FINRA Says Investors Should Consider the Risks Before Investing in SBLOCs

The Financial Industry Regulatory Authority and the Securities and Exchange Commission’s’ Office of Investor Education and Advocacy has issued an investor alert recommending that investors get to know the risks before deciding to invest in securities-backed lines of credit, also known as SBLOCs. Although SBLOCs can be a major revenue for securities firms, there is the chance of increased losses, especially during times of market volatility.

Securities-backed lines of credit are loans that let an investor borrow money using securities that are kept in an investment account as collateral. An SBLOC allows an investor make interest-only payments each month and loans stay outstanding until they are repaid.

SBLOCs are frequently marketed as a low-cost, easy way to gain access to additional money without having to liquidate securities even as an investor borrows against assets in an investment portfolio. However, they come with certain risks, including unintended tax consequences and the possibility that an investor might have to sell his/her holdings, which could affect long-term investment goals.

SBLOCs are similar to home equity credit lines except that they involve securities as collateral rather than the home. An investor is allowed to repay part or all of the outstanding principal at any time and then borrow again in the future.

An SBLOC is a non-purpose loan. This means that the investor is not allowed to use the proceeds to buy or trade securities. However, money from an SBLOC can be utilized to finance almost anything you want, including home renovations, education expenses, or personal travel.

An investor who qualifies for an SBLOC typically must meet certain requirements, such as assets of at least $100K. Depending on your investments’ value, an SBLOCK investor may be able to borrow anywhere from $100K to up to $5M. That said, just because an investor is eligible for an SBLOCK doesn’t mean it is the right choice.

Risks of Investing in SBLOCKs
An investor should also be familiar with the risks. For example, if the value of the securities you declare as collateral goes down, you might need to come up with additional money quickly or risk the liquation of your positions. Market volatility can make risks and resulting losses more likely. And if your securities are liquidated to satisfy collateral requirements, there could be tax consequences, such as having to pay capital gains taxes on sales proceeds.

A rise in interest rates could result in a jump in the broker-call, prime or LIBOR rates applicable to your SBLOC, which could significantly up the costs of the SBLOC. Accounts with bank sweeps and money market funds may, dependent upon firm policy, see a lowering in money fund or cash balances if the interest charge is paid from redemptions. This could lead to a decrease in an investor account’s value or an increase in the investor’s indeptedness. Also, an investor with cash in an account or a money market fund mays sometimes find, in certain interest rate environments, that they having to pay more interest for the SLBOC than what they are earning.

Brokers and advisers may be paid part of the fees or other compensation related to the sale of SLBOCs to investors. Financial representatives also benefit when an investor has an SBLOC because the latter doesn’t have to liquidate account assets or make cash payments.

At Shepherd Smith Edwards and Kantas, Ltd LLP, our securities law firm represents investors that have suffered losses caused by broker fraud, investment adviser fraud, or other forms of negligence. Contact our SBLOC fraud lawyers today.

Securities-Backed Lines of Credit – It May Pay to See Beyond the Pitch