THE NATIONAL FUTURES ASSOCIATION

Excerpts of testimony before the U.S. Senate Committee on Agriculture, Nutrition and Forestry Subcommittee on Agricultural Research,
1982.

The birth of the National Futures Association (NFA) was a painful and arduous process. But it was a must. The authority for such a self-regulatory body with a mandatory membership requirement—which had been a primary focus of the futures industry—had been authorized under Title III of the original CFTC act. Our primary motivation for its creation was to institute a uniform minimum financial rule and oversee the vast number of unregulated non-member Futures Commission Merchants (FCM)—who were not members of any exchange, received and held customer money but had no supervision with respect to their finances, and whose ranks were growing by the day.

At that time, the foregoing was considered the financial Achilles Heel of our industry. The CFTC neither had the resources nor the know-how to regulate this large number of non-member FCMs. In addition to assuring that adequate capital requirements were met, the NFA was also willing to assume a number of other CFTC regulatory functions which in the opinion of the industry, the NFA could perform better and cheaper, i.e., regulation of sales practices, protection of customers funds, examination and registration of commodity representatives, and arbitration and reparation procedures.

However the concept had opposition not only from members of the futures industry—who opposed the idea for the creation of another regulatory policeman—but from some within the CFTC itself who feared the NFA would usurp its power base. The conflict between these forces lasted for years. Finally, in 1981, the process moved forward until the CFTC nearly killed it again. The CFTC sponsored a proposal for a user fee (a special regulatory transaction tax) to fund the NFA. The industry was inexorably opposed to such a tax for many of the same reasons that still apply today. While the industry was willing to tax itself to fund the NFA, it was unwilling to do so if it was also to be subject to a federal transaction tax.

We prevailed. On behalf of the industry, I negotiated an agreement with Majority Leader of the United States Senate, Senator Robert Dole whereby, in lieu of any federal transaction tax on futures, the industry would place an NFA charge on each non-member customer transaction for the purpose of carrying out certain regulatory functions and relieving the CFTC of those burdens.

Mr. Chairman, I appear before you today to acquaint you with the life of an entity conceived by the very same body that all of you proudly represent; a life that today is in your hands and whose future depends on your decision; a life that represents the hope and promise for our industry; and a life you sponsored, we devised, and the Commodity Futures Trading Commission ordained.  I speak of the very short life of the National Futures Association—the NFA.

Conception of the NFA occurred in 1974 when the United States Congress adopted the Commodity Futures Trading Commission Act and provided, under Title III thereof, for the birth of a new self-regulatory organization for the commodity futures industry. Two years of incubation followed the act of conception.  The first signs of fertility occurred in 1976 when a not-for-profit corporation, sponsored by leaders of our industry and called the National Futures Association, was registered under the corporate laws of the State of Delaware. What followed was one of the most difficult periods of gestation ever recorded in private sector embryology.  It was a five year painful and dangerous pregnancy during which the prognosis for a healthy birth was often in doubt. 

There were many who were against its conception from the beginning. The antagonists from within our industry argued that the NFA would represent but one more body of regulation in a world already possessed of too many regulators; that this new organization could not and would not fairly represent all the diverse sectors of the industry; that it would be too costly to ourselves; that it would duplicate functions of the CFTC; and some cynically asked why we should regulate properly and forcibly in areas where the CFTC had failed. The antagonists from outside the industry argued simply that NFA represented a ruse to divert authority from the CFTC and that no self-regulatory private-sector organization could be trusted to do a proper job.

But there were also protagonists—both from within and outside our industry—who claimed to be more responsible and farsighted.  They insisted that the NFA could be the potential savior of the futures industry and of its federal regulatory agency; that it could save the industry from unnecessary duplicative regulations, perform regulatory functions in a more proficient manner, relieve the CFTC of some obligatory burdens so it could better perform its oversight mandate in areas where it had failed to so do expeditiously, and that it would prevent the onerous onslaught of those who proposed a user fee system to defray the cost of regulation. Aside from these specifics, the protagonists argued that the NFA was consistent with the banner of self-regulation the futures industry so proudly hailed for over 100 years of its existence.

The protagonists prevailed, and in March 1981, the NFA filed its application before the CFTC for designation as a futures association pursuant to Section 17 of the Commodity Exchange Act. As delineated in the comprehensive application package filed with the CFTC, NFA was devised to do the following: To effectively police the futures industry itself as well as those segments operating outside the system of exchange standards and surveillance; To achieve better cost control over regulatory expense by eliminating duplication and conflict between governmental and self-regulatory programs; and, To facilitate a reduction in the costs of federal regulation for the benefit of taxpayers in general and market users in particular.

