By Jason Zweig | 1:38 pm ET Jan. 23, 2015
Image Credit: Christophe Vorlet
When you use margin, there is no margin for error.
In an account that permits the use of margin, you can borrow against the market value of most stocks, bonds, mutual funds or exchange-traded funds. That enables you to leverage a smaller position into a bigger one. If your holdings do well, the margin will magnify your gains.
In recent years, investors have racked up plenty of margin debt. Such loans totaled more than $457 billion as of the end of November, the most recent data available, according to the New York Stock Exchange.
But a margin loan is secured by your investments. If they drop sharply in price, the brokerage firm can invoke a “margin call,” triggering a forcible sale to ensure that the firm will be able to get its money back on the loan it made to you. So margin can magnify your losses.
Many foreign-currency traders learned that on Jan. 15 when the Swiss franc shot up in price, handing them severe losses and leading U.S. regulators to consider tighter margin limits on currency trading. Similar concerns this past week led Chinese authorities to crack down on trading stocks with margin.
And, in a sign that the brokerage industry may need to pay closer attention to smaller accounts, it turns out that you also can incur margin debt without meaning to, as Edith Berwald Steierman recently found out.
Earlier this month, Ms. Steierman, toting a plastic bag full of manila folders stuffed with old brokerage statements, told me her story. She and her family, she says, fled Belgium in 1940 to escape the Nazis.
Bright and feisty but financially unsophisticated, Ms. Steierman, who is in her 80s and lives in New York, opened a brokerage account with Merrill Lynch in the 1970s.
She says she hasn’t made a single trade in her account since April 13, 1987, when she sold her stocks and invested $240,000 in a Putnam U.S. government-bond fund.
Four or five years ago, Ms. Steierman says, a broker at Merrill Lynch told her that she appears to have borrowed $3,525 in margin around 1987. But, she insists, she didn’t fully understand the implications.
At the end of December, she received a letter from Merrill Edge, the division of Bank of America where her account now resides, informing her that she owed $65,094.50 in margin debt and that she had racked up $4,330.63 in margin interest for 2014 alone.
“We may be required to place a freeze on your account,” warned the letter, adding that she might have to “deposit additional funds to avoid forced liquidation of securities to cover margin calls.”
“When I saw this $65,000 number, I almost passed out,” Ms. Steierman says. “I have this strange nightmare that they’re going to take my money and I would be with a cup on the street.”
She contacted Merrill, she says, and insisted that she had never bought any securities using margin. “I told it to them, straight-point in their face,” Ms. Steierman says. “Why would I borrow $3,525 when I gave them a check for $240,000? What kind of stupidity is that?”
Industry lawyers say that investors can inadvertently incur margin debt—for example, by writing a check against an account with insufficient cash to cover the amount or through unpaid fees.
Of course, every month for more than 27 years, Ms. Steierman’s account statements showed that she owed a relentlessly escalating pile of margin debt—at rates ranging from more than 11% in the late 1980s to 7.5% last year.
But the main thing Ms. Steierman focused on when she read her statements, she says, was the amount of the monthly income from her bond fund—which has shrunk to about $400 from $2,300. The notation “DR,” the brokerage-industry abbreviation for “debit” that signals a margin balance, didn’t mean anything to her.
“These brokerages give you more papers than a stationery store,” she says. “Who can understand it all?”
Ms. Steierman could have avoided the problem by opting out of any margin agreement when she originally opened her account, says Howard Meyers, who runs the Securities Arbitration Clinic at New York Law School.
But, she says, “No broker ever called me in all those 27 years and said, ‘I think you have a problem with this margin.’ Isn’t it their duty to call me once a year or something and look over my account with me?”
That is a good question, says Marc Menchel, former general counsel for regulation at the Financial Industry Regulatory Authority and now a consultant in Washington. As brokerage firms pursue the wealthiest clients, many smaller investors are “being put at higher risk just because they have a lower balance, and basic maintenance and oversight of accounts is being reduced,” he says.
After an inquiry from The Wall Street Journal, Merrill Lynch looked into the matter and concluded that the firm’s records don’t date back far enough to pinpoint the origins of the margin debt, says Bill Halldin, a spokesman for the firm. He says Merrill is erasing all the margin debt and interest from her account.
“We continuously strive to work with every client to help them achieve their financial goals,” Mr. Halldin says. Should this kind of problem have been detected sooner? He says Merrill takes compliance very seriously and is always seeking to improve account supervision.
For Ms. Steierman, all’s well that ends well. But her story is a reminder that big brokerage firms need to work harder to keep the problems of their smaller clients from falling through the cracks—and that clients have to watch out for themselves in case no one else happens to be.
Source: The Wall Street Journal