In an Investor Alert that was issued on November 8, 2018 (“Know What Triggers a Margin Call”), the Financial Industry Regulatory Authority (“FINRA”) warned investors that “volatility is back, and market swings can sometimes bring an uncomfortable surprise to investors – a margin call.”
When an investor purchases stock on margin, the investor’s brokerage firm is lending the investor cash, using assets in the investor’s account as collateral, which is then used to purchase securities.
In order to trade on margin, an investor must have a margin account with his or her brokerage firm. As noted by FINRA, “there is a difference between a margin account and a cash account. In a cash account, all transactions must be made with available cash, while a margin account allows you to borrow against the value of the assets in your account to purchase securities.”
While using margin increases an investor’s purchasing power, FINRA notes that “there’s a flip side to buying with borrowed funds. Not only do you pay interest on the money you borrow, but buying on margin leaves you open to the potential for larger losses. In fact, you can even lose more money than you invested.”
If the securities an investor is using as collateral go down in price, the brokerage firm can issue a margin call. This 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 securities in your account.
If an investor fails to make the required deposit, and the firm does not grant an extension to do so, the firm is required to liquidate the shares that were purchased on margin, or can liquidate other assets that were put up with the firm as collateral.
And FINRA notes an important reality check: a firm is not required to notify an investor of the sale, though most do so as a courtesy, nor does the firm let the investor choose which securities or assets are sold to meet a margin call.
With the recent volatility in many sectors of the market – especially in many technology and energy-related individual stocks – investors’ portfolios have been exposed to the potential danger that can be associated with a margin account. In fact, as of month-end September 2018, the amount of margin debit balances in customer accounts exceeded the monthly margin debit balances that were reported for each month in calendar year 2017.
Clearly a margin account and the attendant dangers associated with the same are not appropriate for every investor – especially for those who do not understand or want to assume the unlimited risks that are associated with them in an extremely volatile environment.
If you are an individual or institutional investor who has any concerns about your investments or margin account with any brokerage firm, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).