A margin account is a type of investment account that allows investors to borrow funds from their broker-dealer to purchase securities. With a margin account, investors are able to leverage their trades by borrowing against the value of their portfolio. This means that investors can potentially earn larger returns on their investments but also exposes them to increased risk.

Broker-dealers have a number of responsibilities when it comes to margin accounts. One of their primary responsibilities is to ensure that investors understand the risks associated with trading on margin. This includes providing investors with a detailed explanation of how margin accounts work, the potential risks and benefits, and any costs or fees associated with trading on margin.

Another important responsibility of broker-dealers is to ensure that investors meet the eligibility requirements for trading on margin. These requirements may vary depending on the broker-dealer, but typically include factors such as an investor’s financial standing, trading history, and investment objectives. Broker-dealers must also maintain appropriate documentation to demonstrate that investors meet these requirements.

Once an investor has been approved for a margin account, broker-dealers are responsible for monitoring the account to ensure that the investor is maintaining sufficient collateral to cover any potential losses. This is known as a margin call. If the value of the investor’s portfolio falls below a certain level, the broker-dealer may issue a margin call, requiring the investor to deposit additional funds or securities to maintain the required level of collateral.

Broker-dealers should clarify for investors that the broker-dealer has almost unfettered control over the margin account. The broker-dealer, in the face of a ‘margin call,’ can raise money to meet the margin call by selling stocks from an investor’s account without first asking the investor. The broker dealer can even sell out the entire account without the client’s authority to protect the broker-dealer.

Broker-dealers are also subject to the Financial Industry Regulatory Authority’s (FINRA) rules regarding margin accounts. These rules require broker-dealers to provide investors with a risk disclosure statement outlining the risks associated with trading on margin. Broker-dealers must also provide investors with regular statements outlining the status of their margin accounts, including the amount of margin used and any potential margin calls. Additionally, broker-dealers must also comply with all applicable laws and regulations governing their conduct, including the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.

Another important responsibility that broker-dealers have is the responsibility to ensure that all investors are treated fairly and with integrity. This includes providing investors with accurate and timely information about their margin accounts, as well as ensuring that any fees or charges associated with trading on margin are reasonable and transparent. Broker-dealers must also have adequate safeguards in place to protect investors’ assets and prevent unauthorized access or theft.

Margin accounts offer investors the opportunity to potentially earn larger returns on their investments, but such accounts also come with increased risk. Broker-dealers have a number of important responsibilities when it comes to margin accounts, including ensuring that investors understand the risks and benefits of trading on margin, monitoring accounts to ensure sufficient collateral, preventing illegal trading practices, and complying with applicable regulations. As an investor, it’s important to work with a reputable broker-dealer who is committed to transparency, fairness, and integrity when it comes to margin accounts.

The PRI is an independent network of investors who promote responsible and sustainable investing by incorporating ESG factors and considerations into their investment decisions. Although the PRI is not a part of the UN itself, the UN supports and partners with the group. In 2006, when the PRI was formed, it managed about $7 Trillion in assets, and in 2020, it managed over $100 Trillion. [1]

So why should you as an investor care about ESG investing? ESG factors and criteria empower investors to make “socially responsible” and sustainable investment decisions by providing important insight into a company’s operations, standard practices, and culture through the lens of Environmental, Social, and Governance considerations.

For example, a company might disclose Environmental factors such as their carbon emissions or water usage, aimed at conserving our natural world. Social factors place an emphasis on how a company treats both its employees and the public and include employee diversity statistics or human rights considerations. Finally, Governance factors focus on the way in which the company is led and include information like executive pay scales as well as political leanings. [2]

When an investor is equipped with meaningful – and truthful – ESG information, they can be confident in their monetary support of a company. As a result, ESG investing continues to be top of mind for investors and regulators in the United States. However, investor interest is not the only factor influencing ESG popularity. Sound ESG investing also yields relatively high returns when compared to conventional funds while providing relatively lower risk, according to a study by Morgan Stanley in 2019. [2]

While many companies voluntarily disclose ESG data, there is currently a gap in investor knowledge, as many ESG disclosures are not yet compulsory. One particular area in which this is true is with regard to climate change disclosures – which the SEC published guidance on in 2010 but have not been adjusted since then.

At Wednesday’s PRI event, Commissioner Gensler focused in on the value and importance of climate change disclosures and provided a glimpse into the future of SEC regulation of the topic. In particular, Gensler emphasized that these disclosures must be “decision useful,” meaning that they include sufficient factual information to allow proper decision-making to take place.

Gensler also highlighted the intense interest modern investors have in the climate risks associated with stocks they purchase, likening the investor push for climate risk disclosure today to the push for disclosure of basic financial information decades ago. In response to this investor interest, Gensler announced that he has tasked his staff with developing a proposal for mandatory climate risk disclosures for review by the end of 2021. [3]

The transition from the SEC’s current climate risk guidance to mandatory SEC climate risk disclosures is monumental, and it will allow investors to compare “apples to apples” when analyzing climate risk data between companies.

