Investors often don't even know they have a margin account, even though many brokerage firms automatically put investors into margin accounts when they sign up. The incentives are plenty: Not only do brokerages reap interest charges and transaction fees, they also profit by lending shares held in margin accounts to other traders. To avoid getting sucked dry, investors must ask to be put into cash accounts. - Forbes
Somewhere in the brokerage account opening package is a clause that approves the opening of a margin account instead of a cash account. (A cash account is one where you pay the full price of the stock at the time you purchase it.) You are expected to read the application. Even if you did not, once the account is open you would see margin data in your portfolio, and eventually being charged for taking advantage of margin the first time you purchased more stock than you had deposited money for. If you don't know if you have a margin account, then you should seriously consider not investing.
So how do different firms present the option of opening a margin account? I went to TD Ameritrade, which I currently use, and checked out the open a new account option. As you can see from the screen shots, TD Ameritrade requires you to request the ability to trade on margin. No trickery here.
Too bad they are not as upfront with you when it comes to their paper application. It is setup to for you to automatically open a margin account, unless you opt-out.
This is the source of the problem mentioned in the article. By wording it this way, it gives the impression that it is normal to open a margin account. So why would you not open a normal account, right? It seems pretty strange that they would require you to request margin approval when opening the account online, but require you to opt out of a margin account when filling out a paper application. Are they guiding older, less internet savvy, clients to margin accounts? I think TDAmeritrade has some explaining to do here. Not for anything, many people are going to miss the opt-out because they are busy filling out the other info requested in the section. So how about giving those using a paper application the same clear choice that they are given when applying online?
"All qualified accounts are opened as margin accounts, allowing you to borrow against the value of certain securities"
Pretty open and clear application process here. (I did not check their paper application as it is delivered by mail.)
Schwab seems to have the sneakiest application process that I can see, since they pre-select margin trading for your account type, even if you mark on the previous screen that you have low income and have no investment experience. Come on Chuck, how about listening to your new clients who tell you that they have no investment experience. Do you really think putting them in a margin account is the right thing to do? How about putting that in your next commercial?
Good luck finding that account agreement mentioned in the above screenshot as I did not see a clear link to one on their website. Here is one clause that I found interesting from their margin agreement:
We may transfer Securities and Other Property from any brokerage account in which you have an interest to any other brokerage account in which you have an interest, regardless of whether there are other Account Holders on either Account, if we determine that your obligations are not adequately secured or to satisfy a margin deficiency or other obligation. You agree to pay on demand any account deficiencies after liquidation, whether liquidation is complete or partial. - Schwab Margin Agreement extract (4/28/07)
So, if they decide that you are in trouble on your account, they have the right to raid any other account you might have, like your child's account that your a custodian on, or perhaps a parent's account, depending on what 'in which you have an interest' means. Taking money from joint accounts is pretty a pretty low thing to do, even for a brokerage.
Now why does this matter? Take this recent alert from the SEC:
NASD Warns Investors of the Risks Associated with Using Margin to Purchase Securities
Washington, DC — NASD today issued an updated Investor Alert warning investors about the risks associated with trading on margin. Since the release of a previous Alert on this topic in 2003, the amount of debt taken on by investors to buy securities has reached a record high of $321.2 billion in February 2007.
"We are concerned too many investors are unaware they could suffer substantial financial losses by using debt to purchase securities," said Mary L. Schapiro NASD Chairman and CEO. "By updating our Alert on this topic, we hope to remind investors not to underestimate the risks involved."
The Alert, Investing with Borrowed Funds: No "Margin" for Error, explains that investors who cannot satisfy margin calls can have large portions of their accounts liquidated under the market conditions at the time, favorable or unfavorable. That liquidation can result in substantial losses. Some of the risks associated with opening a margin account explained in the Alert are:
* Firms can force the sale of securities in accounts to meet a margin call.
* Firms can sell securities without contacting the account holder.
* Account holders are not entitled to choose which securities or other assets can be sold.
* Firms can increase margin requirements at any time and are not required to provide advance notice.
* Account holders are not entitled to an extension of time on a margin call.
* Account holders can lose more money than is deposited in a margin account.
* Account holders should ask whether they will automatically be placed into a margin account and, if so, what the rate of interest will be and what circumstances would trigger a margin loan.
Along with explaining the risks involved with margin, the Alert provides some basic facts about purchasing securities on margin and where to turn for help. Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck. NASD makes BrokerCheck available at no charge. In 2006, members of the public used this service to conduct more than 4.7 million searches for existing brokers or firms and requested more than 207,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to BrokerCheck at www.nasd.com/brokercheck. Investors can also access this service by calling (800) 289-9999.
Too many rookies trading on margin result in inflating the stock market like a bubble. The problem with bubbles is that they pop and the more margin accounts that are long in the market, the more dramatic the drops are when the market goes red. When the stock market has a bad day, margin accounts get margin calls. Since many will not have the money to meet a margin call, they will instead sell driving the price of stocks lower. This is combined with brokerages liquidating accounts of those who have not cleared their margin call. Anyway, the price of most stocks fluctuate, and many will fluctuate due to a generally down day, even though there is nothing wrong with the stock itself.
Do you still want that margin account?
I want you to have one. It is those really bad days with lots of margin calls where I pick up some good stock being sold cheap.
Hopefully your not using any margin so you can request to have your account changed to a cash account.