Emergency Surgery Fails To Remove Margin Call

February 12, 2018

With the roller-coaster of a stock market lately, I suspect that a lot of public customers are going to get hit with margin calls. The complaints often explain that the brokerage firm sold 5,000 shares of XYZ at $12, which the customer had purchased at $11; and that sale was to cover the diminished account value caused by the ABC shares which were purchased at $3 and dropped to 35˘. The problem is that the next day, XYZ announced that it had developed the cure for cancer and the stock is now worth $1,000 per share but for the fact that the margin sell-out left the unhappy customer with no shares. Okay, that's all a bit over-the-top but if you talk to enough public customers about what happened to them when they got hit with a margin sell-out, their version of events sure as hell sounds pretty similar to my hypothetical. Read a recent FINRA arbitration in which a public customer relates his tale of margin-call woe. 

Case In Point

In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed pro se by Claimant Evans in October 2017, he asserted breach of fiduciary duty; misrepresentation/non-disclosures; omission of facts; breach of contract; failure to supervise; margin calls; and negligence in connection with Respondent Motif Investing's alleged unauthorized sale of Claimant's unspecified common stock to cover a margin call. Claimant Evans sought $5,000 in compensatory damages, $25,000 in punitive damages, and $15,000 in treble damages. In the Matter of the FINRA Arbitration Between Brian Evans, Claimant, vs. Motif Investing, Inc., Respondent (FINRA Arbitration 17-02893, February 2, 2018). 

Oddly, the FINRA Arbitration Decision does not indicate whether Respondent Motif Investing denied any charges or asserted affirmative defenses, as is typically set forth in the published arbitration document. 

In denying Claimant's claims, the sole FINRA Arbitrator offers this rationale, which I reprint below in it sull version: 

In his Statement of Claim, Claimant states that, after receiving a margin call on October 17, 2017 on his Motif Investing, Inc. brokerage account, "Due to an emergency surgery (that was life threatening), I alerted Motif that I would make a deposit into my account that upcoming Tuesday. I even sent records from the hospital to confirm that this emergency was true. In response, they sent me an email that they would note my account, acknowledged that I was telling them, and hoped I would feel better. As any reasonable person would assume, that response that they were noting my account led me to believe that they would await the $10,000 I was about to deposit." 

Nowhere in any of his pleadings does Claimant make reference to the fact that Respondent apparently sent him a second e-mail on October 19, 2017, within hours of receiving the first one mentioned above, stating: "Thank you for reaching out and following up. The call for $1273.45 is due by 10/23/17 as long as the funds are here by then you will be fine. Hope all is well and quick recovery of health." This second e-mail was quoted in Respondents Answer dated December 22, 2017, and was mentioned again in Respondents Response to Claimants Reply to Respondents Answer dated January 4, 2018. Although Claimant filed a total of five (5) pleadings in this matter, nowhere does he address Respondents second e-mail of October 19, which clearly put him on notice that funds had to be in his margin account by October 23 to  meet Respondents margin call. Respondent's comment, in the first e-mail of October 19, that they "have noted your account of your planned deposit, does not constitute a waiver of any requirement that the funds had to be in Claimants account by October 23. Any doubt in Claimants mind should have been removed by the second e-mail quoted above, along with the numerous phone calls Claimant apparently made during the days preceding October 23, as well as the numerous occasions on which Claimant logged in to his account during that same time period, a time when notice of the pending margin call appeared (according to Respondents pleadings) on Claimants account at log-in. Claimant apparently could have moved funds into his account by using his mobile phone at any time during that period. 

Respondent took action as required by pertinent SEC regulations governing Claimant's account. Even if any liability on Respondents part could have been shown, which it was not, Claimants damages for lost opportunity or lost profits are entirely speculative. 

Bill Singer's Comment

Compliments to this FINRA Arbitrator for a thorough explanation of the rationale underlying the Decision. Nicely done!

Margin liquidations are a common source of customer complaints because many customer's misunderstand the legal and regulatory requirements pertaining to margin and margin calls.  Let me briefly try to clarify some misconceptions.

Generally, when the equity in a margin account is deficient according to the maintenance 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.

As the Securities and Exchange Commission warns in its online Investor Bulletin "Understanding Margin Accounts" (SEC Pub. No. 156 (8/13) ) :

Understand Margin Calls
You Can Lose Your Money Fast and With No Notice.

If your account falls below the firm's maintenance requirement, your firm generally will make a margin call to ask you to deposit more cash or securities into your account. If you are unable to meet the margin call, your firm will sell your securities to increase the equity in your account up to or above the firm's maintenance requirement.

However, your broker may not be required to make a margin call or otherwise tell you that your account has fallen below the firm's maintenance requirement. Your broker may be able to sell your securities at any time without consulting you first. under most margin agreements, even if your firm offers to give you time to increase the equity in your account, it can sell your securities without waiting for you to meet the margin call.

Similarly, consider FINRA's online Investor Alert: "Updated: Investing with Borrowed Funds: No "Margin" for Error," which notes, in part:

Margin Trading Risks
There are a number of risks that you need to consider in deciding to trade securities on margin. These include:
  • Your firm can force the sale of securities in your accounts to meet a margin call. If the equity in your account falls below the maintenance margin requirements under the law-or the firm's higher "house" requirements-your firm can sell the securities in your accounts to cover the margin deficiency. You will also be responsible for any short fall in the accounts after such a sale.
  • Your firm can sell your securities without contacting you. Some investors mistakenly believe that a firm must contact them first for a margin call to be valid. This is not the case. Most firms will attempt to notify their customers of margin calls, but they are not required to do so. Even if you're contacted and provided with a specific date to meet a margin call, your firm may decide to sell some or all of your securities before that date without any further notice to you. For example, your firm may take this action because the market value of your securities has continued to decline in value.
  • You are not entitled to choose which securities or other assets in your accounts are sold. There is no provision in the margin rules that gives you the right to control liquidation decisions. Your firm may decide to sell any of the securities that are collateral for your margin loan to protect its interests.
  • Your firm can increase its "house" maintenance requirements at any time and is not required to provide you with advance notice. These changes in firm policy often take effect immediately and may cause a house call. If you don't satisfy this call, your firm may liquidate or sell securities in your accounts.
  • You are not entitled to an extension of time on a margin call. While an extension of time to meet a margin call may be available to you under certain conditions, you do not have a right to the extension.
  • You can lose more money than you deposit in a margin account. A decline in the value of the securities you purchased on margin may require you to provide additional money to your firm to avoid the forced sale of those securities or other securities in your accounts.
  • Open short-sale positions could cost you. You may have to continue to pay interest on open short positions even if a stock is halted, delisted or no longer trades.