. This plan evolved from numerous meetings and discussions among NFA organizers, futures industry leaders and CFTC officials, from legislative efforts in 1978 to perfect Section 17, and from a sober and realistic assessment by NFA organizers of both the benefits and limitations of a registered futures association (See Organizing Efforts below and Genesis of the NFA Concept, Preliminary Statement to NFA's March 16, 1981 Application for Registration Under Section 17 of the Commodity Exchange Act, and NFA Organizing Committee.).
NFA performs several regulatory activities:
- Auditing and surveillance of Members to enforce compliance with NFA financial requirements;
- establishing and enforcing rules and standards for customer protection;
- providing an arbitration forum for futures and forex-related disputes;
- screening to determine fitness to become or remain an NFA Member.
NFA's programs are operational for Futures Commission Merchants ("FCMs"), Introducing Brokers ("IBs"), Commodity Trading Advisors ("CTAs"), Commodity Pool Operators ("CPOs"), and Retail Foreign Exchange Dealers ("RFEDs").
In addition, as authorized under Section 17, NFA performs registration functions under the Commodity Exchange Act — functions previously performed by the CFTC.
NFA Membership is open to any person registered (or exempt from registration) with the CFTC and all futures exchanges provided that the applicant meets NFA's membership qualification standards.
The CFTC has also authorized NFA to process CFTC registration applications by screening applicants, and where appropriate, granting or denying registration applications in all categories.
By virtue of NFA Bylaw 1101 and CFTC Rule 170.15, membership is mandatory in NFA for any FCM, IB, CTA and CPO that transacts futures business with the public. Similarly, by virtue of Compliance Rule 2-36(d) and CFTC Rule 5.22, NFA membership is mandatory for any FCM, RFED, IB, CTA and CPO that transacts forex transactions with the public.
From the beginning, NFA's leadership recognized that NFA must benefit both the public and the futures industry to reach its full potential. To accomplish this, two basic objectives were set, which are incorporated in NFA rules approved by the CFTC:
- More effective policing by the futures industry itself of those segments operating outside the system of exchange standards and surveillance.
- Better cost control over regulatory expenses by eliminating duplication, overlap and conflict between existing governmental and self-regulatory programs, and by facilitating a reduction in the cost of federal regulation for the benefit of taxpayers in general and market users in particular.
The driving force behind NFA was an organizing committee (See NFA Organizing Committee) formed in 1976 by futures industry officials from Chicago and New York City, with broad experience in exchange operations, brokerage house management, commodity merchandising, and trade association activities. Each member of the organizing committee conferred individually with other futures industry leaders, and formal meetings of the organizing committee with industry representatives were held on a number of occasions. These meetings continued into 1981 when NFA formally applied for registration by the CFTC.
Early in its deliberations, the organizing committee reached certain important conclusions. First, substantial cost savings could best be realized from a single organization representing all futures industry segments nationwide, rather than a separate futures association for each segment or region. Second, industry segments could not be successfully self-regulated unless they joined NFA and could not freely resign from it to avoid compliance with ethical and financial rules. Accordingly, the organizing committee decided that membership in NFA should be open to everyone in the futures industry, and that membership in NFA should be mandatory for those who handle transactions directly with the trading public.
In February 1977 the organizing committee appeared before the CFTC to explain its preliminary proposal. In response, the CFTC announced that the NFA proposal was "a valuable first step toward implementing the purposes" of a registered futures association. Moreover, the CFTC offered "to work with the representatives of the NFA to establish a viable organization" and "to find solutions to problems and to seek alternatives where required." In June 1977, the NFA organizing committee presented to the CFTC its plan for uniform required membership, whereby industry segments doing a direct public business would have to be members of NFA, and the CFTC "approved in principle" this concept of mandatory NFA membership.
During 1978, the organizing committee focused its attention on proposed amendments to the Commodity Exchange Act. Three amendments sought by NFA were adopted by Congress in the Futures Trading Act of 1978. These amendments dealt with the mandatory membership question as well as the streamlining of costly programs. Additional perfecting amendments were enacted by the Futures Trading Act of 1982, including an expansion of NFA's authority to assume all registration responsibilities under the Commodity Exchange Act. In addition, Congress again affirmed the principle of mandatory NFA membership.
