Nichols, who was released by the Western Sydney Wanderers last Thursday, was allegedly at a nightclub in Double Bay during a random drug sweep by police.
Just before 12:30am on Saturday the 28-year-old was arrested at a night club on Cross Street, Double Bay, believed to be Casablanca, during a drug dog operation.
Police allegedly located three small, clear, resealable plastic bags containing 1.1 grams of a white powder believed to be cocaine.
Nichols was issued with a field court attendance notice for possession of a prohibited drug. He is due to appear in the Downing Centre local court on Friday the 9th of June.
"FFA takes matters such as this very seriously," a Football Federation Australia spokesperson said.
"The matter has been referred to the FFA Integrity Department, which has spoken to the club, and will be dealt with under the FFA Code of Conduct."
The Wanderers released a statement on Tuesday saying they were working with Football Federation Australia regarding the incident.
"Western Sydney Wanderers Football Club is aware of the police matter involving former player Mitch Nichols at a Sydney nightclub late last week," the statement read.
"The club is currently working with Football Federation Australia regarding the matter.
"The Western Sydney Wanderers remain totally committed to it's anti-drugs stance and will continue to reinforce the club’s zero-tolerance message.
"While Mitch was released by the club prior to the incident, the player's well-being remains a priority and every support will be offered to him during this time."
The controversy has been Nichols' playing future in doubt.
It has been reported he was bound for a Europe move, with a deal to be announced imminently. Now there will be a cloud over any potential deal.
The Wanderers last Thursday announced the departures of captain Dimas Delgado, vice-captain Nichols, Perth Glory-bound Scott Neville, Uruguayan midfielder Bruno Pinatares, veteran attacker Ryan Griffiths and young trio Liam Youlley, Stefan Zinni and Emilio Martinez.
They join Mario Shabow, who has signed for Newcastle Jets, and foundation player Shannon Cole, who flagged his departure earlier last week.
Nichols, whose contract with the Wanderers officially expires at the end of this month, exits the club after 63 appearances.
Western Sydney was his fourth club, following stints with Perth Glory, Melbourne Victory and Brisbane Roar, where he won two grand finals.
Nichols has also played five times for the Socceroos, with his most recent cap coming in November 2014 against Japan.