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Burned by a Margin Call? You May Have a Case of Margin Abuse

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  • Posted on: Jun 4 2018

Margin abuse occurs when investment professionals take advantage of investors that do not entirely appreciate the risk associated with margin-based investments. In fact, these professionals have a duty to ensure that the investor understands the danger of such an account before entering into an investment agreement. Failure to meet this duty could result in legal liability. 

What Does Buying on Margin Mean?

When you “buy on margin,” you are purchasing securities with (at least partly) borrowed money. Borrowed money can come from virtually any source, but when you use an investment firm, you must create a “margin account” with that firm. By engaging in this type of investing, you increase your overall purchasing power, which can, in turn, increase your return on your investment. These accounts have minimal risk for the investment firm, and they generate income as well.

The advice that you might get from an investment firm or advisory firm is to buy on margin—because they often have commissions or other financial incentives to push you in that direction. Nonetheless, margin investing comes with several risks attached for you, even though it is relatively safe for the investment firm.

What is a Margin Call?

When you buy on margin, you generally purchase part of the securities with your own money and finance the rest. When you make this type of arrangement, the securities you bought are the collateral for the remaining portion of the investment.

If the collateral value dips below a certain amount, the investment firm can take steps to increase their position. This process is generally referred to as a “margin call.” The investment firm will require you to add more money to the margin account. If you do not do this within a specified timeframe, then they can start liquidating your securities to increase the value of the account. There are no extensions for margin calls, making them very risky and potentially very costly.

Other Risks Associated with Buying on Margin

Investing on margin is not for the faint of heart. It is possible that the entire security could have little to no value, which would require that the investor input more money for an asset that is virtually worthless. While you really take that risk with any investment, buying on margin makes the potential losses a multiple of what you actually invested.

You are also charged interest and/or fees for having the margin loan. This means that you could end up paying for the margin loan before you make any money on the securities. Forced sales due to a margin call could also mean that you sell the securities long before you would in a typical investing situation, significantly decreasing your overall return.

Margin call abuse does happen. If you have been forced into fronting more money or your securities have been sold because of a margin call, you may have legal options. Investors should consult an attorney to understand whether they have been the victim of margin abuse.

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