FINRA issues investor alert on Margin Trading Risks
The Financial Industry Regulatory Authority (FINRA) recently issues an investor alert based on these margin statistics. It’s important for investors to understand margin trading risks and how margin calls operate.
According to the FINRA, investor purchases of securities “on margin” averaged more than $592 billion for the first eleven months of 2017. It broke the $600 billion mark in October 2017 for the first time in history.
During unfavorable market conditions, investors who cannot satisfy margin calls can have large portions of their accounts liquidated. These liquidations can create substantial losses for investors.
Consider the margin trading risks:
- Your firm can force the sale of securities in your accounts to meet a margin call.
- Your firm can sell your securities without contacting you.
- You are not entitled to choose which securities or other assets in your accounts are sold.
- Your firm can increase its margin requirements at any time and is not required to provide you with advance notice.
- You are not entitled to an extension of time on a margin call.
- You can lose more money than you deposit in a margin account.
How Margin Accounts Work
A margin account is used to borrow money from your brokerage firm to purchase securities. The portion of the purchase price that you must deposit is called margin and is your initial equity or value in the account. The loan from the firm is secured by the securities you purchase.
If the securities you’re using as collateral go down in price, your firm can issue a margin call, which is a demand that you repay all or part of the loan with cash, a deposit of securities from outside your account, or by selling some of the securities in your account.
When you buy on margin, you must repay both the amount you borrowed and interest, even if you lose money on your investment. Some brokerage firms automatically open margin accounts for investors. Make sure that you understand what type of account you are opening. If you don’t want to trade on margin, choose a cash account for your transactions.
Margin Costs
This cost of buying on margin is the interest you will pay on the amount you borrow until it is repaid. Margin interest rates generally vary based on the current “broker call rate” or “call money rate” and the amount you borrow.
Rates also vary from firm to firm. Most brokerage firms publish their current margin interest rates on their websites.
Margin loans may be highly profitable for your broker and brokerage firm. Its possible that your broker may be receiving fees based on the size of the loan.
Margin Requirements
Margin trading is regulated by The Federal Reserve Board, FINRA, and securities exchanges, including the New York Stock Exchange (NYSE). Most brokerage firms also establish their own more margin requirements.
Minimum Margin
FINRA Rule 4210 requires that before purchasing a security on margin, you deposit $2000 or 100 percent of the purchase price, whichever is less, in your account. This is called “minimum margin.”
For day trading, you are required to deposit $25,000.
Initial Margin
The “initial margin” is 50 percent of the total purchase price of a stock for new, or initial, purchases.
If you don’t have cash or other securities in your account to cover your share of the purchase price, you will receive a margin call from your firm that requires you to deposit the other 50 percent of the purchase price.
Maintenance Margin
Under FINRA’s “maintenance margin requirements“, your equity in the account must not fall below 25 percent of the current market value of the securities in the account. If it does, you will receive a maintenance margin call that requires you to deposit more funds or securities in order to maintain the equity at the 25 percent level. The failure to do so may cause your firm to force the sale or liquidation of the securities in your account to bring the account’s equity back up to the required level.
Firm (House) Requirements
Your firm has the right to set its own margin requirements, as long as they are higher than the margin requirements under Regulation T or the rules of FINRA and the exchange. These are often called “house requirements“.
Some firms raise their maintenance margin requirements for certain volatile stocks or a concentrated or large position in a single stock to help ensure that there are sufficient funds in their customer accounts to cover the large swings in the price of these securities.
In some cases, a firm may not even permit you to purchase or own certain securities on margin. These changes in firm policy often take effect immediately and may result in the issuance of a maintenance margin call (or “house call”). Again, if you fail to satisfy the call, your firm may liquidate a portion of your account.
Margin Trading Risks
There are a number of risks that you need to consider in deciding to trade securities on margin.
- If the equity in your account falls below the maintenance margin requirements under the law—or the firm’s higher “house” requirements—your firm can sell the securities in your accounts to cover the margin deficiency. You will also be responsible for any short fall in the accounts after such a sale.
- Some investors mistakenly believe that a firm must contact them first for a margin call to be valid. This is not the case. Most firms will attempt to notify their customers of margin calls, but they are not required to do so. Even if you’re contacted and provided with a specific date to meet a margin call, your firm may decide to sell some or all of your securities before that date without any further notice to you.
- You are not entitled to choose which securities or other assets in your accounts are sold.There is no provision in the margin rules that gives you the right to control liquidation decisions. Your 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.These changes in firm policy often take effect immediately and may cause a house call. If you don’t satisfy this call, your firm may liquidate or sell securities in your accounts.
- You are not entitled to an extension of time on a margin call.While an extension of time to meet a margin call may be available to you under certain conditions, you do not have a right to the extension.
- You can lose more money than you deposit in a margin account.A decline in the value of the securities you purchased on margin may require you to provide additional money to your firm to avoid the forced sale of those securities or other securities in your accounts.
- Open short-sale positions could cost you.You may have to continue to pay interest on open short positions even if a stock is halted, delisted or no longer trades.
The foregoing information, which is all publicly available on FINRA’s website, is being provided by The White Law Group.
The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm dedicated to the representation of investors in FINRA arbitration claims against brokerage firms throughout the United States.
