If you’ve been investing for any length of time, you’ve probably at least heard of something called a “margin account” or a “margin call.” If you’ve never had this kind of account, don’t open one until you should do some careful research and understand exactly what it is. Even if your broker recommends it, if you don’t understand everything that’s involved, just say no. You can find out one day that your money is completely gone, sometimes in the blink of an eye.
A margin account is used to buy more securities than you would normally be able to, borrowing money from a brokerage in order to do so. It’s highly profitable for both brokerages and brokers, but may not be for you. It is, by many accounts, a “double-edged sword,” and not advised for anyone who isn’t a very skilled trader.
A broker or brokerage may open a margin account for you, in which you’ll deposit a sum of money as collateral. You may open one voluntarily, or it may be part of an agreement when you open an account. In either case, your broker is required to obtain your signature. You’ll also sign a margin agreement, which you must read carefully. Ask your broker questions about anything you don’t thoroughly understand before you sign it.
FINRA, the Financial Industry Regulatory Authority, has specific requirements for margin calls. You’ll be required to deposit a minimum amount, which may be $2,000 or 100% of the purchase price, whichever is less. Your individual brokerage may require you to deposit more. (The Electronic Code of Federal Regulations goes into more detail.)
The “margin” is the part of the purchase price you’re required to deposit, and is your initial equity in the account. The brokerage secures its part with your purchase of securities (although not all securities can be bought on a margin.) The idea is that you sell when the price declines, you’ll increase your purchasing power. But be forewarned—should the price increase, you’ll suddenly owe the brokerage the difference.
Tyler Yell of DailyFX explains, “. . . the common causes of margin call is the use of excessive leverage with inadequate capital while holding on to losing trades for too long when they should have been cut.”
When the margin call comes in, you’ll have to act fast, or you’ll lose everything in a matter of minutes. You no longer have enough leverage (money) to stay in the game, so your broker is now responsible for any losses you incur.
Some brokerages don’t call or notify you—and they generally don’t have to. By signing the agreement, you allow them to sell off as much as they need to satisfy the debt in your account. They can sell all of your investments to recoup the money they’ve loaned you, and you’ll have no say in which securities or how much. You can, potentially, lose all your money, and then some. If there isn’t enough in your account to pay everything, you’ll be required to make up the deficiency. And that’s where the margin call can turn into your worst nightmare if you aren’t prepared for it.
Again, everything is detailed in your account agreement. While some brokerages will call, text or email you notifying you of the discrepancy, many will just put a notice on their website, or simply start selling to recoup their monies without telling you anything. You have no right to tell them not to, or which stocks to sell—they just do it. They don’t have to give you an extension of time to pay it, either.
If you can’t meet the margin call, it’s a little like not paying your credit card bill: you’re in default on an unsecured debt to a brokerage. Depending on what state you live in, your credit rating can sink, other lenders can close your accounts (such as credit cards), insurance rates may substantially increase, and you may be unable to find a job with employers who use credit ratings as deciding criteria. The broker can file a lawsuit to recover the monies it lent you to pay for these trades, making things even worse.
The Securities & Exchange Commission (SEC) offers an easy-to-understand primer into the margin account and margin call. FINRA also offers a more detailed explanation on margin accounts and calls.
Has your broker followed best practices for margin calls, or has he or she violated them? It depends on what’s detailed in your account agreement. A securities attorney can help you decipher if your broker hasn’t worked in your best interest.
Silver Law Group represents the interests of investors who have been the victims of investment fraud. If you have questions about your legal rights, please contact Scott Silver of the Silver Law Group for a free consultation at ssilver@silverlaw.com or toll-free at (800) 975-4345. The Silver Law Group works on a contingency fee basis, meaning you pay us nothing unless we recover money for you.