Market volatility may lead brokers to issue margin calls[i] to investors—i.e., demands of cash or additional collateral from investors trading on margin. Investors may feel such margin calls are unjustified or may disagree with a lender’s valuation of collateral in their account. Lenders may also unilaterally seize and liquidate investor collateral to meet the margin call, often with little or no notice to the investor. This memo addresses some of the most pressing questions being asked by investors and other margin traders in this volatile trading environment.
The mechanics of a margin call are relatively simple. Investors borrow money from brokers to leverage market positions and use the investments as collateral. Investors generally agree to maintain a certain “margin” of equity in the account. When investor equity decreases due to changes in collateral value, brokers may issue margin calls to increase the investor’s equity to meet the margin requirements.
Most margin agreements spell out when and how margin calls can be made, and if the collateral at issue is liquid enough that value is easily determined. In such cases, disputes are unlikely to arise. But for investors trading on margin using less liquid collateral, a broker’s decision to issue a margin call or liquidate an account is often fiercely contested.
This memo analyzes key legal issues surrounding such margin calls and forced liquidations, and provides answers to investors’ most pressing questions.
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