During its organizational period, NFA received funds from futures exchanges to use to further its efforts and gained tax-exempt status under the Internal Revenue Code. NFA also published and distributed a handbook and a brochure explaining the NFA concept in detail. NFA also participated in the rulemaking which resulted in the adoption by the CFTC of Part 170 of its rules, which governs registered futures associations. A provisional board of directors consisting of the members of the organizing committee was elected by the incorporators of NFA, and temporary officers of NFA were appointed for administrative purposes.
NFA's formal application for registration was filed with the CFTC on March 16, 1981. Following hearings and review of extensive public commentary, the CFTC registered NFA on September 22, 1981. An acting executive director was named in December 1981 and temporary offices were opened in January 1982.
During the remainder of 1982, NFA's full-time president was appointed; experienced administrative, legal, compliance, audit and registration staff were hired; systems were designed and implemented; membership enrollment began; a transitional board of directors was named; and permanent offices in Chicago and New York were opened. The first of NFA's regulatory programs (FCMs) was initiated on October 1, 1982. NFA's first Member-elected Board of Directors assumed office in February 1983, marking the end of an extraordinary organizational effort that had spanned more than six years.
1 A detailed description of the genesis of the NFA concept appears at 1005. Knowledge of the history and development of NFA is useful in understanding fully NFA's functions and present and anticipated role in the futures industry.
Board of Directors.
NFA's Board of Directors is composed of 28 directors as follows:
Four exchange members of NFA are represented on the Board. In the event that there are four or less contract market Members having annual transaction volume during the prior calendar year of more than 1,000,000, then one representative of each such contract market Member. In the event that there are more than four contract market Members having annual transaction volume during the prior calendar year of more than 1,000,000, there will be one representative of each contract market Member ranked in the top three contract market Members based on annual transaction volume during the previous year. The other representative will come from all other contract market Members having annual transaction volume during the prior calendar year of more than 1,000,000.
Eight directors represent FCM Members of NFA. At least two FCM representatives would come from the top ten FCMs based on the amount of segregated funds and secured amount, and at least two FCM representatives would not come from the top ten FCMs based on the amount of segregated funds and secured amount.
Two directors represent IB Members of NFA; one IB director would be an independent IB and the second, a guaranteed IB.
Four directors represent CPO/CTA Members of NFA. At least two directors would be affiliated with either CPOs or CTAs that are ranked in the top 20% of funds under management allocated to futures.
Finally, ten seats are held by "public" directors (i.e., individuals who meet the definition of "public director" set forth in section (b)(2) of Core Principle 15 in Appendix B to Part 38 of the CFTC's regulations).
While all decisions about Bylaws, budgets, funding, plans and priorities are made by the full NFA board, it is too large to serve as the daily overseer of NFA management. Thus, an Executive Committee has been created to perform that function.
The Executive Committee has 12 members comprised of NFA's President (who is an ex officio, non-voting member) and 11 directors, including Chairman of the Board (who also represents his membership category). Two directors represent exchange Members. Three directors represent FCMs and IBs. There are two representatives from the CPO/CTA category. Finally, four public directors serve on the Committee.
Because the Executive Committee is organized along category lines, the members are elected by the directors in that particular category. The public directors on the Committee, however, are elected by the full Board.
Election to the Board.
The Board (except as defined below) is elected by the Members of NFA at an Annual Election held in January of each year.
The representatives of the contract market members are selected by the contract markets they represent.
In the case of other directors (except the public directors), candidates can emerge from three sources. First, NFA's Nominating Committee presents a slate of candidates. Second, 50 or more NFA Members in a particular category can nominate a candidate in that category by filing a petition. Third, any association recognized by NFA as fairly representing a particular category of Members may nominate candidates in that category.
Nominees receiving a plurality of votes in their respective category (e.g., the FCM directors are elected solely by the FCM Members) are elected. A person that is a "dual" Member of NFA (e.g., a firm that is both a CTA and a CPO) is permitted to vote only in that category to which its business activities primarily relate.
The Public directors are elected by the full Board from a list of candidates nominated by the Members.
