LOL!
Class action has such a ring to it. -g-
NASD Rule Would Require
Warning on Account Risk
By RUTH SIMON and TERZAH EWING
Staff Reporters of THE WALL STREET JOURNAL
Investors who buy stocks with borrowed funds could soon start seeing Wall Street's equivalent of cigarette-pack health warnings.
Securities firms could soon be required to include dire disclaimers on account statements, cautioning investors of the extreme risks of buying on margin. Among the possibilities: "The [brokerage] firm can sell your securities without contacting you," and "You are not entitled to choose which security in your margin account is liquidated."
It is all part of a regulatory push to rein in problems with margin accounts. Last week, the National Association of Securities Dealers' board passed a rule that would require brokerage firms to give holders of the risky accounts a disclosure statement before they sign on the dotted line -- and then send it again every year. The new rule must be approved by the Securities and Exchange Commission, which declined to comment.
The move is in some ways symbolic. Many brokerage firms already make special disclosures to margin account holders. Nonetheless, the new effort underlines continuing concerns among securities regulators that investors don't fully understand the risks of buying stock with borrowed funds.
Buying stock on margin can magnify the rewards, and risks, of playing the market. If stocks take a hit -- as they did in a big way during the spring and to a smaller extent last week -- customers can face "margin calls"; that is, demands that they put up additional cash or stock. Though investors don't always realize it, brokerage firms have the right to sell stocks to meet a margin call without notifying their customers beforehand.
Regulators say they have received a flurry of complaints from disgruntled investors with margin accounts. In the first half of this year, the SEC received 459 investor complaints about margin sell-outs and margin disclosures. That compares with a total of 314 complaints in all of 1999. Among those who complained is John Storheim, a medical resident in Mesa, Ariz. He received a $35,000 margin call on April 15 from his broker, Scottrade. Mr. Storheim says he arranged to have the money wired to his brokerage account the following Monday. But when he called Scottrade six minutes after the market opened, he says, his portfolio had already been liquidated. Mr. Storheim, who lost $20,000, has filed an arbitration claim with the NASD against his broker.
Mr. Storheim says he "knew there was that risk" that his account could be liquidated, but "was kind of shocked that I was given no time" to meet the margin call. He says he would have been better off had the risks been spelled out more clearly. "I try to be a smart consumer," he says, "but it's hard to really get all those details without someone simplifying it for you."
Bruce Morton, a spokesman for Scottrade, a deep-discount broker based in St. Louis, says the firm discloses that investors can be sold out without notice "in clear type" in its account agreement. "We had [an experienced] customer who was highly concentrated in a [single] stock in a rapidly declining market," he says. "How big and bold I made the type, how clear I made the words, may not have made a difference in these circumstances." He adds that Scottrade "is constantly reviewing these things for clarity."
What is clear is that many investors borrow heavily from their brokers without fully understanding the potential downside. Margin loans hit a record $278.5 billion in March at securities firms, nearly double the $140.3 billion in March 1998. The level of margin debt sank in April after the Nasdaq Composite Index began what would become a 35% plunge from its high, triggering a flurry of margin calls. Yet in June, such debt increased nearly 3% from May's level, to $247.2 billion.
More recently, margin debt has held fairly steady, brokerage firms say. At E*Trade Group Inc., "margin balances have stayed pretty stable since about June," says spokesman Patrick Di Chiro. At Datek Online Holdings Inc., investor borrowing has "crept up slightly since the beginning of June ... but is still below April levels," says Mike Dunn, a company spokesman.
The NASD says there should be a fairly uniform way of clarifying margin accounts' risk. A week ago, its board approved a rule that would require all member firms to give customers seeking to open a margin account a clear statement of the possible perils.
The rule filing even includes a sample form with risks underlined and boldfaced: "The firm can force the sale of securities in your account," "You are not entitled to an extension of time on a margin call," and "You can lose more funds than you deposit in the margin account." NASD officials say firms would be able to use the sample form or customized forms, provided they disclose all of the risks.
Brokerage firms say they generally support the idea of providing more information to investors, though they haven't fully analyzed the proposed rules.
"We're still waiting to see and digest the details, but conceptually we like the idea of disclosure," says Greg Gable, a spokesman for Charles Schwab Corp. "We think we're already doing the kinds of disclosures that are helpful and useful to people making decisions about using margin."
Melissa Gitter, a spokeswoman for TD Waterhouse Group Inc., says her firm "fully support[s] educating investors on the risks associated with using margin. However, we need to study the proposed rules further before we can make additional comments."
Some firms say they have already taken steps to better educate investors about the risks of investing with borrowed funds. "There's very little in it that we don't already do," says Mr. Di Chiro of E*Trade. In June, Datek sent its investors a mailer explaining what it means to buy stocks on margin. The notice used language suggested by the SEC, Mr. Dunn says.
A couple of factors pushed the NASD to attempt to impose the requirement. Mary Schapiro, president of the organization's regulatory arm, says that while many firms already make risk disclosures to new customers, the NASD discovered that the disclosures aren't necessarily clear and methods for making them vary from firm to firm.
Moreover, after the sharp downturn in the Nasdaq index in the spring prompted an increase in margin calls and account liquidations, "we saw a ramping up of customer complaints. Customers were angry, but mostly they were just confused," Ms. Schapiro says.
The NASD in the spring mulled raising the amount of money a customer is required to keep in a margin account. But the NASD hasn't gotten other parts of the industry, notably the Big Board, to agree to that measure.
Currently, the Federal Reserve sets a minimum initial-margin requirement of 50%, which means when an investor buys $10,000 of stock, he or she must put up at least $5,000; the rest is paid by a margin loan from his or her broker. After that, the NYSE and NASD require a lower "maintenance" margin requirement of 25% of the value of stocks held (though individual firms can demand more). The NASD's chairman, Frank Zarb, had said he would like to see that raised to 30%. |
