CFTC vs SEC vs NFA

The U.S. has multiple regulators to ensure the integrity of its financial system: the Federal Reserve, the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Consumer Financial Protection Bureau (CFPB), the National Futures Association (NFA), the Federal Deposit Insurance Corporation (FDIC) , the Financial Industry Regulatory Authority (FINRA), and the Treasury, etc. Within that group, three regulators stand out for overseeing retail brokers and protecting traders: the CFTC, NFA and the SEC.

Let’s examine each one more closely, understand their roles, and consider how they affect the industry and traders.

CFTC—An Introduction

All Forex and futures brokers offering services to U.S.-based clients must be registered with the Commodity Futures Trading Commission (CFTC) and comply with its standards. The agency regulates the U.S. derivatives markets, including futures, swaps, spot Forex and specific options.

The CFTC’s vision is to be “the global standard for sound derivatives regulation,” with a mission to “promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.” It operates under the Commodity Exchange Act (CEA) statutory framework to protect market users and the public from fraud, manipulation, abusive practices, and systemic risk.

The CFTC delegates much of its oversight operations to the National Futures Association (NFA). For example, it requires retail Forex brokers offering services in the U.S. to be members of the NFA.

The CFTC’s Division of Enforcement (DOE) has filed hundreds of enforcement actions and ordered billions of dollars in enforcement relief from firms breaking its rules. For example, famously in the Forex world in 2017, the CFTC fined one of the largest Forex brokers, FXCM, for fraudulent activities and barred them from operating in the U.S. They also operate a whistleblower program that accepts complaints directly from the public about suspicious activity, paying whistleblowers a percentage of sanctioned money—the program has paid out hundreds of millions of dollars in its history.

The CFTC publishes a “RED List” of foreign brokers that are not registered but appear to offer services in the U.S. that require CFTC registration. Individuals can check CFTC and NFA registration through the NFA verification system, BASIC.

Pros & Cons for Traders Using CFTC-regulated Brokers

Pros

CFTC regulations set minimum standards to help minimize the risk of fraud, give clients a transparent and fair marketplace and ensure the stability of the broker. Measures include:

1. Segregated accounts, i.e., keeping customer funds in accounts separate from the firm’s money. This is the most crucial requirement for ensuring the safety of client funds.
2. Pricing must be reasonably related to current market prices and conditions. Brokers must execute market or limit orders at or near the price at which other customers’ orders have been executed during the same period. Any slippage must be based on real market conditions.
3. Automatic rollovers must comply with the terms disclosed in the customer agreement.
4. Minimum capitalization. Brokers must maintain a $20 million security deposit (significantly higher than any other global regulators). As a result, only larger and well-capitalized brokers choose to offer services to U.S. clients, and smaller and potentially less stable brokers focus on different parts of the world.
5. Data security. Brokers must keep customer orders and personal information confidential.

Cons

1. The CFTC restricts retail Forex leverage to 50:1 for major Forex pairs (EUR/USD, GBP/USD, USD/JPY, USD/CAD, USD/CHF, AUD/USD, NZD/USD, USD/SEK, USD/NOK, and USD/DKK) and 20:1 for minor Forex pairs.
2. No hedging. The CFTC does not permit holding two opposing positions in the same currency pair.
3. First in, First Out (FIFO) requirement. Traders must liquidate positions in the order they were opened in a currency pair. For example, if I opened two positions in EUR/USD, I must close the first one before closing the second one.

NFA—An Introduction

Membership in the National Futures Association (NFA) is mandatory for all Forex and futures brokers offering services to U.S.-based clients. The NFA is the self-regulatory organization (SRO) for the U.S. derivatives industry, including futures traded on exchanges, Forex, and swaps. The NFA and CFTC are closely related—the CFTC created the NFA in 1981, and the CFTC delegates much of its oversight operations to the NFA.

The NFA’s chief responsibilities include registering firms and individuals wanting to do business in the U.S. derivatives industry, monitoring trades, creating rules and best practices, taking disciplinary actions, mediating disputes between brokers and their clients, and protecting investors.

The NFA provides an easy way to check membership through its online verification system, BASIC, using the broker’s NFA ID, firm name or other identifying information.

