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FINRA Margin Arbitration Proves All That Glitters Is Not Goldman Sachs
January 15, 2021
The nature of a so-called "demand" loan is that you're not entitled to notice. It's a pay up when we demand repayment. Wall Street's margin loans are creatures of the same stripe. You are extended a loan by your brokerage firm, but if your maintenance margin drops below what is required, the firm can sell whatever needs to be sold in order to protect itself. The firm may give you notice. It may not. Okay, sure, the firm has to exercise reasonableness and good faith, but when a market is crashing and your assets dwindling and full panic mode sets in, you'd be surprised how reasonableness and good faith get stretched. In a recent FINRA arbitration, the onerous nature of margin loans came into play.
Case In Point
In a FINRA Arbitration Statement of Claim filed in April 2019 and as amended thereafter, public customer Gerstenbluth alleged excessive margin call and the improper sale of Goldman Sachs common stock. Ultimately, Claimant sought $40,000 in compensatory damages plus fees, costs, and interest. In the Matter of the Arbitration Between Martin David Gerstenbluth, Claimant, v. Fidelity Brokerage Services LLC, Respondent (FINRA Arbitration Award 19-00913)
https://www.finra.org/sites/default/files/aao_documents/19-00913.pdf
https://www.finra.org/sites/default/files/aao_documents/19-00913.pdf
Respondent Fidelity generally denied the allegations and asserted various affirmative defenses.
By way of spoiler alert, Claimant Gerstenbluth's case went down in flames, as apparently did his brokerage account. My interest in reporting about this arbitration was largely based upon the fact that I read, and then re-read the Award, and, try as I might, I couldn't quite figure out what constituted the substance of the customer's complaint -- other than what is often the driving force behind such complaints: The loss of money.
SIDE BAR: The BrokeAndBroker.com Blog frequently reports about margin disputes. See:
- BrokeAndBroker.com Blog "Margin" archive at http://www.brokeandbroker.com/index.php?a=topic&topic=margin
The Arbitrator's Report
Sole FINRA Arbitrator Paul Allan Massaro penned an exemplary Award replete with as fine an "Arbitrator's Report" as has graced the pages of FINRA's online content. To Arbitrator Massaro's credit, he explains the context of the dispute, presents us with sufficient content so as to make the dispute intelligible, and then dazzles us with a compelling rationale for his decision to deny Claimant's claims.
The "Arbitrator's Report" asserts that in 2006 Claimant Gerstenbluth executed a Fidelity "Customer Agreement and Margin Call Agreement," which purportedly disclosed that Fidelity reserved the right to take measures to secure its margin loan by acting with or without prior notice of buying in a given margin position. As Arbitrator Massaro explained in part:
The evidence established that in December 2018, U.S. stocks experienced volatile market movements culminating in December 26, 2018 being the third lowest market day for that year. As a result of market volatility, previous trading in the period just before December 26, 2018, and Claimant's portfolio concentration, the margin rate on the Claimant's account for December 26th 2018 moved from 40% to 60%, based upon algorithms which Respondent uses in ascertaining a margin rate.Just prior to this latter event, Claimant had been given seven (7) margin calls beginning on December 1, 2018 through December 23, 2018. The testimony from Respondent's witness advised that the Claimant did not respond to any of these calls. Because the margin debt balance on the Claimant's account was over $215,000 on December 26, 2018, Respondent issued another margin call for December 26, 2018. The Claimant did not respond. At this point the equity in Claimant's account was approximately $110,000.00. The Respondent, therefore, had to act quickly to prevent further loss and sold 870 shares in that account. That sale is the subject of this arbitration.
Making matters worse for Claimant, the FINRA Award alleges that his "portfolio was concentrated 100% in one stock." Frankly, it's no small wonder that Fidelity pulled the plug, even if in a panic. As set forth in the Award, Fidelity apparently sold 870 shares of Goldman Sachs stock in order to cover its margin call. Historical data shows that Goldman Sachs Group, Inc. (Symbol: GS) shares opened on December 26, 2019, at $230.26 and closed at $231.21.
Bill Singer's Comment
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. Re-read your Margin Agreement and you will likely see that sell-out consent buried among the thousands of words. If the equity in your account falls below the legal 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 to cover the debit? You may be responsible for any resulting deficiency.
As the Securities and Exchange Commission warns in part in its online
Investor Bulletin "Understanding Margin Accounts" (May 14, 2018)
https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_marginaccount
Investor Bulletin "Understanding Margin Accounts" (May 14, 2018)
https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_marginaccount
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.
Additionally, consider:
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).