A lengthy and exhaustive as well as constructive review process followed.  All went well, and with no small measure of pride, the CFTC announced the birth of the National Futures Association on September 22, 1981.  The NFA was designated as an official "registered futures association."  At first our industry went into shock.  It had been such a long arduous process we were not fully prepared for the event.  Soon, however, with the realization of parenthood, preparations for the offspring's well-being began.

Our progress has been swift and impressive.  Since December 15, when Pat Carlisle was chosen as Acting Executive Director, substantial sums of money have been committed to the project.  The core of a full-time professional staff was hired to develop programs and systems for membership qualification, member registration, FCM financial audits and NFA's professional standards and compliance programs.  The national headquarters of the NFA was opened at 120 South Riverside Plaza in Chicago.  An advisory was mailed to all exchanges and 3,500 futures industry professionals apprising them of the next immediate stages of NFA formation and the expected timetable for membership.  A plan was formulated to appoint the first 40-person NFA Board of Directors to represent every segment of our industry.  Additionally, the agenda was prepared for a full briefing of our industry at the annual Futures Industry Association (FIA) convention later this week. In short, we are well on the way to fulfilling our objectives and on target for meeting the goal of being a significant self-regulatory factor in our industry by October 1 of this year. 

The NFA proposes to enhance regulation by assuming the following obligations: comprehensive FCM audits; introducing broker oversight and ethical standards; pool operator and trading advisor oversight and ethical standards; sales practice reviews; options program oversight of FCMs and introducing brokers; registrations and fitness standards for industry professionals including sales personnel; speedy, inexpensive, equitable customer claim procedures; and enforcement of ethical rules on all industry professionals.

We propose an emphasis on self-regulation by the nation's eleven commodity exchanges through streamlined exchange rule-approval procedures; streamlined market-designation procedures; giving exchanges front-line responsibility over speculative limits; and avoidance of duplicative and redundant programs including surveillance and enforcement efforts. When implemented, NFA estimates that it will permit the CFTC to reduce its staff levels by at least one-third and result in a substantial reduction of its 1983 budget request. 

Suddenly the NFA's very existence is being threatened, even before it can justify its existence; before it can produce any of the benefits it was so painfully programmed to perform; before it is even one year old. Its existence is threatened by the CFTC's recent decision—supported by the Office of Management and Budget—to propose a special regulatory tax on all futures market participants including hedgers and market makers.

Mr. Chairman, I am here to plead for the life of the NFA and to impress upon you why the enactment of the CFTC tax is unnecessary, unwise, and incompatible with the premise upon which the NFA was created.  The CFTC's proposed tax would deprive NFA of its funding base, thereby destroying the underlying reason for its creation (to absorb some of the regulatory burdens in a cost efficient manner) and removing the single most effective incentive of a self-regulatory organization (to prevent duplicative oppressive regulation).  Our industry cannot rationally be expected to pay twice for the same regulatory process.  It would make little sense for our industry to fund a self-regulatory organization if the CFTC plan is enacted.

CFTC Chairman Johnson, who for many years has been a foremost protagonist of NFA, was in error when he recently stated "that proponents arguing abandonment of NFA if a fee system is adopted, are largely the same people who earlier opposed NFA for other reasons."

Mr. Chairman, I represent one of the seven organizers of NFA who toiled against bitter odds to give birth to this entity. I am testifying today to respectfully advise you that we cannot in good conscience tell our industry members that NFA would represent the same purpose, the same promise, the same productive result if the CFTC tax system were imposed.

Justice John Marshall said that  "The power to tax involves the power to destroy."  That is clearly the central view of the present Administration.  President Reagan has repeatedly spoken out against burdensome taxation and its destructive force on the private sector.  Succinctly, he set the tone for the Administration by declaring in his State of the Union Address that his plan for recovery is "removing unnecessary regulation to spark productivity."  Moreover, both Republicans and Democrats alike have gone on record against excessive regulation and have urged self-regulation in its place wherever possible. A futures transaction tax is not merely perverse in economic terms and a dangerous incentive for growth of federal economic regulation, it represents the antithesis of the agreed-to theme of both the Administration and Congress.

Ours is not an instance where an industry is shirking its responsibilities.  Quite the contrary.  The futures industry exemplifies the finest tradition of participation in the burden of government.  We are prepared, willing, and capable of sharing the regulatory burden and costs estimated at between 6 to 8 million dollars annually. That sum will no doubt grow over time. However, we are not prepared to duplicate these costs.

We agree with CFTC Commissioner David Gartner who stated "This organization [NFA] will be totally funded by the industry to the tune of millions of dollars annually.  And [NFA] will take over many of the functions performed by the Commission. Having mandated the NFA, I do not believe . . .that the Commission should place an additional burden on market user(s) by way of the transaction tax."

