NASD Warns Investors – Not Brokers – of the Risks Associated with Using Margin to Purchase Securities

Washington, DC – The NASD today issued an updated Investor Alert warning investors – not brokers – about the risks associated with trading on margin. Since the release of a previous Alert on this topic in 2003, the amount of debt taken on by investors to buy securities has reached a record high of $321.2 billion in February 2007.

“We are concerned too many investors are unaware they could suffer substantial financial losses by using debt to purchase securities,” said Mary L. Schapiro NASD Chairman and CEO. “By updating our Alert on this topic, we hope to remind investors not to underestimate the risks involved.”

The Alert, Investing with Borrowed Funds: No “Margin” for Error, explains that investors who cannot satisfy margin calls can have large portions of their accounts liquidated under the market conditions at the time, favorable or unfavorable. That liquidation can result in substantial losses. Some of the risks associated with opening a margin account explained in the Alert are:

* Firms can force the sale of securities in accounts to meet a margin call.
* Firms can sell securities without contacting the account holder.
* Account holders are not entitled to choose which securities or other assets can be sold.
* Firms can increase margin requirements at any time and are not required to provide notice.
* Account holders are not entitled to an extension of time on a margin call.
* Account holders can lose more money than is deposited in a margin account.
* Account holders should ask whether they will automatically be placed in a margin account and, if so, the rate of interest and what circumstances would trigger a margin loan.

It is interesting that the NASD should undertake to make such blanket statements about the lack of legal requirements on NASD members since court decisions over the years are split both for and against firms who treat margin borrowers in an unconscionable manner. Observers note that the NASD is prone to take such positions on behalf of its members, although its retulatory purpose is to protect investors.

Furthermore, many question why the NASD is not concentrating its efforts on requiring brokerage firms to discourage unsuitable borrowings. All NASD members must react to NASD Notices to Members, while the vast majority of investors have no knowledge or contact with NASD releases. It is clear that efforts to restrict member lending would have a far greater effect on solving the problem than the NASD’s recent action.

Meanwhile, the NASD may be reluctant to take steps to address this problem because approximately $20 billion in margin interest is earned each year by NASD member firms, with very few losses incurrred. Thus, the NASD is avoiding any true effort to discourage borrowing and instead offering obscure warnings to investors while also making questionable statements to exonerate its members from liability.

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