Furthermore, Commissioner Gensler spoke about the possibility of requiring disclosure of carbon emissions data not only for the company itself, but for each member of the company’s value chain. Granular data like this will provide investors with a truly actionable and “decision useful” basis for making investment decisions by providing not just a piece of the puzzle, but instead the full picture of a company’s true impact on the environment.

As we enter the back half of 2021, investors should be on the lookout for additional remarks by Commissioner Gensler relating to climate risks and ESG disclosures. While we have only a blueprint now, support and demonstrated investor interest in ESG factors will encourage the SEC to continue its pursuit of meaningful regulation to benefit investors like you.

Sources:

[1] https://www.unpri.org/pri/about-the-pri

[2] https://www.nerdwallet.com/article/investing/esg-investing

[3] https://www.sec.gov/news/speech/gensler-pri-2021-07-28

Margin debt can be simply understood as debt taken on by an investor in order to extend their buying, and earning, power in the market. In essence, an investor borrows money to increase their initial investment and, hopefully, to supercharge their eventual profit.

For example, an investor might borrow $10,000 from their broker on margin in order to increase their initial investment from $20,000 to $30,000. If the shares they’ve purchased increase by 10%, the investor stands to make 50% more than they would have with only their own $20k.

Of course, taking on margin debt is also highly risky. When an investor’s balance falls below the minimum amount required by the broker, they may face a margin call. This margin call requires the investor to deposit more money or securities to maintain the broker’s minimum required value within the account.

Trading on margin is an attractive option when investors feel optimistic about the future of the security they’re investing in, or the overall market. However, this practice may have detrimental, rippling impacts within the market. Because borrowing on margin adds additional investment money into a particular stock or stocks, high levels of margin may actually begin to create a bubble. [2]

Excessive margin debt can be symptomatic of these speculative market bubbles, and eventual bursts, because it may signal overexuberant investor behavior, behavior that is not fully based in fact. As a result, several experts agree that exceedingly high levels of margin debt may signal an impending market drop.

In fact, sky-rocketing levels of margin debt have preceded both of this century’s extended economic downturns. Just before the dot-com bubble burst in 2000, margin debt was up more than 80%, and before the great recession in 2008, margin debt had risen by over 60%. [3] For context, margin debt is currently up more than 50% since this time last year and has risen 10.5% to date in 2021.

While high levels of margin debt are but one indicator of a potential market downturn, they are a critically important one to watch. In 2000 and in 2007, the S&P hit its own peak just a few months after margin debt peaked. Similarly, once margin debt hit its lowest point in 2009 following the recession, the S&P hit bottom just one month later. [4] The takeaway: the cyclical and relational nature of margin debt and overall market performance is not to be ignored.

The popularity of trading on margin has exploded, particularly in light of the newfound ease of doing so through popular app-based platforms like Robinhood. However, it is important for investors to keep in mind the broader market implications that an abundance of such trading may have, potentially in the near future.

Sources: [1] https://www.finra.org/investors/learn-to-invest/advanced-investing/margin-statistics [2] https://www.gobankingrates.com/money/economy/signs-of-market-bubble-crash-what-to-expect/ [3] https://www.fool.com/investing/2021/06/12/whos-ready-stock-market-crash-5-reasons-big-drop/ [4] https://www.advisorperspectives.com/dshort/updates/2021/07/20/margin-debt-and-the-market-up-2-4-in-june-continues-record-trend

There are some situations in which FINRA arbitration is required, such as when a written agreement between the parties mandates it. In order to be eligible for FINRA arbitration, an investor must be seeking to file a claim stemming from the business activities of their broker or brokerage firm, and the event in question must have taken place within the last six years (in most states). [1]

Generally, FINRA arbitration allows an investor to seek either monetary or securities damages resulting from the business activities of their broker or brokerage firm. To get the filing process started, an investor must submit a Statement of Claim, a FINRA Submission Agreement, and related filing fees, all of which are available to view on FINRA’s website. [2]

The format and related fees for the arbitration itself vary based on the amount of money in controversy. When the amount in controversy is below $10,000, a hearing session will be conducted with just one arbitrator, and the session fee will be between $50 and $450. If the amount in controversy is above $10,000, a panel of three arbitrators may be used instead, and the hearing session fee will range from a minimum of $600 to a maximum of $1,575. [3]

Once FINRA receives all of the initial required documents, they analyze the claim and determine whether a one- or three-person arbitration panel will be used. A case number is created, and FINRA will notify the respondent – the party the investor has filed their claim against – about the case. So long as the respondent is registered with FINRA, they will be required to arbitrate.

