The Financial Industry Regulatory Authority (FINRA) is concerned about the slew of investors that underestimate the risks of trading on margin and misunderstand the reason for margin calls. In 2012 alone, investors purchasing on margin has averaged more than $320 billion per month. The problem lies in not being able to satisfy margin calls under unfavorable market conditions - investors can have large portions of their portfolios liquidated, and these liquidations can cause substantial losses for investors. Therefore, before an investor decides to open a margin account, he or she should understand all the risks associated with purchasing securities on margin.
Margin accounts allow investors to borrow money from their brokerage firm to purchase securities. The portion of the purchase price that the investor must deposit is called margin, and it is the investor's initial equity in the account. The loan from the firm is secured by the securities the investor purchases. If the securities on margin go down in price, the firm can issue a margin call, which is a demand that the investor repay all or part of the loan with cash, make a deposit of securities, or liquidate some of the securities in the account. Therefore, buying on margin amounts to getting a loan from the brokerage firm, which entails repaying the amount borrowed plus interest - even if you lose money. Some firms automatically open margin accounts with the account owner knowing.
The Federal Reserve Board, FINRA, and securities exchanges, including the New York Stock Exchange (NYSE), regulate margin trading, and most brokerage firms also establish their own stringent margin requirements. Before purchasing a security on margin, FINRA requires that the investor deposit the lesser of $2000 or 100 percent of the purchase price in the account - called minimum margin. Federal Reserve rules allow investors to borrow up to 50% of the total purchase price of a stock for new, or initial, purchases - called initial margin. If the investor does not already have cash or other securities in the account to cover the share of the purchase price, the investor will received a margin or Fed call from his or her firm that requires the investor to deposit the other 50 percent of the purchase price. Under FINRA's margin maintenance requirements rule, the equity in the account must not fall below 25 percent of the current market value of the securities in the account. If it does, the investor will receive a margin maintenance call that requires the investor to deposit more funds or securities in order to maintain the equity at the 2 percent level in order to avoid the risk of a forced sale of securities by the firm. Also, firms have the right to set their own margin requirements - called house requirements. As long as requirements are set higher than the margin requirements under Regulation T or the FINRA rules and the exchanges, firms are permitted to do so.
Investors should consider the number of risks associated with opening and trading in a margin account. The following points should be kept in mind while making a decision:
-The firm can force the sale of securities in your account to meet a margin call. Investors are responsible for the margin deficiency and shorts falls in the account after the sale should the accounts fall below the maintenance margin requirements under the law or set by the firm.
-Your firm can sell your securities without contacting you. Many investors believe that a firm must contact them first for a margin call to be valid. Although most firms will attempt to contact the account holder, they are not required to do so. Firms can even initiate a sale after a deadline is provided to the account holder.
-You are not entitled to choose which securities or other assets in your account are sold. The firm may decide to sell any of the securities that are collateral for your margin loan to protect its interests.
-Your firm can increase its house maintenance requirements at any time and is not required to provide you with advance notice. If an unexpected house call is made, the firm can liquidate any holdings they choose.
-You are not entitled to an extension of time on a margin call. Although an extension of time may be available under certain conditions, there is not right to an extension.
-You can lose more money than you deposit in a margin account. A decline in value of the securities purchased on margin may require the investor to provide additional money to the firm to avoid forced sale of those securities or other securities held in the account.
Have you suffered losses resulting from your broker's recommendation to open and trade in a margin account? If so, call Robert Pearce at the Law Offices of Robert Wayne Pearce, P.A. for a free consultation.
The most important of investors' rights is the right to be informed! This Investors' Rights blog post is by the Law Offices of Robert Wayne Pearce, P.A., located in Boca Raton, Florida. For over 30 years, Attorney Pearce has tried, arbitrated, and mediated hundreds of disputes involving complex securities, commodities and investment law issues. The lawyers at our law firm are devoted to protecting investors' rights throughout the United States and internationally! Please visit our website, www.secatty.com, post a comment, call (800) 732-2889, or email Mr. Pearce at email@example.com for answers to any of your questions about this blog post and/or any related matter.