Series 3 License: A Career With No Limits

There are two career paths that one can take when deciding to become an investment professional. The traditional path of trading or buying and selling securities (like stocks and bonds) can be pursued by taking a test known as the Series 7. This test is administered by the Financial Industry Regulatory Authority (FINRA) and is considered one of the most difficult tests you can take to obtain a professional license.

While the Series 7 is important, it does limit professionals to offering only a narrow sector of investments to their clients. The second, lesser-known career path involves taking the National Commodity Futures Examination, otherwise known as the Series 3 test. This test allows anyone in the U.S. the ability to offer alternative investments in commodities and futures securities.

TUTORIAL: Futures Trading 101

The Series 3 examination is the all-encompassing test that is required by the National Futures Association (NFA) and the Commodities Futures Trading Commission (CFTC) in order to be considered a commodities and futures professional. Stockbrokers can hold both a Series 7 and a Series 3 license simultaneously, but if they don't, they are required by law to refer a client interested in commodities and futures on to a licensed Series 3 representative. (To learn more about these tests, check out "Putting Licenses to the Test.")

The Series 3 test is administered in two parts:

1. Market knowledge

2. Regulatory knowledge

Because the Series 3 exam is so thorough in covering the needs of people that do use commodity and futures trading, the CFTC gives those that pass wide latitude in what investment vehicles they can offer to their clientèle. This leads many newly licensed Series 3 brokers to be content with passing the test and becoming associated persons (APs). This does not have to be the case. A newly minted AP can immediately go one of two routes in their commodities career, in the form of either a branch manager or an introducing broker.

There are several other related exams that can be taken which will allow varying degrees of professional responsibility:

• The Series 30 (Branch Manager Test)
• The Series 31 (Futures Managed Funds Test)
• The Series 32 (Limited Futures Examination)

Branch Manager
In order to become a branch manager, an AP must pass the Series 30 examination. The test is comprised of only 50 questions that measure your understanding of a wide range of NFA and CFTC rules regarding marketing, regulatory issues and customer requirements. Once completed, you have the ability to oversee other APs, while handling the day-to-day operations of your own commodities branch office. By taking the test to become a branch manager soon after taking the Series 3, you would have the advantage of what was recently learned for the regulatory section of the Series 3, and this can make the branch manager exam easier to pass.

If you are an entrepreneurial type who is willing to strike out on your own and go beyond managing a branch, you can register with the NFA as an introducing broker (IB).

Introducing Broker
Becoming an IB does not require any additional licensing beyond passing the Series 3. Like a branch manager, you will be able to oversee APs in your office, but unlike a branch manager, you assume all of the liability and rthe ewards of obtaining and working with clients directly.

Not just anyone can set up shop as an IB. The only way you can obtain the IB designation (or any of the other designations listed in this article) is by going through the NFA. The NFA requires a fee, certain capital requirements and periodic reporting requirements for IBs, Commodity Trading Advisors (CTA), Commodity Pool Operators (CPOs) and Futures Commission Merchants (FCMs).

If you plan to become an IB, you can set up your business in one of two ways:

• "Guaranteed" IBs
  The majority of APs making the transition from being simply a commodities broker to becoming a brokerage firm typically decide to become "guaranteed" by an FCM. By agreeing to be an guarantor, an FCM not only handles all of the customer funds and trading operations, it also vouches for the IB, reducing the need for the IB to have any capital requirements, while at the same time putting the IB into an exclusive relationship with the FCM that is guaranteeing it.
• "Independent" IBs
  The second way to set up an IB is to become independent. Independent IBs still rely on FCMs to handle their trading operations, but instead of having a captive relationship, the IB and their clients can have multiple relationships with as many FCMs as they choose. Over the years the NFA has instituted various capital requirements that an IB must maintain in order to have the privilege of being independent. This has varied in price from $25,000 or greater and has the potential to become more costly in the future. The key benefit is that IBs can negotiate the best commission rates possible from the various FCMs because of the forced competition for the IBs' business. This can increase the IBs' profits while passing on better savings to their customers.

There are also those people that take the Series 3 test who feel that they have unique insight into how the markets work. They feel like they have the ability to manage their clients' money and would rather gain a percentage of the profits, instead of just earning a commission on the transactions. Those APs that want to go in this direction can actually apply to become a CTA or CPO with the NFA. IBs can also register their firm or set up a sister company to handle these money management services.

Commodity Trading Advisors
By obtaining the CTA designation, an AP has to register with both the CFTC and the NFA. A CTA has the ability to register with the CFTC and not the NFA, but not the other way around. If an AP registers as a CTA only with the CFTC, he or she is allowed to give general trading advice, put out newsletters and make recommendations, but cannot handle clients' money. This is known in the business as a being an "educational" CTA. If you wish to actively manage client funds, then you must register with NFA as a CTA, pay additional fees and adhere to a strict set of rules and regulations.

The NFA requires that CTAs who handle clients' funds must let potential clients know how successful they are in managing money. Both the successful accounts and the unsuccessful accounts must be transparently represented in order to give new clients the best representation of how the manager operates. Another strict rule is that CTAs must maintain segregated accounts for each client that they manage money for. This requires that each account has orders independently executed and trades must be allocated to each client's account in order to properly attribute gains and losses. In this way, the CTA is much like the commodities equivalent of a registered investment advisor for an individual's stock and bond portfolio.

In exchange for all of this extra work, CTAs are able to collect a management fee and a performance fee. The management fee is typically 2% of all of the assets under management, and the performance fee can range from 20% to upwards of all of the new money raised. As CTAs build their business, there is no limit to the amount of capital that they can have under management ... if they are good managers.

Commodity Pool Operators
Another type of money management professional is the CPO. CPOs are able to collect the same management and performance fees as CTAs, but instead of having to track each client individually, they are able to aggregate all of the capital under one account and allocate returns according to the percentage that each investor owns.

There are two types of CPOs: public and private. Public CPOs must jump through a lot of hoops with both the CFTC and Securities and Exchange Commission (SEC) to be listed on any of the exchanges and raise money. Private CPOs are able to use SEC Regulation D, which governs private placements, in order to raise funds from accredited investors only.

An AP or an IB may end up creating enough of a client base over the years to fund his CTA or CPO operations without ever having to market or raise too much outside capital. For APs that have been in the business for years, this is simply one of many logical steps to increase their value in the eyes of their clients and to raise their status among their peers. As a CTA or a CPO, you can operate on par with an IB by hiring your own APs to promote and market your services, paying them bonuses as they acquire clients.

The Series 3 is just one way to access the world of commodities for your clients. Stockbrokers that want to narrow their work to helping CTAs and CPOs raise capital can take the Series 31 Exam, which has only 45 questions. Once completed, stockbrokers can introduce their clients to the alternative world of futures and commodities investing while still fulfilling their fiduciary responsibility.

Those stockbrokers or commodities brokers that are licensed in the United Kingdom can enter the United States structure of futures by simply taking the Series 32. Once they pass the Series 32 they can then be an IB, CTA, CPO or FCM.

Becoming a commodities or futures broker does not have to end with passing the Series 3. That is just your gateway to managing other brokers, setting up your own brokerage firm and/or managing client funds. This is a career where the sky is the limit. A commodities broker can transition from making a small percentage of the commission charged for every transaction all the way to running his or her own money management firm, which could generate millions in income for themselves and their clients.

Keep reading on this subject in "Fatten up Your Take-Home Pay in 4 Easy Steps."