Excessive Margin Use

When you use a margin account to purchase securities, your brokerage firm is lending you money to purchase these securities. Whether you put up cash equal to some portion of the initial purchase or deposit other stock into the margin account as security for the margin loan, you are borrowing money from your brokerage firm (or its clearing firm).

If the securities in your margin account decline in value sufficiently, your brokerage firm will require you to deposit more collateral to secure the loan. This is called a margin call. When you receive a margin call, if you cannot deposit additional money or securities into the account, the firm will sell enough securities to cover the margin call and meet the required equity maintenance levels. If the value of the securities falls too far, you may end up losing everything in the account and even owing money to the brokerage firm.

Margin trading can be an effective strategy for an investor who understands the risks, but it is not a prudent tool for most average retail investors. Many investors do not fully understand margin trading, and this may cause them to underestimate its risks. Hence, financial advisers have a duty to investigate their clients’ ability to afford the financial risks inherent in a margin transaction and to determine whether they understand these risks before entering into such a transaction.

When a financial adviser wrongfully encourages clients to use margin, possibly so that the financial adviser can charge commissions on larger transactions or numerous additional transactions , this is a violation of industry rules and may be considered fraud.  Also, many types of accounts do not allow margin loans. Chief among these are retirement accounts such as IRAs, Keoghs, SEP-IRAs, and 401(k) accounts (unless specifically allowed). Also excluded are trust estate accounts, fiduciary accounts (unless specifically allowed), and accounts established under the Uniform Gift/Transfer to Minors Acts (UGMA/UGTA). While an investor’s mutual fund shares are marginable, the brokerage account of a mutual fund is excluded from margin status by the Investment Company Act of 1940.

If you suspect that your financial adviser engaged in excessive margin use in your account or engaged in another sales practice abuse, please contact Wittenberg Law to discuss your legal rights and options.