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E*Trade Loses Shocking FINRA Margin Call Arbitration
December 19, 2018
When it comes to margin accounts on Wall Street, many customers believe that they have the right to prior notification from their brokerage firm before any positions are liquidated to cover margin calls. In fact, many customers sincerely believe that they will be entitled to a modest delay in order to pick and choose which securities will or will not be sold off to cover the debt. Consequently, it often comes as a shock -- a severe one -- when customers discover that their brokerage firm sold their securities without first contacting them. In fast moving markets with dramatic drops or rises, many brokerage firms won't wait for things to get worse and will seek to mitigate damages by going into a non-compliant account and selling whatever they think makes the most sense at the appointed hour. Few interactions between customers and brokerage firms prompt more lawsuits than those involving sell-outs to satisfy margin calls. Few disputes end more overwhelmingly in the brokerage firms' favor than those involving margin sell-outs -- except in today's featured FINRA arbitration.
Case In Point
In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in October 2017, and as amended thereafter, public customer Claimants Herbert Moskowitz and Marilyn Moskowitz, appearing pro se, asserted breach of fiduciary responsibility; failure to timely notify client (or liquidate account) when account equity fell below margin requirements; failure to effectively notify client when account equity fell below margin requirements; violation of FINRA Rules 2010, 5310 and 3110. The causes of action relate to the trade execution of the VXX stock in Claimants' account on February 5, 2018. Ultimately, Claimants sought $258,921.00 in damages plus interest; punitive damages, costs, and fees.In the Matter of the FINRA Arbitration Between Herbert Moskowitz and Marilyn Moskowitz, Claimants, vs. E*Trade Securities LLC, Respondent (FINRA Arbitration 18-00915, December 14, 2018).
http://www.finra.org/sites/default/files/aao_documents/18-00915.pdf
http://www.finra.org/sites/default/files/aao_documents/18-00915.pdf
An interesting development during Discovery was explained in the FINRA Arbitration Decision:
On or about November 29, 2018, Claimants filed a Motion for Leave to Amend the Statement of Claim, in which they asserted that the validity of one of the key claims in their original Statement of Claim was based on Claimants' reliance on information that was communicated to them orally by one of Respondent's employees, and that, through the discovery process, Respondent provided valid documentation which contradicted the information provided earlier to Claimants and invalidated that claim. . .
Respondent E*Trade generally denied the allegations, asserted various affirmative defenses, and filed a Counterclaim asserting failure to repay margin balance in Claimants' account. In its Counterclaim, E*Trade ultimately sought the outstanding margin balance of $41,038.34.
The Panel granted Claimants' motion to amend. Also the Panel denied Claimants' Motion to Strike Respondent's Defense, which had argued that "since Respondent's conduct was so egregious, Respondent was not entitled to enter a defense and should be barred from doing so."
Award
The FINRA Arbitration Panel found Respondent E*Trade liable for its
failure to timely notify client (or liquidate account) when account equity fell below margin requirements and failure to effectively notify client when account equity fell below margin requirements . . .
Accordingly, the Panel ordered E*Trade to pay to Claimants $75,000.00 in compensatory damages.
Bill Singer's Comment
A stunning decision!
Not sure that I can recall the last time that public customer Claimants won a margin dispute based upon a FINRA member firm's failure to timely and/or effectively notify a customer that the account's equity had fallen below margin requirements. In today's featured FINRA arbitration, the customers' victory is all the more impressive given that they proceeded on a pro se basis. Unfortunately, not only is there no explanation in the FINRA Arbitration Decision as to why only $75,000 was awarded as against some $259,000 in requested damages, but there is no rationale provided by the arbitrators as to the core issue of why E*Trade was found liable in the first place -- no, I am NOT disputing such a finding but I am clamoring for some insight and guidance as to how and why these arbitrators rendered this unique decision.
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 CallsYou 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.
For a better understanding of why I don't understand the rationale for this Award (and, pointedly, I am NOT disagreeing with the Decision but simply expressing my bewilderment), consider that FINRA Rule 2264 specifically admonishes that:
The firm can sell your securities or other assets without contacting you. Some investors mistakenly believe that a firm must contact them for a margin call to be valid, and that the firm cannot liquidate securities or other assets in their accounts to meet the call unless the firm has contacted them first. This is not the case. Most firms will attempt to notify their customers of margin calls, but they are not required to do so. However, even if a firm has contacted a customer and provided a specific date by which the customer can meet a margin call, the firm can still take necessary steps to protect its financial interests, including immediately selling the securities without notice to the customer.