Each elected director serves a two-year term. The terms of the members of the initial Board elected by the membership in 2002 were staggered, however, to assure continuity. In the exchange category, each representative serves a one-year term, from the date of the Board's regular annual meeting following the Annual Election.
In 1978, Congress amended Section 17 of the Commodity Exchange Act expressly to permit NFA to have rules requiring mandatory membership. NFA's Articles of Incorporation seek to achieve this result with respect to certain futures professionals. Basically, the Articles as implemented by Bylaw 1101 prohibit a Member of NFA from accepting futures orders from another person (except a direct customer) unless that other person is a member of either NFA or another registered futures association.1 The requirement focuses on the flow of customer orders and, in effect, interrupts that flow if an ineligible person becomes involved. NFA Compliance Rule 2-36 imposes a similar requirement on Members.2 for forex related transactions.
One exception to the requirement is the handling of orders by floor brokers. Floor brokers and floor traders are regulated by the exchange where they conduct business, not by NFA. Thus, floor brokers and floor traders are not compelled to join NFA in order to accept futures orders for execution. However, from the point of order origination (i.e., the first FCM, IB, CTA or CPO) until the order reaches a floor broker for execution, only eligible persons may participate in that order flow.
1 In addition, CFTC Rule 170.15 requires that every FCM required to register as such must be a member of a registered futures association.
2CFTC Rule 5.22 requires RFEDs, IBs, CPOs and CTAs dealing in forex to be a member of a registered futures association.
NFA'S REGULATORY OPERATIONS
One of the principal functions of NFA is to establish, audit and enforce minimum financial requirements for its FCM, FDM and IB Members and to receive and analyze financial reports from those Members. No such requirements currently are established under NFA rules for other Members of NFA, such as CPOs and CTAs. Under the Joint Audit Agreement, executed between NFA and the various exchanges, the futures exchanges are responsible for financial compliance for exchange-member FCMs, although at the request of an exchange NFA may perform those functions for such FCMs.
NFA financial requirements were patterned after existing financial standards of the CFTC and futures exchanges. Certain financially related matters, such as the setting of margin levels, remain exclusively with the exchanges (although NFA retains authority to require Member FCMs to collect margins in accordance with exchange requirements).
The ethical standards adopted by NFA include those specifically required by Section 17 of the Commodity Exchange Act, such as prohibitions against fraud, manipulative and deceptive acts and practices, and unjust and inequitable dealings. In addition, bucketing is prohibited, and there are required procedures for the supervision of employees and the handling of discretionary accounts that are similar to CFTC and exchange requirements. In addition, CPO and CTA Members are required to follow specific CFTC rules, and detailed rules have been prescribed for exchange-traded options transactions. NFA has also adopted an advertising rule which contains specific provisions concerning communications with the public and promotional material and a "know your customer" rule which requires Members to obtain information about new customers and provide disclosure about the risks of futures trading before the customers open futures or forex accounts and to verify the information annually and determine whether additional disclosure is required.
Members and Associates.
Membership in NFA is open to any CFTC registrant and any futures exchange, unless the registrant or exchange is subject to one of the specified membership disqualifications (e.g., a CFTC order revoking registration). Each employee of a Member of NFA who is an "associated person" under the Commodity Exchange Act is required to become an NFA "Associate." These individuals are subject to the same disqualification standards as Members.
An important first step in regulating NFA Members and Associate Members is screening the applicants for membership and registration as Associates. NFA staff conducts the initial screening process. Based on the screening process, NFA's President may determine that the applicant does not meet the membership qualifications or that the application is intentionally incomplete, inaccurate or false. NFA's President must notify the applicant in writing of this determination and provide the Membership Committee with a copy. The Membership Committee makes the final determination on membership eligibility, after providing the applicant with an opportunity for a hearing before the Membership Committee.
Under the supervision of the Compliance Director, NFA's Compliance Department is responsible for monitoring NFA Members for compliance with NFA's financial and business conduct requirements. In the event the Compliance Department determines that a Member or Associate has committed a possible violation of an NFA Rule, the Compliance Department prepares a written report summarizing the matter and submits it to NFA's Business Conduct Committee (BCC) for review. The BCC determines whether to close the matter or serve a written and dated Complaint outlining the alleged violation(s) on the Member or Associate. If a Complaint is issued, the Member or Associate must file an Answer and may request a hearing on the charges before an NFA's Hearing Panel. If the matter is not settled, and the Hearing Panel issues a decision finding the Member or Associate committed the alleged violations, the Member or Associate may appeal the decision to NFA's Appeals Committee, which is a committee of Board members created to hear these matters. The Appeals Committee's decision is final, subject to review by the CFTC.
