The duty to investigate the financial capability of an investor entering a margin transaction and to inform that investor of the implications of a margin purchase is part of a stockbroker’s professional responsibility.

Even many experienced investors do not understand margin accounts. When you purchase securities on margin, your brokerage firm is lending you money to pay for these securities. Initially, you may use cash equal to half the securities purchased, or pledge certain fully paid securities. Either way, you owe the brokerage firm, or most likely its clearing agent, the debit balance, or the amount borrowed to pay for these securities. Trading on margin increases the risk of loss to a customer for two reasons. First, the customer is at risk to lose more than the amount invested if the value of the security depreciates sufficiently, giving rise to a margin call in the account. Second, the client is required to pay interest on the margin loan, adding to the investor’s cost of maintaining the account and increasing the amount by which his investment must appreciate before the customer realizes a net gain. At the same time, using margin permits the customer to purchase greater amounts of securities, thereby generating increased commissions for the salesperson.

In general, unless you purchase more securities or pay down the balance, the debit or the amount borrowed does not change. Stock prices, however, change and if the market value of the securities in your account declines in value, you will be required to meet margin calls and will be called upon to deposit additional cash, or fully-paid securities, into your account. If you fail to meet a margin call, or if your account falls below minimum maintenance levels, even in the absence of notice of a margin call, by contract, your broker is able to liquidate your investments. Under most circumstances, such conduct is not actionable.

However, many unscrupulous brokers use margin to increase the purchasing power in your account in order to facilitate excessive activity or Margin Account Fraud. Aside from this practice, unless you are able to make and meet margin calls, and have the financial ability to satisfy the debit balance in your account, based on your overall financial condition, you may be unsuited for a margin account. The unsuitable extension of margin credit is a form of stockbroker fraud or misconduct

While a broker may have no duty or liability with respect to purely unsolicited transactions, the purchase of a security, on margin, even without any recommendation by the broker may be actionable. In addition, such lending activities can result in a conflict of interest between the customer and the member, particularly when such lending activities allow customers to continue to trade when they would not otherwise be in a financial position to do so, thereby generating more commission income to the member.

If your broker has placed your account on margin, and you do not understand, or are unwilling to trade on margin, you should have your account evaluated by a professional. Such practices are a form of stockbroker fraud or misconduct and are usually the warning sign of other inappropriate activity in your account.

Guiliano Law Firm

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