In a separate document of legislative recommendations, NFA has set forth many compelling reasons why a transaction tax is indefensible from the standpoint of economic policy, principles of regulatory reform and legal/ historical doctrines.  This document also contains recommendations that relate directly to NFA's ability to act as a self-regulatory unit and its ability to improve the level and efficiency of regulation at significant cost savings to the U.S. taxpayer. I respectfully request that this document and the accompanying complete text of a Futures Trading Regulatory Improvements Act of 1982 be made a part of the record of these hearings and be given your most serious consideration.

We submit that if NFA were allowed to function and our recommendations implemented, there would be no reasonable or proper fiscal rationale for the imposition of a special regulatory tax on futures transactions.  Not only would a significant cost savings to the Federal Government be accomplished through NFA, not only would the government have advanced its cause in favor of deregulation and on behalf of self-regulation, but it would have avoided the danger seen by Federal Reserve Chairman Volcker when he cautioned "One danger from . . .the imposition of heavy costs [on organized futures markets] is that activity will shift to unregulated channels here and abroad ... ."

NFA is the self-regulatory answer to increased CFTC budget demands in an era of diminishing federal resources.  NFA is an answer that requires no new taxes and that significantly cuts taxpayer costs while actually enhancing the level and quality of customer protection.

To this end, NFA makes the following specific recommendations for Commodity Exchange Act improvements: Provide that NFA can assume the burden of all registration-related functions under the Act at no cost to the government; Provide that NFA's uniform, national arbitration system can effectively supplant the CFTC reparations system at no cost to the government; Direct the CFTC to achieve regulatory efficiency and economy by integrating its programs with private sector programs, avoiding duplication and redundancy and permitting a substantial reduction in its budget or at least a major reallocation of its resources; Repeal current CFTC "user fee" authority hastily adopted in 1978 and replace it with a constitutionally permissible service fee provision to defray CFTC expenses which directly benefit particular recipients (for example, subscription charges, charges for CFTC reports, duplication fees); Prohibit the imposition of futures trading transactions and related taxes on a state and local level since such taxes, wherever imposed, are incompatible with the economic function of futures markets.

We respectfully urge that these recommendations be enacted into law.  Detailed supporting analysis is contained in the bluebook we have submitted to you.

We believe that the CFTC's legislative proposals relating directly to NFA—with the exception of one technical correcting amendment included in NFA's legislative recommendations—are wholly unnecessary and are unacceptable substitutes for NFA's recommendations.  In particular, NFA opposes the proposal that the Commission be empowered to order NFA to perform certain functions relating to registration, as well as the CFTC's recommendation concerning agents.  We strongly endorse the industry recommendation for direct regulation of introducing brokers.  The NFA program already calls for this and we believe the Commodity Exchange Act should as well.

We should remember that the futures markets of the United States have long functioned in the interests of both producers and consumers of agricultural products.  There were agricultural futures markets before the CFTC.  The transference of marketplace risks through futures has contributed to America's enjoyment of a degree of price stability and an abundance of food products unknown elsewhere.  Indeed, our agricultural industry is the marvel and envy of the rest of the world.

In recent years, financial futures have introduced to the business community those same or similar benefits available in agriculture.  These benefits are not inconsiderable in a period such as we live which has witnessed double-digit inflation and extremely volatile movements in interest rates.  Financial futures have quickly become a valuable and indispensable asset to business and money managers in our financial community.  Indeed, financial futures are modern-day examples of the validity of the adage that "necessity is the mother of invention."

We should also recall that the futures exchanges of the United States are among the oldest continuously existing financial institutions of the Western World.  The youngest major exchange is more than fifty years old while the oldest dates back almost a century and a half.  Few institutions in any field of commerce approach—much less equal—that record. The longevity of our exchanges is a direct result of the stern discipline imposed internally by the members themselves.  Long before there was even a suggestion of governmental oversight for the exchanges, the members were making and enforcing stringent rules to protect and defend the integrity of the markets.  Those rules have no parallel in other sectors of business.  Few industries can boast—as we can—that no single dollar of the public's money was ever lost as a result of a failure or insolvency of an exchange member firm. The NFA is proud to become a part of this great tradition of self-discipline and self-regulation.  NFA is willing and able to bear its share of the burdens and costs if just given a chance.

Finally, our economic, social, and political systems are already staggering under the excesses of those who trust government regulation and distrust freedom.  Of late, however, there is a general recognition that this country and the Congress must move in the direction of lessening the burdens of regulation. The CFTC's bill—including its tax plan—is a giant step in the opposite direction.  I do not believe that the members of this Committee will want to add to the burdens already imposed upon our free and functioning futures markets by supporting such legislation.  It is a measure that is ill-conceived and ill-considered.  If enacted, it could only have the worst of ill effects.

NFA respectfully urges Congress to reject the CFTC's legislative and taxing plan. We urge you to choose the NFA alternative instead. This alternative is the only sensible and certain means to lower the costs and burdens of federal regulation while at the same time assuring that the public interest is well protected.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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