Buying on margin can lead to higher returns but also significant losses. Moreover, brokers and financial advisors can only recommend the use of margin or a leveraged strategy if it is suitable and in the best interest of their client. Brokers and financial advisors can earn more commissions or fees on margin accounts and profit from the interest they charge their clients for borrowing money. Financial professionals who fail to disclose the risks of margin or recommend the unsuitable use of leverage should be held accountable.
If you lost money because your broker or financial advisor didn’t disclose the risks of margin trading, recommended the unsuitable use of margin or leverage, or otherwise mismanaged your portfolio, contact Erez Law, PLLC immediately. You might be entitled to compensation in an excessive-use-of-margin case.
What Are Leverage and Margin Trading?
“Margin” involves borrowing money from a brokerage firm to buy securities and using the securities as collateral to repay the loan. Margin trading allows investors to use their portfolio holdings as collateral to acquire a loan from a brokerage firm. Margin is the difference between the value of the investor’s accounts and the loan they use to initiate a trade. Investors can use their loan proceeds to invest in bonds, exchange-traded funds (ETFs), stocks, and other securities.
Investors can diversify their portfolio with other assets while margin trading without using more equity. Instead, they use proceeds from the loan for other investments and attempt to enhance their returns.
The Financial Industry Regulatory Authority (FINRA) requires investors to follow various rules while trading on margin, such as:
- Meeting the minimum margin by depositing $2,000 or 100 percent of the purchase price of a proposed trade, whichever is less
- Borrowing no more than 50 percent of the securities’ value
- Having a specific amount of equity in the margin account by maintaining at least 25 percent of the securities’ total market value
Leverage refers to borrowing money to increase returns. Investors can increase their trading power by borrowing capital from a broker to make trades in excess of the account’s equity. Leverage in a stock account occurs when investors borrow money to trade securities using the account’s margin.
Excessive Use of Margin or Leverage
As an investor, you can use the value of securities in a brokerage account as collateral for a loan from a brokerage firm. The borrowed money can go toward purchasing additional securities. However, you must pay interest until you repay the loan in full.
The fees a brokerage firm or broker earns depend on the amount of money an investor borrows on margin and the time the loan is outstanding. Brokerage firms and brokers can profit significantly from fees generated by their use of margin, which is why they may recommend this type of investment in the first place. They can also earn additional commissions when their client purchases more securities for their account.
Brokers often recommend margin trading to investors because of the money they stand to make. They could withhold the unique risks of trading on margin to benefit themselves. When they do, they may commit investment fraud and be responsible for the losses you suffer as a result.
Understanding the Risks Associated with Margin and Leverage Trading
The stock market’s volatility and unpredictability contribute to the inherent risks of margin transactions. The costs and interest associated with margin accounts can also increase the risks an investor faces. Securities must perform well enough to cover the interest charged on the loan, the purchase price, and brokerage commissions to generate a profit. However, many investors don’t understand the potentially damaging effects margin trading can have on their finances, including the fact that they may lose more money than they invested.
A margin call is when a broker requires their client to provide more collateral to cover the securities’ decrease in value and secure the margin loan. The brokerage firm will issue a margin call when the value of securities in a margin account declines significantly.
The investor must deposit additional securities or more money into the account. However, if they don’t have the necessary securities or funds, the firm can sell the securities to satisfy the margin call. Typically, the sale involves distress pricing, in which the firm sells the securities at a low price, leading to fewer proceeds to cover the loan. The investor must pay back the remaining amount owed despite suffering financial losses.
When Can Investors Who Traded on Margin Pursue Claims for Fraud?
Brokers sometimes recommend margin trading despite the risks. You might be able to pursue a claim to recover your losses if your broker or financial advisor:
- Failed to adequately explain the associated risks of trading on margin
- Did not disclose the costs and fees you would incur from margin trading
- Charged excessive fees or interests
- Provided investment advice unsuitable for your financial condition and interests
- Overconcentrated your portfolio after convincing you to participate in margin trading
- Used distress pricing unnecessarily to sell assets in your portfolio to cover a margin call
- Recommended trading on margin for their personal interests and gain
An investment attorney from Erez Law, PLLC can represent you in your margin or leverage case. Most people don’t know where to look for evidence of investment fraud or how to navigate the complex legal process. Making a mistake can negatively affect the outcome of your case and cost you severely.
How Legal Representation Can Help
Erez Law, PLLC is committed to representing investors harmed by broker misconduct. You deserve the chance to hold your broker liable and recover compensation for your losses. Founding Attorney Jeffrey Erez has extensive experience in securities arbitration and litigation and has tried over 40 FINRA arbitrations to a verdict or final hearing. When you hire us, you will have a skilled and knowledgeable investment fraud attorney fighting for your rights and justice.
If you suffered financial losses due to your broker’s excessive use of margin, call Erez Law, PLLC, or reach out to us online for a free consultation with one of our nationwide margin and leverage attorneys to learn more about how we can help.