FINRA recently issued an Investor Alert, “Investing with Borrowed Funds: No ‘Margin’ for Error,” warning investors about risks of trading on margin. When an investor uses margin, he or she is essentially using a loan from the firm to purchase securities. FINRA explained that it was re-issuing the Investor Alert, because investor purchases of securities on margin averaged more than $406 billion for the first nine months of 2013 – a 27 percent increase over the same period last year. FINRA stated that “we are concerned that many investors may underestimate the risks of trading on margin and misunderstand the operation and reason for margin calls. Investors who cannot satisfy margin calls can have large portions of their accounts liquidated under unfavorable market conditions. These liquidations can create substantial losses for investors.”
The Investor Alert urges investors to understand the following risks associated with margin:
- Your firm can force the sale of securities in your accounts to meet a margin call
- Your firm can sell your securities without contacting you
- You are not entitled to choose which securities or other assets in your accounts are sold
- Your firm can increase its margin requirements at any time and is not required to provide you with advance notice
- You are not entitled to an extension of time on a margin call
- You can lose more money than you deposit in a margin account
The Investor Alert explains “[w]ith a margin account, you can borrow money from your brokerage firm to purchase securities. The portion of the purchase price that you must deposit is called margin and is your initial equity or value in the account. The loan from the firm is secured by the securities you purchase. If the securities you’re using as collateral go down in price, your firm can issue a margin call, which is a demand that you repay all or part of the loan with cash, a deposit of securities from outside your account, or by selling some of the securities in your account.”
In addition, the Investor Alert cautions that “[b]uying on margin amounts to getting a loan from your firm. When you buy on margin, you must repay both the amount you borrowed and interest, even if you lose money on your investment. Some brokerage firms automatically open margin accounts for investors. Make sure that you understand what type of account you are opening. If you don’t want to trade on margin, choose a cash account for your transactions.”
The Investor Alert also encourages investors to “Do Your Margin Homework” and consider the following:
- Make sure you fully understand how a margin account works. If you don’t, limit your investments to a cash account. Cash accounts are not subject to margin calls. It is important to take time to learn about the risks involved in trading securities on margin. Consult with your broker about any concerns you may have with your margin account.
- Know the margin rules…To learn more, read FINRA Rule 4210 and Regulation T.
- Know your firm’s margin policies. Read your firm’s margin agreement and margin disclosure statement. Be sure to ask whether you will automatically be placed into a margin account and, if so, what the rate of interest will be and what circumstances would trigger a margin loan. Speak with your broker or check your firm’s website for any changes in margin policies. Firms can make changes at their discretion, and are more likely to do so in volatile markets.
- If you use a margin account, you may not want to use all your available money to trade securities in your margin account. For example, you may want to keep some money in a checking or savings account so that you can promptly meet a margin call.
- Manage your margin account. Margin accounts require work. Monitor the price of the securities in your margin account on a daily basis. If you see that the securities in your account are declining in value, you may want to consider depositing additional cash or securities to attempt to avoid a margin call. If you receive a margin call, act promptly to satisfy the margin call. By depositing cash or selling securities that you choose, you may be able to avoid your firm liquidating or selling securities it chooses.
Sonn Law Group specializes in representing investors (not brokerage firms) in securities arbitration and investor fraud cases throughout the country. Sonn Law Group has represented numerous investors in FINRA arbitration claims against the brokerage firms who sold illiquid, high-commissioned, non-traded investments, including TICs, REITS, promissory notes, and more, as well as investors who have been encouraged to use margin or other borrowed money to purchase securities. To learn more, including whether you may have a claim for investments related to the use of margin or other investment losses, please call us at 844-689-5754 or complete our “contact form.”