Did the FINRA Arbitration Panel disregard the industry protocol about member firms NOT having to contact their customers about before liquidating positions to cover margin calls? Did a negotiated agreement exist for these customers that mandated prior notice? Did the arbitrators find that E*Trade's notice was faulty or included an enforceable promise to forbear on the sales at issue? Again, given the dramatic nature of this decision it is unfortunate that the arbitrators failed to present a rationale for their ruling. For an even more expansive understanding of the leeway that FINRA member firms are afforded concerning their customers' margin accounts, read:
FINRA Rule 2264: Margin Disclosure Statement(a) No member shall open a margin account, as specified in Regulation T of the Board of Governors of the Federal Reserve System, for or on behalf of a non-institutional customer, unless, prior to or at the time of opening the account, the member has furnished to the customer, individually, in paper or electronic form, and in a separate document (or contained by itself on a separate page as part of another document), the margin disclosure statement specified in this paragraph (a). In addition, any member that permits non-institutional customers either to open accounts online or to engage in transactions in securities online must post such margin disclosure statement on the member's Web site in a clear and conspicuous manner.
Margin Disclosure StatementYour brokerage firm is furnishing this document to you to provide some basic facts about purchasing securities on margin, and to alert you to the risks involved with trading securities in a margin account. Before trading stocks in a margin account, you should carefully review the margin agreement provided by your firm. Consult your firm regarding any questions or concerns you may have with your margin accounts.When you purchase securities, you may pay for the securities in full or you may borrow part of the purchase price from your brokerage firm. If you choose to borrow funds from your firm, you will open a margin account with the firm. The securities purchased are the firm's collateral for the loan to you. If the securities in your account decline in value, so does the value of the collateral supporting your loan, and, as a result, the firm can take action, such as issue a margin call and/or sell securities or other assets in any of your accounts held with the member, in order to maintain the required equity in the account.It is important that you fully understand the risks involved in trading securities on margin. These risks include the following:
- You can lose more funds than you deposit in the margin account. A decline in the value of securities that are purchased on margin may require you to provide additional funds to the firm that has made the loan to avoid the forced sale of those securities or other securities or assets in your account(s).
- The firm can force the sale of securities or other assets in your account(s). If the equity in your account falls below the maintenance margin requirements, or the firm's higher "house" requirements, the firm can sell the securities or other assets in any of your accounts held at the firm to cover the margin deficiency. You also will be responsible for any short fall in the account after such a sale.
- The firm can sell your securities or other assets without contacting you. Some investors mistakenly believe that a firm must contact them for a margin call to be valid, and that the firm cannot liquidate securities or other assets in their accounts to meet the call unless the firm has contacted them first. This is not the case. Most firms will attempt to notify their customers of margin calls, but they are not required to do so. However, even if a firm has contacted a customer and provided a specific date by which the customer can meet a margin call, the firm can still take necessary steps to protect its financial interests, including immediately selling the securities without notice to the customer.
- You are not entitled to choose which securities or other assets in your account(s) are liquidated or sold to meet a margin call. Because the securities are collateral for the margin loan, the firm has the right to decide which security to sell in order to protect its interests.
- The firm can increase its "house" maintenance margin requirements at any time and is not required to provide you advance written notice. These changes in firm policy often take effect immediately and may result in the issuance of a maintenance margin call. Your failure to satisfy the call may cause the member to liquidate or sell securities in your account(s).
- You are not entitled to an extension of time on a margin call. While an extension of time to meet margin requirements may be available to customers under certain conditions, a customer does not have a right to the extension.
(b) Members shall, with a frequency of not less than once a calendar year, deliver individually, in paper or electronic form, the disclosure statement described in paragraph (a) or the following bolded disclosures to all non-institutional customers with margin accounts:Securities purchased on margin are the firm's collateral for the loan to you. If the securities in your account decline in value, so does the value of the collateral supporting your loan, and, as a result, the firm can take action, such as issue a margin call and/or sell securities or other assets in any of your accounts held with the member, in order to maintain the required equity in the account. It is important that you fully understand the risks involved in trading securities on margin. These risks include the following:
- You can lose more funds than you deposit in the margin account.
- The firm can force the sale of securities or other assets in your account(s).
- The firm can sell your securities or other assets without contacting you.
- You are not entitled to choose which securities or other assets in your account(s) are liquidated or sold to meet a margin call.
- The firm can increase its "house" maintenance margin requirements at any time and is not required to provide you advance written notice.
- You are not entitled to an extension of time on a margin call.
The annual disclosure statement required pursuant to this paragraph (b) may be delivered within or as part of other account documentation, and is not required to be provided in a separate document or on a separate page.(c) In lieu of providing the disclosures specified in paragraphs (a) and (b), a member may provide to the customer and, to the extent required under paragraph (a) post on its Web site, an alternative disclosure statement, provided that the alternative disclosures shall be substantially similar to the disclosures specified in paragraphs (a) and (b).(d) For purposes of this Rule, the term "non-institutional customer" means a customer that does not qualify as an "institutional account" under Rule 4512(c).
http://www.brokeandbroker.com/index.php?a=topic&topic=margin