Investors who buy an asset on a margin do not purchase the asset by free and clear. They pay a portion of the price and then essentially get a loan from a bank or investment firm for the balance of the purchase. The broker who arranges the loan also sets up a margin account that can be used to make the regular loan and interest payments. Firms often loan their clients money, so that those clients can purchase more securities from the firm. This increases the money the firm makes in two ways: through commissions paid to the firm, and through interest. The advantage of increased purchasing power that margin trading allows is often offset by a variety of risks the broker should disclose to the investor.
The securities investment lawyers at The Frankowski Firm fight to hold brokers and investment firms responsible when they push investors into these loans that are often unsuitable for the investor’s needs and risk tolerance. We understand how to prove negligence and fraud, and how to fight on your behalf to get the full amount of financial damages.
Let us say an investor wants to buy a stock for $1,000, but only has $500. The broker facilitates the purchase by creating a margin account and by setting the initial down payment as $500. The brokerage firm will advance the additional $500 while the investor agrees to pay back the advanced sum of $500 plus 10% interest.
If the investment goes up to $1,800 and the investor wants to sell, the investor will not get the increase in value of $800. He/she first has to pay back the $500 he/she borrowed, plus $50 for the 10% interest – totaling $550. The investor’s bottom line is that he/she makes a profit of $750 — $1,800 minus the down payment of $500 minus the $550 owed to the brokerage firm.
If the stock drops to $350, the investor has to pay the $350 to the brokerage firm and still owes the brokerage another $200 – the balance of the $550 due the firm for advancing the money with interest.
In short, the more an investor purchases, the more the underlying debt may increase, and thus the more the risk to the investor increases – what we call an increase in “downside risk.” Investors should be advised of the risks involved with margin trading and with the obligations:
Stockbrokers have a duty to disclose the risks of margin trading with the investor and to review whether margin trading is a suitable investment strategy. Brokerage firms can be liable if they fail to supervise their broker’s actions. Investors who cannot understand how margin trading works or can’t reasonably be expected to meet margin calls should be told that the margin trading investment is not suitable. If this is not done, the investors may have grounds for legal recourse.
The attorneys at The Frankowski Firm bring securities claims in state and federal court and in FINRA arbitration. Do not assume that your financial losses were just bad market luck. You may have a strong financial negligence or fraud claim. Call us at 888.741.7503 or compete our contact form to arrange to speak with one our experienced securities negligence attorneys.
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Disclaimer: Mr. Frankowski is licensed in Alabama,Florida and Texas. He is not licensed in any other state including Nevada and California. Mr. Frankowski has represented investors from all over the country in securities cases including: Alabama, California, Colorado, Florida, Georgia, Illinois, Kentucky, Louisiana, Mississippi, Nevada, New Mexico New York, North Carolina, Tennessee, Texas.