NFA has authority to discipline any Associate and any of its Members that are required to be registered with the CFTC.
The penalties that may be assessed include expulsion or suspension for a specified period from NFA membership or from being associated with a Member, censure, reprimand, an order to cease and desist, a fine not to exceed $250,000 per violation, or any other appropriate penalty or remedial action. A summary action may be taken by the President with the concurrence of the Executive Committee when necessary to protect the markets, customers or other Members. If it is not practicable to hold a hearing before the summary action is taken, the Member or Associate will be afforded an opportunity for a hearing before the Hearing Committee as promptly as possible.
Another principal function of NFA is to provide a fair, equitable and expeditious procedure for settling customer claims and grievances as required under Section 17(b)(10) of the Commodity Exchange Act. NFA's Code of Arbitration provides a framework for this procedure. NFA's arbitration program has been fully operational since 1983. Subject to certain exceptions, NFA arbitration is mandatory when a Demand for Arbitration is filed by a customer against an FCM, FDM, IB, CTA or CPO Member, or its employees, or against an Associate. Also, under NFA's Member Arbitration Rules arbitration between and among NFA Members and Associates is mandatory in most cases. Counterclaims, cross-claims and third-party claims involving the same acts or transactions that form the basis of the customer's or Member's claim also will be heard.
Arbitration claims are decided by panels of one or three arbitrators appointed by NFA's Secretary. Customers generally have the right to request a non-Member panel consisting of a majority of arbitrators not connected with an NFA Member or NFA to decide their claim. Smaller claims are generally resolved by a single arbitrator through written submissions. Proceedings are informal; however, parties may be represented by counsel. No appeal to NFA is permitted. Awards may be enforced in any court of competent jurisdiction.
Additionally, to complement its successful arbitration program and to encourage settlements, NFA incorporated mediation into the early stages of the arbitration process in June 1991, making NFA arbitration even less expensive and more efficient.
The Bylaws of NFA set forth the following funding plan.
The annual assessment for each exchange member is calculated on the basis of $.005 for each round-turn futures contract traded there. The total of such assessments paid by a contract market Member that had 20 percent of aggregate contract market transaction volume during that fiscal year shall not be more than $150,000 and the total of such assessments paid by a contract market Member that had transaction volume of 20 percent or less of aggregate contract market transaction volume during that fiscal year shall not be more than $100,000. Where "mini contracts" are involved, an adjustment is made to equalize them with the larger-sized contracts in the same commodity (e.g., five 1,000 ounce or bushel contracts will be treated as one 5,000 unit contract, if the latter is traded). Each exchange is free to raise these funds in any manner that it chooses.
The annual assessment for FCMs consists of two elements:
- Annual dues of $1,500 for exchange Member FCMs and $5,625 for non-exchange Member FCMs.
- An assessment fee of $.04 for each commodity futures contract (other than an option contract traded on a contract market and a dealer option contract) on a round-turn basis and $.02 for each option contract traded on a contract market on a per-trade basis carried for a customer who is not a member (or an affiliate under common ownership with a member) of the exchange where the trade is made. The assessment must be invoiced to the customer. The collection of this assessment can be suspended or the fee adjusted by the Board for a period not to exceed three months when in the judgment of the Board such action is appropriate in light of NFA's overall financial goals. The assessment fee does not apply to trades that are executed by clearing FCMs for customer omnibus accounts that they carry for non-clearing FCMs, where the non-clearing FCM has already made the assessment. (The non-clearing FCM will make the assessment in this situation because it has the direct relationship with the customer.)
Forex Dealer Members.
Forex Dealer Members (FDMs) pay assessment fees on off-exchange forex transactions. Additionally, Forex Dealer Members pay dues based on their gross annual revenue from retail customers for these activities. Effective April 30, 2006 the dues structure is as follows:
- If the firm's gross annual revenue from retail forex is $5,000,000 or less, the firm's dues are $125,000 if NFA is responsible for auditing the firm and $25,000 if NFA is not responsible for auditing the firm.
