Key Information to know before you get started.
While the potential gains associated with securities trading in a margin account may be substantial, so can the potential losses. This is critical for investors to understand, along with the facts and risks associated with this type of trading.
Simply put, a margin account is an account offered by brokerage firms that allows investors to borrow money to buy securities. The investor typically deposits 50 percent of the value of the purchase and the brokerage firm loans the investor the rest of the money, using the securities as collateral.
How a margin account works is much more complicated. New investors or those not positioned to take financial risks may be better directed to more conservative investment strategies.
Margin Requirements, Maintenance Margins & Margin Calls
The requirements of a margin account are governed by federal regulation, the rules of FINRA, and the securities exchange. According to information provided for investors on the FINRA website, the Federal Reserve Board Regulation T says that brokerage firms can lend an investor up to 50 percent of the total purchase price of a stock. The “maintenance margin” requirement of Regulation T says that an investor’s equity must not fall below 25 percent of the current market value of the securities in the account.
Should the value of the securities fall below the maintenance margin, the brokerage can issue a “margin call”, forcing the investor to either deposit more money in the account or sell assets to cover the margin deficiency.
Here’s an ideal example of a margin transaction – and what can happen as provided by FINRA:
“If a customer buys $100,000 of securities on Day 1, Regulation T would require the customer to deposit margin of 50 percent or $50,000 in payment for the securities. As a result, the customer’s equity in the margin account is $50,000, and the customer has received a margin loan of $50,000 from the firm.
Assume that on Day 2 the market value of the securities falls to $60,000. Under this scenario, the customer’s margin loan from the firm would remain at $50,000, and the customer’s account equity would fall to $10,000 ($60,000 market value less $50,000 loan amount).
However, the minimum maintenance margin requirement for the account is 25 percent, meaning that the customer’s equity must not fall below $15,000 ($60,000 market value multiplied by 25 percent). Since the required equity is $15,000, the customer would receive a maintenance margin call for $5,000 ($15,000 less existing equity of $10,000).
Because of the way the margin rules operate, if the firm liquidated securities in the account to meet the maintenance margin call, it would need to liquidate $20,000 of securities. “
House requirements, margin agreements, and disclosures
It is important to know that firms can set their own margin requirements, called “house requirements”, as long as they are higher than the Regulation T minimum. Firms are allowed to raise their house requirements at any time. These policy changes take effect immediately and may cause a maintenance margin call to which investors are not entitled to a time extension. The brokerage firm has the right to sell investor’s funds without notifying them.
Additional charges on margin accounts include interest on the borrowed money and investors are encouraged to read the brokerage firm’s margin agreement and disclosure to properly understand potential costs. Margin is a major profit center for most brokerage firms. Many FINRA arbitration claims allege the improper use of margin and cases against large brokerage firms and cold-calling brokerage firms focus on the excessive use of margin.
If you have concerns with your margin account, consult your broker. If you have suffered financial loss as the result of a wrongful liquidation or margin call or the unsuitable use of margin, contact Silver Law Group today.