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Margin Calls

The use of margin exposes an investor’s portfolio to greater risk and costs. Margin interest increases the breakeven point for any investment strategy. The breakeven point for a portfolio is defined as the rate of return required to breakeven. The portfolio cost ratio is the measurement of the breakeven rate of return which includes all costs, including commissions and margin interest. When margin is used, the net rate of return that is required to equal a more conservative investment strategy is greater. This fact must be weighed carefully and disclosed by your financial advisor. Some financial advisors recommend the use of margin to diversify. According to academic studies, the use of margin to diversify a portfolio does not reduce the overall level of portfolio risk. The use of margin in many situations is considered unsuitable investment advice.

Financial Incentives to Recommend Margin

Major Wall Street brokerage firms provide financial incentives to brokers who recommend the use of margin in brokerage accounts because the lending activities are a huge source of profits. The margin loans are fully collateralized with no chance of default because of the protections provided to the brokerage firm in the margin agreements. The margin agreement and Federal Reserve lending regulations create a risk free lending business model for brokerage firms. For these profits, substantial financial incentives are paid to financial advisors whose clients’ accounts have margin loans.

Know the Risks of Margin Calls

Margin accounts are very risky and are only suitable for sophisticated investors who can assume the substantial risk of loss in principal. Before an investor uses margin, they should understand that:

  • they can lose more money than their initial investment;
  • they may have to deposit additional cash or securities in their
    account immediately to meet margin calls;
  • they may be forced to sell some or all of their account
    positions to meet margin calls; and
  • brokerage firm may sell some or all of your securities without
    consulting you to meet margin calls.

You can protect yourself by knowing how a margin account works and what happens if the price of the stock purchased on margin declines. A financial advisor should calculate the decline in account value that will trigger a margin call. A financial advisor should recommend the use of risk management strategies in brokerage accounts subject to the risks of margin calls.

Margin abuse exists when brokerage firms and their financial advisors recommend the unsuitable use of margin which results in greater risks and costs to investors. If you have had margin calls or paid a significant amount of margin interest over the life of the account, you may have a legitimate claim for damages. To consider whether you are the victim of margin abuse, consider the following FAQs.

Frequently Asked Questions:

Q: What is the margin maintenance ratio?

Q: I was advised to manage all my personal finances through my brokerage account. I purchased an automobile and paid for my kids living expenses in college with credit cards that accessed my brokerage margin account. When my account value dropped I was required to meet margin calls from loans taken for personal expenses, do I have a viable claim for damages?

Q: When my brokerage account had a margin call, my broker informed me that the shares that traded below $5 were no longer eligible as collateral, is this correct? What other securities are not eligible as collateral?

Q: My broker advised the use of margin to trade options in my account. He used margin to close out my positions for losing trades and he continued this strategy until I faced margin calls. What claim do I have for damages?

Q: How do I determine whether I have a viable Securities Arbitration Claim?

 


Q: What is the margin maintenance ratio?
The margin maintenance requirement ratio is the lowest level of account equity allowed before a margin call is triggered. The margin maintenance requirement ratio for most brokerage accounts comprised primarily of stocks is 30%.


Q: I was advised to manage all my personal finances through my brokerage account. I purchased an automobile and paid for my kids living expenses in college with credit cards that accessed my brokerage margin account. When my account value dropped I was required to meet margin calls from loans taken for personal expenses, do I have a viable claim for damages?
The recommended use of margin for personal expenses is unsuitable. There are no advantages from an interest cost or tax deductibility perspective. The use of margin results in portfolios that are over invested without any allocations made in cash to meet scheduled and expected expenditures. Even though the increased risk to the portfolio might be considered a result of your own actions, the broker should have discussed the risks of margin calls and recommended risk management strategies to prevent margin calls.


Q: When my brokerage account had a margin call, my broker informed me that the shares that traded below $5 were no longer eligible as collateral, is this correct? What other securities are not eligible as collateral?
Yes, it is correct. Certain securities are not eligible to meet margin maintenance requirements, such as, low price stocks, stock warrants and right, restricted Rule 144 stock, variable annuities, non-publicly traded REITs and Private Placements.


Q: My broker advised the use of margin to trade options in my account. He used margin to close out my positions for losing trades and he continued this strategy until I faced margin calls. What claim do I have for damages?
In situations where an investment strategy involves high risk and speculation a review of new account documents is important to determine whether it is suitable. Factors to consider are stated investment objectives, risk tolerance, net worth relative to the size of the account, past investment history and holdings in contemporaneous accounts. If it is apparent to an arbitration panel that you are unsophisticated and the broker controlled the account activity, you are likely to have a successful outcome.


Q: How do I determine whether I have a viable Securities Arbitration Claim?
Take the Following Steps to Begin the Recovery of Your Investment Losses:

  • Contact Our Legal Team to complete a Case Facts Summary
  • Schedule a time For an Interview with an Industry Expert
  • Gather Critical Case Documents
  • Complete Risk Tolerance Assessment
  • Assess Account Damages and Financial Advisor Misconduct
  • File Statement of Claim for Securities Arbitration