Investor Alert - Record Margin Debt Points to Highly Leveraged Stock Market
When we last addressed the issue in late December, prevailing statistics (drawing upon data from month-end, November 2020) demonstrated that investors had already taken on a record amount of margin debt. At that time, some $722.1 billion in borrowed capital was backstopped by investors’ collateralized securities portfolios. Now, less than six months later, the situation has only grown more extreme, with margin debt surging to a new all-time-high of $847.1 billion, as of month-end, April 2021.
For those unfamiliar, buying on margin entails an investor borrowing monies from his or her brokerage firm in order to purchase additional securities. In exchange for acting as lender, the brokerage firm will then charge an investor a certain interest rate, based on the amount borrowed. Moreover, the brokerage firm will encumber securities in the investor’s margin account to act as collateral on the outstanding margin loan. For so long as the margin loan balance remains in check, and provided the value of the securities held as pledged collateral maintain their value, investing on margin can generate enhanced returns, courtesy of the leverage achieved through borrowed monies.
However, as it concerns the magnifying power of leverage, the reverse holds equally true. Which is to say that when securities collateralizing a margin loan deteriorate significantly in value, an investor may well be subject to a margin call, thereby exposing an investor to potentially massive losses. Depending on the severity of the margin call, the losses can well exceed the initial capital invested, thus potentially placing an investor in a dire situation where their entire investment portfolio has been liquidated to satisfy a margin call, with the investor still possibly owing on an outstanding margin loan.
Unfortunately, in some instances, uninformed and unsophisticated retail investors may have been inappropriately steered into buying stocks (or other securities) on margin by their financial advisor. And in those instances where investors may have been unsuitably solicited to purchase securities on margin—on the advice of a financial advisor—these investors may have arbitration claims to be pursued before the Financial Industry Regulatory Authority (FINRA) to seek recovery of investment losses.
Pursuant to applicable FINRA rules—including Rule 2111 (Suitability) and recently adopted Regulation Best Interest (Reg BI)—brokerage firms and their affiliated advisors must seek to ensure that an investment (or investment program) is appropriate for an individual investor. In offering guidance on the matter, FINRA has stated that “a broker’s [investment] recommendations must be consistent with his customer’s best interests.” Furthermore, both “FINRA and the SEC have found brokers in violation of the suitability rule by placing their interests ahead of customers’ interests…” where, for example, a broker “sought to increase his commissions by recommending that customers use margin so that they could purchase larger numbers of securities.” See Stephen T. Rangen, 52 S.E.C. 1304, 1311, 1997 SEC LEXIS 762, at *19 (1997).
Ultimately, financial advisors have a duty to disclose the risks of margin investing with a customer and to review whether margin investing is a suitable investment strategy for that customer. The attorneys at Giarrusso Law Group LLC have extensive experience representing investors unsuitably allocated to risky and complicated investment products and programs, including the unsuitable use of margin. Investors may pursue a claim to recover monies through securities arbitration before FINRA, or in some instances, through litigation. Investors who wish to discuss a possible claim may contact us by telephone at (201) 771-1115 or by email at info@gialawgroup.com for a no-cost, no-obligation and confidential consultation.