As recently reported in the Wall Street Journal, investors borrowed a record $722.1 billion against the value of their investment portfolios through month-end November 2020, eclipsing a previous record high of $668.9 billion in margin debt balances for the month of May 2018. Investors who have purchased securities on margin on the advice of a financial advisor may have arbitration claims to be pursued before the Financial Industry Regulatory Authority (FINRA), provided the investment strategy to utilize margin was unsuitably recommended by a stockbroker without a reasonable basis.

Buying on margin simply involves borrowing money from a broker-dealer to purchase stock (or other securities). A margin account can be utilized to increase an investor’s purchasing power, affording an investor the opportunity to use someone else’s money to increase financial leverage. Under Federal Reserve Board Regulation T (Reg T), brokerage firms may only lend a customer up to 50% of the total purchase price of a stock for new, or initial purchases, on margin. In addition, applicable rules set forth by FINRA and various securities exchanges further supplement the requirements of Reg T by placing “maintenance” margin requirements on customer accounts. As a general matter, a customer’s equity in a margin account may not fall below 25% of the current market value of the securities held in the account. 

While investing on margin can potentially generate enhanced returns, the downside risk is also amplified and can lead to catastrophic losses for uninformed investors. Unfortunately, in some instances, investors are unsuitably steered into margin accounts by their financial advisor without first being adequately informed of the many risks associated with investing on margin. To begin, an investor should be cautioned that any decline in the value of securities purchased on margin may require an investor to provide additional funds as collateral to the broker-dealer that extended the margin loan. Further, in a margin call scenario, investors should be made aware that a brokerage firm has wide discretion to force the sale of securities held in a margin account, even selling securities without first contacting the customer.

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. For example, FINRA Rule 2111(a) mandates that reasonable diligence be conducted to determine what investments are suitable for a specific customer, and further, to ascertain the customer’s investment profile. This review should include the investor’s age, other investments, financial situation, tax status, investment experience, investment objectives, liquidity needs, risk tolerance, and other relevant information. 

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 are invited to contact us by telephone at (201) 771-1115 or by email at info@gialawgroup.com for a no-cost, no-obligation consultation