The regulators: CFTC, NFA, exchanges

U.S. futures are policed in layers. At the top is a federal agency. Below it sit self-regulatory organizations (SROs): bodies run by the industry that write and enforce rules for their own members, with the federal agency watching over them. This lesson maps out who does what.

The layers at a glance

The CFTC: the federal regulator

The Commodity Futures Trading Commission is the federal regulatory agency created in 1974 to administer the Commodity Exchange Act (CEA), the main federal law for futures. Its stated mission is to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.

The CFTC’s industry oversight covers:

• Trading organizations, such as designated contract markets (exchanges) and swap execution facilities.
• Clearing organizations (derivatives clearing organizations), which can substitute their own credit for the credit of the parties to a trade.
• Intermediaries, such as futures commission merchants.
• Data repositories, market surveillance, and the contracts and products themselves.

CFTC enforcement

The CFTC’s Division of Enforcement detects, investigates, and prosecutes violations of the CEA and CFTC regulations. Its list of violations includes fraud, price manipulation, false reporting, misappropriation, registration violations, a registrant’s failure to supervise, and illegal off-exchange activity.

What it can seek:

• Administrative relief: cease and desist orders, civil monetary penalties, trading restrictions, and restitution.
• Federal court relief: restraining orders to freeze assets and preserve records, injunctions, appointment of a receiver, civil monetary penalties, restitution, and disgorgement of unlawful gains.
• Criminal cases: the CFTC does not prosecute crimes itself. When it finds evidence of criminal violations, it may refer the matter to the Department of Justice.

NFA: the industry’s self-regulator

National Futures Association describes itself as the industrywide self-regulatory organization for the U.S. derivatives industry. Key facts from NFA’s own pages:

• The CFTC designated NFA a registered futures association on September 22, 1981, and NFA began regulatory operations in 1982.
• The CFTC has delegated registration to NFA, so NFA processes registration for firms and individuals that must register with the CFTC.
• With few exceptions, CFTC registered firms must be NFA Members.
• NFA writes rules, takes disciplinary actions against Members, offers arbitration to resolve disputes, and provides market regulation services to designated contract markets and swap execution facilities.
• NFA is financed mainly by membership dues and fees, and by assessment fees paid by Members and users of the markets.

The CFTC glossary adds that NFA’s focus is the qualifications and proficiency, financial condition, retail sales practices, and business conduct of futures professionals, all under CFTC oversight. Its members include futures commission merchants, introducing brokers, commodity pool operators, commodity trading advisors, designated contract markets, swap execution facilities, commercial firms, and banks.

Exchanges: self-regulators of their own markets

A designated contract market (DCM) is a board of trade or exchange designated by the CFTC to trade futures, swaps, and options under the CEA. Designation comes with duties. The CEA’s core principles (7 U.S.C. 7(d)) require a DCM to:

• Establish, monitor, and enforce compliance with its own rules.
• Have the capacity and responsibility to prevent manipulation, price distortion, and disruptions of the delivery or cash-settlement process.
• Establish and enforce disciplinary procedures that let it discipline, suspend, or expel members or market participants that violate its rules.

So the exchange polices activity in its own markets, while NFA polices the firms and people who deal with customers. The CFTC oversees both.

When a firm answers to more than one SRO

The CFTC glossary lists both the commodity exchanges and registered futures associations as SROs that enforce minimum financial and reporting requirements for their members. If a futures commission merchant belongs to several SROs, the SROs can agree among themselves which one takes primary responsibility. Once the CFTC approves the plan, that body becomes the firm’s designated self-regulatory organization (DSRO).

A worked example (made-up scenario)

Imagine a made-up broker, Example Futures LLC, registered with the CFTC and a Member of NFA, whose customers trade on a made-up exchange.

• A customer complains that a salesperson made misleading claims. That is a sales practice issue, which falls within NFA’s focus. NFA can investigate and discipline its Member, and the customer may be able to use NFA arbitration.
• Someone tries to push the exchange’s settlement price around with fake orders. The exchange must have the capacity and responsibility to prevent manipulation and price distortion, and can discipline its members.
• The same conduct is also a possible violation of the CEA, so the CFTC’s Division of Enforcement can investigate and seek penalties, and refer any criminal case to the Department of Justice.

One event can draw attention from every layer at once.

Key ideas

• The CFTC is the federal agency (created in 1974) that administers the Commodity Exchange Act and oversees exchanges, clearing organizations, and intermediaries.
• CFTC enforcement seeks civil and administrative remedies; criminal cases are referred to the Department of Justice.
• NFA is the industrywide SRO, a CFTC-designated registered futures association since 1981 (operating since 1982). It handles registration (delegated by the CFTC), member rules, discipline, and arbitration, and is funded by its Members and market users.
• Exchanges (designated contract markets) are SROs that must establish, monitor, and enforce their own rules and discipline their members.
• A firm with several SROs has one designated self-regulatory organization for its financial and reporting oversight.