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Margin trading is a practice in which a financial advisor recommends an investor purchase stocks by borrowing money from a broker-dealer using securities that are already owned as collateral. Brokers sometimes recommend margin accounts as a way to generate commissions without an additional up-front investment from their customers, despite the fact that margin trading is a high-risk strategy that is not in the best interests of many investors.
Financial advisors and brokers have an obligation to make investment recommendations that are consistent with an investor’s financial objectives, risk tolerance, income level and other factors.When recommending margin accounts, financial advisors must make investors aware of the associated risks and receive written client consent prior to establishing margin accounts and engaging in margin trading. Investors should receive a margin disclosure statement that defines the terms of the margin account, including the interest charges linked to borrowing money for the margin account.
If your financial advisor or broker recommended a margin account that was inappropriate for your established circumstances and investment goals, or improperly used the margin account as a line of credit or to purchase unstable securities, he or she may have committed a breach of fiduciary duty and you may be able to pursue losses incurred as a result.
Margin Trading Risks
Margin accounts may be sold to investors as a means of increasing their buying power to own more stock without full, immediate payment. Margin accounts are especially high risk for average investors seeking to build portfolios for retirement. Investors may suffer significant losses even in legitimate, consensual margin trading, although customers who agree to margin accounts are often not made fully aware of the risks. If the equity level of a margin account falls below the investment firm’s maintenance margin requirements (the amount an investor’s account must maintain after margin trades) the broker can sell securities without contacting or obtaining permission from the investor to cover the difference. Brokers may also charge commissions on the sale of these securities to compensate for the deficit, further depleting investors’ resources.
Some financial advisors and brokers also make improper use of margin accounts to purchase speculative or volatile stocks, or tread margin accounts as lines of credit. Because of the complexities of margin accounts and the regulations that bind them, securities arbitration claims related to margin trading can be challenging for investors without the help of an attorney with extensive experience in cases related to investment malpractice.
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