Margin Abuse Attorney
A customer who purchases securities may pay for them in full or may borrow part of the purchase price from his/her brokerage firm, financial institution or advisory firm. Purchasing securities using borrowed funds is known as “buying on margin.” If the customer borrows funds from an investment firm, the customer must open a margin account with the firm. At the time the customer opens a margin account, the investment professional must determine whether the customer can afford the financial risks of margin investing, explain the risks inherent in a margin transaction, and determine whether the investor understands the risks before entering into the agreement.
Customers generally use margin to leverage their investments and increase their purchasing power. When the customer borrows money from the investment firm to pay for his/her securities, the portion of the purchase price that the customer borrows is called margin and is secured by the securities that are purchased by the customer. The margin loans are fully collateralized with no chance of default because of the protections provided to the investment firm in the margin agreements.
Many brokerage firms, financial institutions, and advisory firms provide financial incentives (such as increased commissions) to their investment professionals who recommend the use of margin because the lending activities represent a substantial source of revenues for the firm.
Investing on margin involves numerous risks. First, the customer could lose more than the amount invested if the value of the security depreciates sufficiently. The margined security could decline to zero, which would require the customer to pay off the entire amount of the loan, plus interest, without having any value in the collateral. Second, the interest being charged to the account adds to the customer’s costs, thereby requiring the investments to appreciate even more to cover the cost of the interest before the customer realizes a net gain. Third, the customer could be required to deposit more money into the account, causing the customer to lose more funds than he/she deposited in the margin account. Fourth, the brokerage firm, financial institution, or advisory firm could force the sale of securities in the customer’s account, possibly at a substantial loss to the customer, without advance notice to the customer. Finally, the customer could end up owing money to the brokerage firm, financial institution, or advisory firm. The customer is not entitled to an extension of time on a margin call.
In light of these risks, margin investing is suitable only for sophisticated investors who understand the risks of loss in their account. Thus, for many investors, trading on margin is far too risky and unsuitable.
Investment professionals and the firms in which they are employed (e.g., brokerage firms, financial institutions or advisory firms) are required to disclose the risks of margin investing. Investment professionals should recommend the use of risk management strategies to manage the risk of a margin call. Indeed, they can protect a customer’s account through risk management strategies in the event the price of the stock purchased on margin declines. In fact, investment professionals can calculate, in advance, the decline in account value that will trigger a margin call.
Investment professionals have a duty to investigate the ability of an investor to afford the financial risks inherent in a margin transaction, and to determine whether the investor understands the risks before entering into a margin agreement. If the investment professional fails to investigate the customer’s ability to incur the risk in a margin account, or if he/she fails to make certain that the investor understands the risk in a margin transaction, the customer may be able to recover any damages incurred as a result of any margin calls.
Freiberger Haber LLP can help you determine whether an investment loss is the result of margin account abuse. If you believe your investment professional did not explain the impact margin can have on your account, (i.e., the risks of investing on margin), or you did not understand margin investing and told your investment professional as much, contact Freiberger Haber LLP to discuss your rights.