In an Investor Alert issued on November 8, 2018 (“Know What Triggers a Margin Call”), the Financial Industry Regulatory Authority (FINRA) warned investors that volatility in the stock market can sometimes bring an uncomfortable surprise to investors — a margin call.
When an investor buys stock on margin, the brokerage firm lends to the investor up to 50 percent of the total purchase price and uses the assets in the investor’s account as collateral for the loan. In order to trade on margin, the investor needs to open a margin account with the brokerage firm. In the more common cash account, all securities purchases are paid for with available cash in the account.
Using a margin account can significantly increase an investor’s purchasing power. However, 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.”
There are basically two margin call “triggers.” First, if the securities the investor is using as collateral go down in price, the brokerage firm can issue a margin call. This is because FINRA and stock exchange rules require that the customer’s equity in the margin account must be at least 25 percent of the current market value of the securities in the account. (Many firms set the requirement at 30 or even 40 percent.)
Second, if the investor fails to make the required deposit for the purchase in the first place, and the firm does not grant an extension to do so, the firm is required to liquidate the securities that were purchased on margin or can liquidate other assets that were deposited with the firm as collateral.
To make matters worse, the brokerage firm is not required to notify the investor of the sale of securities to meet margin requirements (although most do so as a courtesy). Nor does the firm let the investor choose which securities or assets are sold to meet the margin call.
With the recent volatility in the stock market, investors’ equity portfolios purchased on margin are exposed to the dangers of a margin call.
What You Can Do
First, read your margin agreement. Pay close attention to the firm’s explanation of regulatory requirements and the firm’s own margin requirements. Pay particular attention to the “minimum margin” requirements.
Second, monitor your maintenance requirement. Does your firm use the FINRA minimum requirement of 25 percent of the current market value of the securities, or is the requirement set to a higher level? Know the price that, if reached, will likely trigger a margin call. If you are uncertain, ask the firm representative to explain it to you.
Clearly, a margin account is not appropriate for every investor, particularly those who do not understand or want to assume the risks associated with it. If you have any concerns about your investments or your margin account with any brokerage firm, please contact the Law Office of Scott Lane for a no-cost, no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an arbitration claim with FINRA.