Pros & Cons for Traders Using NFA-registered Brokers

Given that the NFA carries out much of the CFTC’s oversight operations and that futures and Forex brokers offering services in the U.S. must be both CFTC-regulated and NFA-registered, many of the same advantages and disadvantages apply to both CFTC and NFA registration. It’s worth reading the pros and cons of the CFTC section as well, when looking at the advantages and disadvantages of NFA registration.

Pros

1. NFA membership confirms the broker has a minimum level of capitalization, which helps ensure the broker’s financial stability.
2. NFA-member brokers must keep client money in segregated accounts separate from the company’s operation.
3. Trade execution must be fair and transparent. Brokers must execute client orders at or near the price of other customers’ orders during the same period, and slippage must be based on real market conditions.
4. NFA-registered brokers will have procedures to safeguard the confidentiality of client information.
5. Clients can utilize the NFA’s dispute resolution channel and potentially avoid lengthy legal processes.

Cons

1. The most impactful negative aspect of NFA registration is that all the CFTC trading restrictions apply, principally, restricted retail Forex leverage (50:1 for Forex major pairs and 20:1 for Forex minor pairs), no hedging (i.e., not having a simultaneous long and short position on the same currency pair), and First-In-First Out (FIFO) rules, which dictate the order in which multiple positions on the same currency pair can be closed.
2. NFA dispute resolution may not always be swift and does not guarantee a satisfactory outcome.
3. NFA membership does not guarantee that a broker will always act in the best interests of their clients.

SEC—An Introduction

As its name suggests, the Securities and Exchange Commission (SEC) regulates the U.S. securities industry, which includes stocks, bonds and some associated derivatives. Brokers offering these securities must be registered with the SEC.

The SEC oversees the Financial Industry Regulatory Authority (FINRA), the largest independent regulator for firms doing securities business in the United States. Brokers conducting securities transactions (e.g. equities) must also be registered with FINRA.

Pros & Cons for Traders Using SEC-registered Brokers

Because securities brokers must be SEC and FINRA-registered, I will cover the pros and cons of both entities.

Pros

1. Tough regulation: SEC-registered brokers must follow strict SEC rules and regulations, which help protect clients from fraud and malpractice. Brokers are subject to regular audits and reviews. Misconduct can lead to fines or license revocation.
2. Disclosure: Brokers must disclose fees, ensure communications with the public are accurate and not misleading (FINRA Rule 2210), and provide customers with accurate and timely account statements (FINRA Rule 2231).
3. SEC registration: This gives clients access to public securities and IPOs unavailable through non-SEC-registered firms.
4. No predictions: FINRA prohibits brokers from guaranteeing that customers will not lose money, making specific price predictions, or trading ahead of customer orders (known as “front running.”)
5. Dispute resolution: Clients can use FINRA’s arbitration process in disputes. It is the largest dispute resolution forum in the securities industry.
6. Suitability (FINRA Rule 2111): Brokers must make recommendations suitable for the customer’s investment objectives, financial situation, and risk tolerance. This rule is more relevant when seeking investment advice rather than execution-only services.

Cons

1. Although SEC-registered firms must disclose fees, the fee structure can still be complex and challenging to understand without digging into the disclosures.
2. SEC-registered brokers follow a suitability standard, meaning they recommend products that are “suitable” based on the customer’s profile. However, that does not guarantee they will be in the client’s best interest. For example, an advisor may recommend a product because it generates a higher commission. This issue is more applicable when seeking investment advice rather than execution-only services.

My Take

The SEC, CFTC, and NFA combined provide comprehensive oversight of the financial markets, covering equities, bonds, Forex, futures contracts traded on exchanges, and specific options contracts. Individuals wishing to trade these instruments in the U.S. will use a broker regulated by one of these bodies. However, traders do not get to choose how the broker is regulated. For example, if I wish to trade stocks, a U.S. broker will be SEC-registered. If I wish to trade Forex from the U.S., the broker automatically overseen by the CFTC and NFA.

Although these bodies can restrict how individuals can trade, for example, by restricting leverage on some instruments, the oversight they provide is invaluable to ensure that brokers execute trades fairly, keep client funds in segregated accounts and respect confidential data. This gives U.S. traders one of the safest environments in which to have brokers and trade.