Every type of investment carries risk, but some carry much more than others. Margin trading greatly increases your risk compared to buying a stock or bond, because buying on margin means you are borrowing money from your brokerage firm to buy a security. This exposes you not only to the risk of losing your investment, but it also puts you on the hook to pay back your broker, even if the stock you buy loses value. Another risk is that the brokerage takes advantage of you by encouraging you to use margin trading excessively in order to drive up their own profits.
At Girard Bengali, APC, our attorneys represent clients who have lost money due to abuse of margin trading and margin-related broker misconduct. Our attorneys have decades of experience in securities litigation and arbitration against high-powered investment firms and advisors. We have a reputation for in-depth knowledge of securities laws and for advocating aggressively on behalf of clients who have been harmed by unsuitable margin trading and other forms of misconduct.
What Is Margin Trading and Why Do Some Investors Do It?
Margin trading, or buying on margin, is a tactic some investors use to increase their buying power and, hopefully, their investment returns. Buying on margin allows an investor to buy more stock without paying cash for all of it. Instead, the investor borrows from the brokerage to pay for some of the stock.
Here is a basic example: let’s say an investor wants to buy a stock for $5 a share. The investor has $5,000 available. If the investor buys the stock using a normal brokerage account, he can buy 1,000 shares. But, if he buys using a margin account, his broker could lend him another $5,000, effectively doubling the investor’s purchasing power: he now has $10,000 available and can buy 2,000 shares.
If the stock price goes up, the investor will gain twice as much because they were able to purchase twice as many chares, and paying back the amount borrowed on margin is possible without cutting too far into the profits.
Why Is Margin Trading Risky?
The prospect of doubling your gains sounds like a great thing. But the problem is that the more money you borrow from your broker, the more risk you’re exposed to. After all, you are essentially taking out a loan from your broker every time you trade on margin, and loans must always be repaid, with interest, even if the stock you buy goes down in value.
Just as buying on margin can amplify your profits, it can also amplify your losses. And brokerage firms can make a “margin call,” a demand that you immediately pay back at least some of what was borrowed.
Many brokerages allow investors to open margin accounts without advising investors about the substantial risks and obligations that come with margin trading. Examples of these risks and obligations include:
- Paying back the amount borrowed from the broker, plus interest.
- The possibility that the brokerage makes a margin call without prior notice, which forces you to sell securities immediately, possibly at a loss.
- Not being able to request more time if a margin call is made.
- The right of the brokerage firm to decide which assets in the margin account are used to pay the brokerage when a margin call is made.
- The risk of losing the value of your collateral (i.e., the investments in your account) and owing more to the brokerage than the collateral is worth.
- Paying fees for your margin account, and those fees can be increased by the brokerage firm at any time.
In addition to these issues, you should also realize that brokerage firms often aggressively push people to use margin accounts. Why? Because brokerage firms get paid multiple times when margin trades are made:
- They get a commission for the original purchase;
- They get paid again for the amount borrowed, plus interest; and
- They might earn another commission when you sell the stock.
When Can You Hold a Broker Liable for Margin Trading Losses?
Because of the potential for brokers to make a lot of money on each client who uses margin trading, brokers too often encourage excessive use of margin trading or get clients involved in margin activity that isn’t suitable for that particular investor.
Investors who suspect a broker of margin-related misconduct should speak with a securities lawyer, who can investigate the situation and take action. Brokers could be held liable for:
- Failure to disclose risk
- Inappropriate margin trading advice
- Failure to investigate risk
- Fraud or other intentional misconduct resulting in losses
Talk to an Experienced Margin Trading Fraud Attorney Today
If you sustained serious losses due to margin trading activity, you should speak with a lawyer about whether you have valid legal claims. The securities lawyers at Girard Bengali, APC, can assess your situation and help you take appropriate action. With offices in Los Angeles, Newport Beach and San Francisco, we represent investors in California and across the U.S. Please call 866-778-6821 or contact us online to arrange a free confidential consultation.