Rude Shock For Margin Traders

In April's slump, brokers did not wait to sell off their stock

Tom Britt never worried about buying stocks on margin. As a former broker who now handles investor relations at a New York stock research firm, he knew about the risks of borrowing to beef up his portfolio. What he didn't know was how fast his broker would sell off his stocks when times turned bad. On Apr. 14, with the market in free fall, Britt called E*Trade Group Inc. to check if there was a margin call on his account. The representative said he owed $4,600, so Britt wired the money that day and called to confirm its receipt. On Monday, Apr. 17, he wired more as the market continued falling. But he later learned that E*Trade had sold off 92% of his account that morning, before the market took off again. "They gave me no notice," complains Britt.

THREATENING TO SUE. Turns out, they're not required to--and that has come as a big shock to many highly leveraged investors. Still smarting from how quickly some online brokerages dumped their stocks to meet margin calls in recent weeks, some investors are even threatening to sue those firms.

But irate investors may not have much of a leg to stand on. Although policies vary, the law says customers are responsible for meeting terms of margin loans--which can make up to 75% of a portfolio total. "If you trade on margin, it behooves you to do a little more research," says Wade Cooperman, E*Trade's vice-president for trading and risk services. After all, waiting for customers to respond puts brokerages' own money at risk. TD WaterhouseGroup Inc., for one, says it recently issued numerous "immediate margin calls," angering investors, to prevent the firm and its clients from suffering huge losses.

While brokers aren't required to tell customers when they get a margin call or even give them time to fill it, most have policies that allow three to five days to fill orders. "Common decency and industry standards require that you at least get a call before they blow out your account," says New York lawyer Steven B. Caruso, who is pursuing margin-trading lawsuits against three online brokerages.

Critics say such calls were rare during the mid-April meltdown. They add that some brokers changed margin terms on a moment's notice--or after money was wired. What's more, online brokers are hardly blameless in their customers' borrowing binge. Many encouraged investors to take on margin debt, now the fastest growing area of U.S. private debt. It's no surprise why: They made 20% of their revenues from margin lending in the past six months--twice the level of traditional brokers.

Tough luck, says David Lackey, president of Weiss Ratings Inc., which rates the financials of the brokerage firms. Unlike full-service firms, "online brokers just execute trades so you should expect impersonal treatment when it comes to margin calls," he says. Many investors have profited hugely of late by trading on the cheap--and on someone else's dime. Now they're simply discovering the practice has its downside as well.

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