An investor can purchase securities by paying the purchase price in full or by borrowing part of the purchase price. If the investor borrows funds from a brokerage firm, the firm will open a margin account. The portion of the purchase price that the customer must deposit is called margin and is the customer’s initial equity in the account. The loan from the firm is secured by the purchased securities.
There are some complicated rules and regulations that deal with margin, but the most important thing to understand about margin is this: Buying on margin is essentially gambling with borrowed money. It is risky because the customer must repay the amount borrowed with interest, even if the securities purchased on margin lose value; thus the customer can lose more than the amount deposited into the margin account.
In addition, securities purchased on margin are collateral that the brokerage firm can sell without notice to satisfy a margin call. A margin call may occur when the margin account value temporarily drops to a predetermined point. As a result of short-term price fluctuations, a customer can lose his or her entire investment and end up owing money to the firm. That is why margin is only suitable for trading and speculation, not for long-term investing.
Despite these risks, some brokerage firms automatically open margin accounts for investors. The Financial Industry Regulatory Authority (FINRA) reports that the amount of debt taken on to buy securities has been growing steadily and reached a record high of $360.8 billion in April 2011.
In a typical case involving the inappropriate use of margin, we find a substantial portion of the customer’s investable assets was traded on margin, the broker failed to disclose or adequately explain the risks of margin trading, and the risks made the use of margin unsuitable given the customer’s investment objectives, risk tolerance and time horizon.
If you have investment losses or problems involving margin problems, call the lawyers at Page Perry for experienced representation at (770) 673-0047 or (877) 673-0047 (toll free).