- If the firm's gross annual revenue from retail forex is more than $5,000,000 but not more than $10,000,000, the firm's dues are $250,000 if NFA is responsible for auditing the firm and $25,000 if NFA is not responsible for auditing the firm.
- If the firm's gross annual revenue from retail forex is more than $10,000,000 but not more than $25,000,000, the firm's dues are $500,000 if NFA is responsible for auditing the firm and $25,000 if NFA is not responsible for auditing the firm.
- If the firm's gross annual revenue from retail forex is more than $25,000,000, the firm's dues are $50,000,000 if NFA is responsible for auditing the firm and $25,000 if NFA is not responsible for auditing the firm.
In addition, FDMs pay a fee of .002 on all order segments processed through NFA's Forex Transaction Reporting Execution Surveillance System (FORTRESS).
Generally, all other Members of NFA are assessed annual dues, as follows:
- Commodity Pool Operators: $ 750 per year.
- Commodity Trading Advisors: $ 750 per year.
- Introducing Brokers (Guaranteed): $ 750 per year.
- Introducing Brokers (Independent): $ 750 per year.
Provided, however, that any commodity trading advisor, commodity pool operator, or introducing broker that has been approved as a forex firm pursuant to NFA Bylaw 301(j) shall pay $750 plus an additional surcharge of $1,750.
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.
PRELIMINARY STATEMENT TO NFA'S MARCH 16, 1981 APPLICATION FOR REGISTRATION UNDER SECTION 17 OF THE COMMODITY EXCHANGE ACT
The National Futures Association (hereinafter "NFA") is the first applicant for registration under the Commodity Exchange Act (hereinafter "the Act") as a Registered Futures Association. Section 17 of the Act provides for the registration with the Commodity Futures Trading Commission (hereinafter "Commission") of one or more such associations.
Among the fundamental purposes of NFA is to relieve the Commission of a significant part of its current burden under the Act, especially in the direct regulation of futures commission merchants that have elected to operate without membership on contract markets where they do business. With the Commission's consent, the NFA could also relieve the agency of much of the clerical burden connected with the registration and testing of associated persons. In all likelihood, the efforts of NFA will allow the Commission to realize other savings in manpower and money as well.
The incorporators and organizers of NFA believe that the assumption by the private sector, through NFA, of a significant part of the Commission's existing burden is both prudent and desirable because it will enable the Commission to devote more of its scarce resources to duties under the Act which, if delayed or deferred, would have a serious adverse impact upon the continued growth of the commodity futures industry and would unnecessarily deprive the public (including businesses and institutions) of the expanding services of that industry.
In particular, the incorporators and organizers note already lengthy processing time at the Commission on such vital matters as approval of proposed new futures contracts; review of changes in contract market rules necessary to assure efficient exchange operations, to meet competition, and to better serve the public; inauguration of commodity options trading under exchange sponsorship; the resolution of customer claims under the reparations program; and other matters.
The incorporators and organizers of NFA believe that the Congress has mandated the regulation of commodity futures trading because it recognizes the important role played by these markets in the economic life of this nation. As such, we believe that Congress' desire to regulate in the public interest was never intended to impede the honest operation or the natural growth of futures markets. We view the creation of NFA as an opportunity for the Commission to carry out that Congressional intent, despite limited resources, and our decision to apply under Section 17 of the Act is motivated in substantial part by the expectation that duties of the Commission under the Act affecting industry growth and development can and will in the future be performed expeditiously.
NFA ORGANIZING COMMITTEE (1976-1982)
Leo Melamed, Chairman
David T. Johnston, Vice Chairman
John J. Conheeney
George D.F. Lamborn
Warren W. Lebeck
Howard A. Stotler
NFA'S MISSION STATEMENT
NFA is a congressionally authorized self-regulatory organization. NFA's mission is to provide innovative regulatory programs and services that ensure futures industry integrity, protect market participants and help our Members meet their regulatory responsibilities. NFA is committed to making decisions and taking actions that reflect the highest level of service excellence for our customers: NFA Members and the investing public.