The value of the California engineer’s technologyladen portfolio plummeted, forcing him to sell $18,000
of stock and to deposit an additional $2,000 in cash in his account to meet a margin call from his broker,
TD Waterhouse Group, to reduce his $52,000 in borrowings.
At least the worst was over, Mr. Bradaran figured, as tech stocks soared the following Monday—only to learn Monday evening that Waterhouse’s Santa Monica, Calif., branch had sold an additional $20,000 of stock “without even notifying me,” he says. His account, which had been worth $28,000 not including his borrowed funds, is now worth just $8,000, he says. “If they had given me a call, and I had deposited the money, I would have gained back at least half” of the $20,000 in losses when the market rebounded, he claims.
Mr. Bradaran is one of many investors who have discovered that buying stocks with borrowed funds—always a risky strategy—can be riskier than they ever imagined when the market is going wild. That’s because some brokerage firms exercised their right to change marginloan practices without notice during the market’s recent nose dive.
The result: Customers were given only a few hours or less to meet a margin call, rather than the several
days they typically are given to deposit additional cash or stock in their brokerage account, or to decide which securities they want to sell to cover their debts. And some firms, such as Waterhouse, also sold out some customers’ accounts without any prior notice, as they are allowed to under margin-loan agreements signed by customers.
Investors generally can borrow as much as 50% of the value of their stocks. Once the purchase is completed
an investor’s equity—the current value of the stocks less the amount of the loan—must be equal to at least 25% of the current market value of the shares.
Many brokerage firms set stricter requirements. If falling stock prices reduce equity below the minimum,
an investor may receive a margin call. The actual amount an investor must fork over to meet a margin call can be a multiple of the amount of the call. That is because the value of the loan stays constant even when the market value of the securities falls.
Many investors were stunned by their firms’ actions, either because they didn’t understand the margin rules
or ignored the potential risks. There aren’t any public statistics on the number of investors affected, but the
margin calls accompanying April’s market roller coaster have clearly hit a nerve.
Some clients of other brokerage firms were affected as well. Larry Marshall, the owner of an executivesearch
firm who lives in Malibu, Calif., says Merrill Lynch & Co. told him the Monday after the market’s drop that he would have to meet an $850,000 margin call immediately. Normally, he says, the firm gives him three to five days to come up with additional funds.
A Merrill Lynch spokeswoman says “as a matter of good business practice in periods of extreme volatility,
offices may be asked to exercise the most prudent measures—clearly outlined in our margin policy—to responsibly manage the risk associated with leveraged accounts.”
Clearly, a lot of investors would have benefited from additional time because of the market’s sharp rebound.
But they, and the brokerage firms on the hook for their loans, could have been in even worse shape if stock
prices had continued to plummet.
SOURCE: Abridged from Ruth Smith, “Margin Investors Learn the Hard Way That Brokers Can Get Tough on Loans,” The Wall Street Journal, April 27, 2000.
