Security Futures Products: A Regulatory Guide - National Futures ...

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What are Security Futures? Security futures products are futures whose underlying instrument is either a single security or a narrow-based security index. Security futures do not include futures on broad-based stock indices, such as the Dow Jones Industrial Average, the Nasdaq indices, the NYSE Composite, and the S&P 500 that currently trade on futures exchanges. These indices are regulated by only the CFTC and must be traded through a futures firm. Security futures products do not represent ownership in a corporation and, therefore, the owner of the security futures contract is not regarded as a stockholder and does not receive dividends or invitations to stockholder’s meetings. Security futures may be traded on a variety of facilities, including registered securities and futures exchanges and alternative trading systems. Like other futures contracts, security futures are currently not fungible (i.e., you must liquidate a specific security futures contract on the same exchange where you purchased it). Futures on Single Securities Futures on single securities can involve a single stock, an exchange-traded fund, or another type of security jointly authorized by the CFTC and the SEC. For example, if a customer purchases a December 2003 contract on XYZ stock at the current futures price, the customer has entered into a legally binding agreement to buy XYZ stock in December 2003. Futures on Narrow-Based Security Indices In this case, a customer purchases a futures contract for a stock index that represents only a small part of the market. The indices may include stocks from particular industries such as telecommunications or airlines. This allows customers to trade in a specific market sector. For example, if a customer purchases a December 2003 contract on the ABC index, the customer has entered into an agreement to buy the underlying stocks in December 2003 in the proportions included in the index. An index is considered a narrow-based security index if it has any one of the following characteristics: • The index consists of nine or fewer component securities; • One stock constitutes more than 30 % of the index’s weighting; • The five highest weighted stocks comprise more than 60 percent of the index’s weighting; or • Securities in the lowest 25 % of the index’s weighting fall below specified thresholds of average daily trading volume. Additional Resources For more detailed information about the specific security futures products that are currently traded, we recommend that you consult the various exchanges that offer these products. We have included a list of these exchanges in Appendix 2 of this Guide. - 2 -
Registration and Proficiency Requirements Because security futures products are securities as well as futures, the CFMA gave the CFTC and the SEC joint jurisdiction over them. As a result, brokerage firms must be registered with both agencies in order to offer and trade these products. FCMs and IBs If your firm is a registered FCM or IB that is also fully registered with the SEC as a broker-dealer, it has no further registration obligations. If your firm is not currently registered as a broker-dealer, it must noticeregister by filing a Broker-Dealer Notice Registration Form (Form BD-N) with NFA. You can download this four-page form directly from NFA’s Web site (www.nfa.futures.org). There is no filing fee and the firm’s notice-registration is effective upon filing as long as the form is complete and the eligibility requirements are met. If your firm notice-registers as a broker-dealer, it will be exempt from some requirements of the securities laws that duplicate futures requirements. These include financial requirements, prohibitions on certain exchange members doing both proprietary and customer trading, and risk assessment rules. Also, your firm is not required to become a member of NASD since the firm’s securities business must be limited to offering and trading security futures products. Similarly, broker-dealers who are not currently FCMs or IBs can notice-register as FCMs or IBs if they are registered with the SEC as full-fledged brokerdealers and members of NASD. These firms notice-register with the CFTC on Notice Form 7-R, which is two pages long. Again, you can download the form from our Web site and file it with NFA. There is no fee, and registration is effective upon filing. CPOs For CPOs and CTAs, SEC registration is not automatically required. If you are a CPO, you may be required to register a fund as an investment company and yourself as an investment adviser if the fund’s security futures activities (combined with its other securities activities) bring it within the Investment Company Act’s definition of investment company, although hedge fund exemptions apply. Persons operating hedge funds and investment companies must register as CPOs if they trade security futures and do not qualify for an exemption from CPO registration. NFA Members need to check to see if the fund manager is either registered as a CPO and a Member of NFA or is exempt from registration before approving a fund account to trade security futures. We have included some common questions and answers based on inquiries NFA has received from fund operators and advisors. Please see Appendix 3, Security Futures Issues for Fund Managers and Advisors, at the end of this Guide. - 3 -
Page 1 and 2: N A T I O N A L F U T U R E S A S S
Page 3: Introduction The Commodity Futures
Page 7 and 8: Again, you may use the Web-based pr
Page 9 and 10: Customer Account Information Althou
Page 11 and 12: a commodity pool operator exempt fr
Page 13 and 14: Account Approval • A DSFP must ap
Page 15 and 16: Promotional Material General Inform
Page 17 and 18: Promotional Material for a Mass Aud
Page 19 and 20: NFA recognizes that speed of execut
Page 21 and 22: Insider Trading Some types of insid
Page 23 and 24: Appendix 1: Selected Listing of NFA
Page 25 and 26: Appendix 2: Sources of Additional I
Page 27 and 28: to the advisors for these funds. Th
Page 29 and 30: Appendix 5: Guidance on Procedures
Page 31 and 32: • Direct compliance personnel to

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