U.S.: Market Idiocy: Margin calls, sellouts anger some investors

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Headline: Margin calls, sellouts anger some investors

Source: USA Today, 11 April 2001

URL: http://www.usatoday.com/money/markets/2001-04-11-margins.htm

The falling stock market is causing a wave of confusion and complaints as investors who borrowed money to buy stocks and were unaware of their vulnerability find themselves facing margin calls. Arbitration cases and complaints to the Securities and Exchange Commission are up sharply from investors who are furious about the way brokers liquidated their portfolios or demanded more collateral.

Borrowing money from a broker to buy stocks, or buying on margin, is always risky. If a stock suddenly drops in price, a margin call can occur — the broker demands that the investor put up more cash or securities as collateral. But many investors don't realize a broker can liquidate stock in the portfolio without notice to cover losses, which is called a margin sellout.

Caught up in the stock market mania, many novice investors started buying on margin. "You can make twice as much," says John Nester, an SEC spokesman. "But you also can lose more than you invested."

John Storheim is pursuing a margin-related claim in arbitration against his brokerage firm. A medical resident from Mesa, Ariz., Storheim says the firm sent him an e-mail message on a Saturday instructing him to wire in money to cover a margin call. On Monday morning, he made the arrangements, then called the broker, only to learn that it already had liquidated his entire position. "He didn't do anything wrong," says his lawyer, Tracy Pride Stoneman, from Colorado Springs.

Margin calls are up fairly significantly since the downturn began last fall, says Daniel Hubbard, a spokesman at Charles Schwab. Like most brokerage firms, it doesn't give out specific numbers. But the situation is not as bad as it could be, because total margin debt outstanding has been declining since last March. At Schwab, for example, margin debt is down 40% from a year ago as investors pare their debt during the market downturn.

That's little comfort to those squeezed by margin calls. Financial planners, lawyers and regulators say margin-related complaints have surged since last summer. And for every investor who lodges a complaint, there are many others in a similar plight who never contact a regulator. Last year, margin sellout complaints to the SEC jumped 133% over 1999. The pace has continued this year, with 100 complaints through March 15.

Margin-related arbitration cases also have been on the rise, says Linda Fienberg, president of NASD Dispute Resolution. In 2000, there were 284 cases, up 173% from a year earlier. In the first 2 months of the year, there were 57 cases, on track to surpass last year's pace.

In many cases, the complaints arise because investors didn't read the fine print in the margin agreement or didn't understand it, says Matthew Nestor, director of the Massachusetts Securities Division. They expect to be given ample time to cover a margin call and are shocked to learn that the broker can liquidate stocks in their portfolio without notice.

"Margin agreements are pretty clear," says Matthew Vetto, Salomon Smith Barney analyst. "If it feels like a splash of cold water to a customer, it's unfortunate. But that's the way the game works."

[As Dave Barry always comments, "I am not making this up." I guess I shouldn’t be so astonished that people turn to litigation when they get hit by margin calls and margin sellouts. Anyone can sue for anything these days. It’s all part of the mania: not understanding the downside risks is part and parcel of the belief that things can only get better, stocks can only go up, and the sun always shines. --Andre]

-- Andre Weltman (aweltman@state.pa.us), April 11, 2001

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