STOCKBROKER PROBLEMS
Margin
Rigorous rules have been enacted to govern margin because of possibility of self-dealing and abuse that comes from “loansharking” practices. A margin account includes the purchase of securities by paying the purchase price in full or by borrowing part of the purchase price. If the customer borrows funds from a brokerage firm, the firm will open a margin account. The portion of the purchase price that the customer must deposit is called margin and is the customer’s initial equity in the account. The loan from the firm is secured by the purchased stocks.
Note that buying on margin is essentially gambling with borrowed money. It is risky because the customer must repay the amount borrowed with interest, even if the securities purchased on margin lose value, thus the customer can lose more than the amount deposited into the margin account.
Also, securities purchased on margin are collateral that the brokerage firm can sell without notice to satisfy a margin call. A margin call may occur when the margin account value temporarily drops. Short term price fluctuations can cause a customer to lose his entire investment and end up owing money to the brokerage firm. That is why margin is only suitable for trading and peculation, not for long-term investing!
Some unscrupulous brokerage firms automatically open margin accounts for investors. In claims of margin abuse, it is not unusual to find a substantial portion of the customer’s assets traded on margin, and the broker failed to disclose or adequately explain the risks of margin trading. Firms can only extend credit to the limit of a customers liquid positions. Violations must be reviewed to quantify losses from unsuitable margin activity.