The respondent then has 45 days to research the claim lodged against them and to respond. FINRA analyzes the response along with any counter claims or cross claims.

Next, the parties choose their arbitrators from a randomly generated list of names supplied by FINRA. FINRA arbitrators are not FINRA employees, instead they are contractors who are evaluated by FINRA on the basis of their employment, professional licenses, and education. They are chosen from diverse backgrounds and must take an oath to remain neutral and decide cases solely on the facts and meris.

Once arbitrators are chosen and agreed upon by both parties, there will be an initial pre-hearing conference, where investors are typically represented by an attorney. The arbitration hearing is scheduled, and discovery begins.

Discovery allows both parties to exchange documents and identify witnesses and is governed by rules within FINRA’s Discovery Guide. After discovery is completed, the arbitration hearing takes place.

The arbitration hearing takes place around a conference table, with arbitrators at the head of the table and the parties on each side. The claimant presents their side of the case first, complete with an opening statement, witnesses, and evidence, and is followed by the respondent. Objections are permitted, and the arbitrators determine whether or not they will accept evidence.

At the completion of the hearing, the arbitrator(s) will deliberate, and render their award, typically within 30 days. The award is legally binding on both parties, and FINRA offers no internal appeals process. While a party may choose to appeal an arbitration award in court, it should be noted that judges rarely overturn these awards.

From start to finish, FINRA arbitration cases that don’t settle before their hearing take approximately 16 months. The process allows for a streamlined and more private alternative to litigation in the courtroom, as FINRA arbitration documents are not made public like court documents. We invite you to contact us for details and support on your potential FINRA arbitration claim.

Sources: [1] https://www.finra.org/arbitration-mediation/arbitration-overview] [2] https://www.finra.org/sites/default/files/Education/p117486.pdf [3] https://www.finra.org/rules-guidance/rulebooks/finra-rules/12902]

Let’s consider an example of margin investing with Robinhood. An investor deposits $5,000 cash into a margin account, and Robinhood lends another $5,000 to allow the investor $10,000 worth of securities. The “margin” is the difference between the value of the securities and the loan from Robinhood. This type of investing increases both purchasing power and financial leverage. [1]

If the securities in the margin account increase in value, the investor has the opportunity for a higher profit than they would have had they invested $10,000 of their own.

On the other hand, if the securities decrease in value, the margin investor is at risk of losing more than they would have had they invested $10,000 of their own.

One of the most significant risks of margin investing stems from margin calls. Because securities purchased on margin are used as collateral against the loan Robinhood extends, Robinhood sets “margin maintenance requirements” on each margin account. These requirements are minimum portfolio values that must be maintained by the investor, and they help Robinhood protect the money they’ve loaned. [2]

So, if the market is volatile, as it has been recently, and the value of securities in a margin account falls too far, Robinhood will issue a margin call. The investor must then either deposit additional cash into their account to meet the margin maintenance requirement or close out their position(s).

However, per Robinhood’s Margin Account Agreement and Margin Disclosure Statement, when Robinhood issues a margin call, they also have the right to sell the account holder’s securities without notice nor consultation. [3],[4]

The language of the agreement specifically states that Robinhood is authorized to liquidate or sell the securities in a margin account to cover any margin deficiency, and that they are not required to notify the account holder before making such a sale. The agreement also stipulates that Robinhood has the sole authority to choose which securities are sold in order to satisfy a margin call, and that Robinhood’s margin maintenance requirements are subject to increase at any time, with no advanced written notice required. [3],[4]

Based on this agreement, which all Robinhood margin investors are required to sign, Robinhood has quite a bit of power over margin accounts. Understood in context, however, these stipulations are designed not to put the investor at risk, but instead to allow Robinhood to protect the money they’ve loaned to investors via immediate liquidation and/or covering losses by requiring additional cash deposits. [3],[4]

Margin investors should also be aware that Robinhood’s margin account agreement explicitly states that any disputes must be resolved via arbitration, so neither party to the agreement may sue one another in court. If a dispute arises, an arbitration case would be filed with the Financial Industry Regulatory Authority (FINRA) in order to reach a resolution or settlement. [3],[4] FINRA arbitration is designed to create a fair and expedited alternative to a traditional court case, but it’s important to understand the arbitration process before deciding to make the leap into margin investing.

So, depending on your risk tolerance, margin trading may or may not be an investment tool you want to use in your accounts.

In our next post, we’ll be sharing a start-to-finish overview of what you can expect from the FINRA arbitration process, particularly as it pertains to margin investing.

Sources: [1] https://www.investopedia.com/ask/answers/041315/why-purchasing-stocks-margin-considered-more-risky-traditional-investing.asp [2] https://robinhood.com/us/en/support/articles/margin-overview/ [3]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Customer%20Margin%20and%20Short%20Account%20Agreement.pdf [4]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Margin%20Disclosure%20Statement.pdf