Many individual and institutional investors received bad news this spring— large margin calls. According to the Financial Times, these investors are preparing possible legal actions against U.S. banks active in wealth management. This is unwelcome news to such banks who routinely offer margin loans to their customers, such as JPMorgan Chase, UBS, and Goldman Sachs. According to the Financial Industry Regulatory Association (“FINRA”) investor purchases of securities on margin averaged over $592 billion during the first 10 months of the last year. Merrill Lynch, Morgan Stanley, UBS, and Wells Fargo all reported increases in their client loan balances last year.
What Claims Do I Have for and Improper Margin or Margin Call?
There are several ways investors can recover on claims relating to improper margin or margin calls. If losses were incurred as a result of securities being sold on a margin call, it may be possible to make a claim asserting that the broker or firm should have first asked the customer to pay the loan through another source, deposit in more cash or securities, or allow the customer to choose what investments to sell to pay the margin call. It is also possible to bring a claim for losses if the margin loan given to the customer was an unsuitable investment strategy or too risky for the investor’s objectives. Finally, if a brokerage firm has sued you to collect on an unpaid margin loan, there are a number of defenses to this claim which can be raised. Please call us today or use our online contact form, for a free consultation.
How Does a Margin Call Work?
A “margin account” is a type of brokerage account in which the broker-dealer lends the investor cash, using the account as collateral, to purchase securities. Margin increases an investor’s purchasing power but also exposes investors to the potential for larger losses.
The mechanics of how a margin call works are simple. When stocks fall, brokers can be forced to call up clients and ask for more cash or securities to secure the margin loan. Under some contracts, brokers can sell the investments in the account to pay the margin loan even without first calling the client.
The Securities and Exchange Commission has published an investor alert explaining to investors how margin accounts work.
You Should Understand How Margin Works
Margin loans are a tool that allows customers to leverage their accounts to make a greater return. Let’s say you buy a stock for $50 and the price of the stock rises to $75. If you bought the stock in a cash account and paid for it in full, you’ll earn a 50 percent return on your investment (your $25 gain is 50% of your initial investment of $50). But if you bought the stock on margin – paying $25 in cash and borrowing $25 from your broker – you’ll earn a 100 percent return on the money you invested (your $25 gain is 100% of your initial investment of $25). You may also owe your broker interest on the $25 you borrowed.
There is a downside to using margin, which is riskier than a cash account. If the stock price decreases, you can quickly lose your money. For example, let’s say the stock you bought for $50 falls to $25. If you fully paid for the stock, you’ll lose 50 percent of your money (your $25 loss is 50% of your initial investment of $50). But if you bought on margin, you’ll lose 100 percent (your $25 loss is 100% of your initial investment of $25), and you still must come up with the interest you owe on the loan. Many investors cannot afford to takes this type of gamble with their funds.
Your Brokerage Firm May Sell Your Stock to Cover a Margin Call Without Notice to You
Some investors have been shocked to find out that their brokerage firm has the right to sell their securities that were bought on margin – without any notification to them and potentially at a substantial loss. If your broker sells your stock after the price has plummeted, then you’ve lost out on the chance to recoup your losses if the market bounces back. You may also suffer additional losses in that you have to pay back the loan and may not be able to get the benefit of any of the proceeds from the forced sale.
Buying or Holding Stocks Using Margin Loans Is not Suitable for Everyone
For people with limited financial means or those who are retired and living on a fixed income, investing in securities using margin may not be a suitable investment strategy. You should ask your broker whether trading on margin is appropriate for you in light of your financial resources, investment objectives, and tolerance for risk.
As you can see, the margin can be risky and is not appropriate or suitable for everyone.
If you believe that you or a loved one has been harmed by investing on margin, have been sued on a margin call, or been harmed by any other type of investment fraud or investment scam, contact our offices today for a free consultation. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers will evaluate your claim at no cost to you. Contact us by filling out our online contact form, or calling 888-768-2499.