When Margin Calls Lead to Investor Fraud Losses
If you are an investor that has lost money because of an unsuitable margin call in your investment account, you may have grounds for filing a Financial Industry Regulatory Authority (FINRA) arbitration claim to try and recover your losses. Unfortunately, a lot of investors may not understand what they are getting into when they open a margin account.
What is A Margin Account?
Margin accounts are not suitable for every investor, especially those that can’t handle too much risk. A customer that sets up with a margin account with a broker is indicating that he or she may want to borrow money later on down the road. With a margin account, you are essentially providing the securities and money in your margin account as collateral for this possible loan. Should you decide to borrow the money to buy securities, a broker is then allowed to sell your assets if necessary to fulfill the margin loan.
This can be precarious for the investor if the account lacks enough to fulfill the margin because it is the investor who is legally obligated to pay any total debt balance that has yet to be paid, which could end up being greater than what was placed in the margin account to begin with.
A Margin Call
Purchasing securities on margin comes with certain risks, including a possible margin call. This can happen when the equity required in comparison to the debt that a customer’s account is holding, known as the equity-to-debt ratio, drops below a certain limit.
• Regulatory changes and asset price fluctuations can cause the account balance to no longer fulfill the regulatory requirements that are established for margin debt.
• A broker-dealer decides to modify its own policies regarding margins in accounts.
A failure to satisfy the required equity-debt-ratio, whether established by the Federal Reserve or a brokerage firm, can lead to a broker making a margin call, requiring the customer to either liquidate holdings in an account and/or put more money in there right away so as to once more satisfy that ratio. This can be problematic for the customer because usually brokers are not required to give more time satisfy a margin call or even talk to the investor before liquidating their accounts’ assets to fulfill any margin debt. To fulfill the margin call, the broker may sell the following in the customer’s accounts:
• Highly appreciated securities, which can lead to huge deferred tax liabilities and capital gain costs.
• Bonds and stocks that are currently undervalued, resulting in unnecessary and unplanned for losses that would not have been incurred otherwise.
Failure to fully meet a margin call can cause a customer to incur:
• Debts that he or she is unable to pay, which can result in a lower credit rating and all that can arise from that (higher insurance rates, closed credit card accounts, etc.)
• Unsecured debt that’s gone into default.
An investor that has suffered from a margin call may even find themselves the defendant of a lawsuit brought by a broker not just demanding repayment of the money now owed but also payment of the firm’s legal fees over the matter.
Margin Call Fraud
A retail investor may not have understood the risks involved when agreeing to open a margin account at their broker’s recommendation. Margin accounts are often best suited for sophisticated investors and other that want to work with a high degree of risk. However, because brokerage firms will give brokers financial incentives, including higher commissions, for recommending that clients use margin in brokerage accounts, this can cause some financial advisers to recommend margin accounts to an investor even when it is not appropriate for the customer.
At Shepherd Smith Edwards and Kantas, LLP (SSEK Law Firm) our margin call fraud lawyers can help you explore your legal options and determine whether you have been the victim of unsuitable use of margin. You may have grounds for a FINRA arbitration claim to recover your investment losses. Contact SSEK Law Firm and ask to speak with one of our experienced investor fraud attorneys today.