February 5, 2014
A husband and wife got into a testy dispute with E*Trade over whether that brokerage firm properly handled a margin call. After the liquidations, the customers sued, lost their arbitration, and then appealed to federal court. In the midst of this mess was a tape recording of a disputed telephone conversation between the parties about whether or when they had to pony up sufficient funds to cover the margin call.
Infer Or Imply?
In early 2008, husband and wife Stanley and Lutgarda Mical opened an E*Trade brokerage account, but things don't seem to have gone particularly well because a $35,000 margin call was issued on July 1, 2008. E*Trade purportedly informed the Micals that they could satisfy the call by depositing cash or additional securities; or, in the alternative, selling sufficient securities to cover the debit.
In response to that advisory, on July 7, 2008, Mr. Mical spoke with E*Trade representative Stuart Novoselski, who the customer claimed had demanded a $111,000 cash deposit as satisfaction for the outstanding margin call. At that time, however, Mr. Mical expressed a willingness to pay only about $35,000. Thereafter, E*Trade apparently liquidated stocks in the Micals' account to cover open call option positions.
So, what likely happened here? My guess is that this margin case is pretty much the same as most of its ilk. The Micals either inferred or they thought that Novoselski has implied that E*Trade would give the customers time to get the margin debit in order -- time, as in, pay a good-faith deposit and we'll work with you. Such an understanding flies in the face of the demand nature of margin loans but, hey, sometimes the customer is right and someone at the firm went a little too far with the customer service and, some times, the customer is just engaging in denial and an excess of wishful thinking.
Let The Hostilities Begin
In a FINRA Arbitration Statement of Claim filed on July 5, 2011, the Micals sought $481,617 in compensatory damages and alleged that Respondents had
negligently liquidated their securities accounts following a margin call. Claimants alleged that E*Trade's margin department should have given them until the close of business on July 7, 2008, to transfer in funds to cover a margin call, allowed Claimants to sell off stock and hold the naked call option positions in order to cover the margin call, or accept Claimants' offer to assign the proceeds of a class action settlement to Respondents rather than liquidate all of Claimants' open stock and option positions in securities including Pulte Homes Inc., Thinkorswim Group Inc., and E*Trade Financial Corporation.
In the Matter of the FINRA Arbitration Between Stanley J. Mical and Lutgarda C. Mical, Claimants/Counter-Respondents, vs. E*Trade Securities LLC and Stuart Novoselsky, Respondents / Counter-Claimants (FINRA Arbitration 11-02628, June 14, 2013).
We Heard It Once
After some two years of arbitration discovery and the submission of briefs to FINRA arbitrators, a hearing occurred over five sessions from June 4 through June 6, 2013. The FINRA Arbitration Panel heard evidence, including that of a tape recording of the July 7, 2008, Novoselski telephone call; however, in lieu of replaying the tape, the arbitrators read the transcript of it. Apparently, the arbitrators had, in fact, played the taped phone conversation once but, thereafter, declined to listen to the recording and referenced a transcript of same.
A June 14, 2013, FINRA Arbitration Decision denied the Micals' claim for $111,000 in damages and found that E*Trade had properly sold the Micals' stocks after Mr. Mical had indicated that he would not fully satisfy the margin call. The Panel also dismissed E*Trade's Counterclaim for the $60,000 outstanding balance in the Micals' account (The firm had withdrawn the Counterclaim at the hearing). Finally, based upon its finding that the Claimants' claims were false, the Panel recommended an expungement from Novoselksi's Central Registration Depository records ("CRD") of the arbitration.
SIDE BAR: According to the FINRA Arbitration Decision:
Claimants presented an Order Amending Plan entered by the United Stated Bankruptcy Court on August 3,2012. Respondent presented an Order Modifying Stay entered by the United Stated Bankruptcy Court on December 5, 2012. The United Stated Bankruptcy Court allowed both sides to pursue their claims in arbitration.
. . .
Claimants submitted a request for an explained decision on or about May 15, 2013. In their response submitted on or about May 15,2013, Respondents did not join in Claimants' request. The Panel denies Claimant's request for an explained decision herein.
On November 20, 2013, the Micals filed a Complaint in federal court in the Northern District of Illinois seeking to vacate or modify the FINRA Arbitration Award. In addition to naming E*Trade, the Micals named all three FINRA arbitrators. In response, E*Trade moved to:
In dismissing the Micals' motion for discovery, and in granting the Defendants' motions to dismiss and to confirm, the Court gave fairly short shrift to the Micals' claims. Noting that arbitrators "perform functionally the same role as judges and have long been held to possess absolute immunity," the Court found that the three named arbitrators' action fell within the scope of absolute immunity; and, accordingly, dismissed the Micals' claims against them. Consistent with that finding, the Court also dismissed that Micals' motion to mandate production of each arbitrator's records was deemed too broad and similarly dismissed. Pointedly, the Court held that:
The Micals fail to plead any facts indicating that the Arbitrators committed misconduct. According to their complaint, the Micals only allege misconduct in the supposed failure of the Arbitrators to consider evidence. Yet, the Micals fail to inform the Court of the precise evidence that the Arbitrators failed to consider, other than not having replayed the tape of the phone call with Novoselski. The Court is satisfied that one playing of the tape, in addition to reading the transcript plus hearing the Micals' commentary regarding the phone call, constitutes sufficient consideration of that evidence by the Arbitrators. . .
Bill Singer's Comment
Margin liquidations are a common source of customer complaints. Many customer beliefs about how margin calls are supposed to be made do not accurately reflect legal and regulatory requirements. Let me briefly try to clarify some misconceptions.
Generally,when the equity in a margin account is deficient according to the percentage levels in effect, your brokerage firm can sell securities in your account without your prior consent, agreement or authorization. Frankly, if you re-read your Margin Agreement, you will likely see buried among the thousands of words that you agreed to that circumstance as a condition precedent to opening that account. If the equity in your account falls below the legally proscribed margin maintenance requirements or the brokerage firm's "house" maintenance requirements, the firm can, without prior notice to you, sell the securities in your account to cover the margin deficiency. While many brokerage firms will send courtesy notices to clients prior to undertaking such margin liquidations, those notices are not legally required. If, however, you have negotiated a specific margin agreement that imposes different terms, that would be a different situation -- good luck trying to extract such concessions from most brokerage firms.
Similarly, many customers believe that they are entitled to an extension of time on a margin call if they simply ask for one. While an extension of time to meet initial margin requirements may be available to customers under certain conditions, a customer is not legally entitled to an extension nor is a brokerage firm obligated to grant one.
What if the forced sale doesn't raise enough cash? You may be responsible for any resulting deficiency.