As volatile market conditions continue and seem to be accelerating on a daily basis, questions are being increasingly raised regarding the risks posed to investors and the relationship of margin to those risks.
Investors who sign a margin agreement can borrow up to 50% of the purchase price of marginable investments (the exact amount varies depending on the investment). Said another way, investors can use margin to purchase potentially double the amount of marginable stocks than they could using cash. In the same way that a bank can lend you money if you have equity in your house, your brokerage firm can lend you money against the value of certain stocks, bonds and mutual funds in your portfolio. That borrowed money is called a margin loan, and it can be used to purchase additional securities.
Each brokerage firm can define, within certain guidelines, which stocks, bonds and mutual funds are marginable. The list usually includes securities traded on the major U.S. stock exchanges that sell for at least $5 per share, though certain high-risk securities may be excluded. Also, keep in mind that you can’t borrow funds in retirement accounts or custodial accounts.
All investors must be aware that the sudden change in the market value of a security may result in an unexpected margin call and a customer’s failure to meet the call may cause the firm to liquidate the securities in his or her account. The financial consequences of a margin call or an account liquidation may be most severe to customers with accounts at retail brokerage firms in view of the fact that their accounts may be more likely to be subject to liquidation.
Although all brokers and investment advisors have the obligation to ensure that any account which is being traded on margin is suitable and appropriate for their customers based on their investment objectives and risk tolerance, investors must recognize the significant risks that are associated with margin accounts.
These risks, which must be fully explained by brokers and investment advisors – and understood by their clients – include the fact that: you can lose more money than you have invested; you may have to deposit additional cash or securities in your account on short notice to cover market losses; you may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities; your brokerage firm may sell some or all of your securities without consulting you to pay off your margin loan; you may not be entitled to choose which securities your brokerage firm sells in your accounts to cover your margin loan; your brokerage firm may increase its margin requirements at any time and may not be required to provide you with advance notice of the increase; and you may not be entitled to an extension of time on a margin call.
If you are an investor that suffered loss on margin, you should consider all legal options. If you wish to discuss your particular situation and the potential for the recovery of your investment losses, or you have information of interest, please contact us for an evaluation of your potential case.