By Julia Schroeder

If you are a millennial and anything like me, you didn’t have a financial literacy class at your high school. If you majored in a humanities subject in college, you likely didn’t take a finance class either. Finance is a particularly sensitive topic for many individuals to openly discuss, but the failure to talk about it has led to people incurring too much debt, or worse, losing their hard-earned savings to fraudsters, or through themselves engaging in a complicated trading strategy that they don’t understand.

The truth is, we are not provided with adequate financial education growing up, and it doesn’t get much better as we grow older. Interning with UM’s Investor Rights Clinic has shown me how many of our elderly clients could have avoided their losses if they only knew more about the types of investments they were agreeing to and how to monitor them when they signed on the dotted line. Instead, many overly relied on brokers or other financial professionals, often without learning anything about their backgrounds. Most of the public has no idea that they can check the backgrounds of their financial professionals by entering their name in “BrokerCheck” on the FINRA.org website.

As a result of schools failing to meet the need for financial literacy courses with enough speed, younger generations are feeling the consequences.  In 2018, just 17 states required high school students to take a course on personal finance. While the number of states that include education about personal finance has risen to 45, only 21 states require such a course in order to graduate from high school. In the meantime, the lack of financial literacy can lead to serious consequences. The fact that so many young people have overextended themselves with student loan debt is, at least in part, attributable to a lack of financial literacy. Moreover, there are now faster ways in which individuals can quickly get into deep financial trouble, and it involves the smartphone likely lying next to you right now.

Social media has promoted the ease by which people with all levels of investment experience can invest in the stock market. In its 2021 Examination Report, FINRA addressed the “surge” of retail investors trading through apps and announced steps to crack down on digital platforms to ensure that they are in compliance with FINRA communication and supervisory rules, and acting in a customer’s “best interest.” This came after findings that in the first half of 2020 alone, individual investors accounted for 19.5% of shares traded in the U.S. stock market, which was an increase from 14.9% in 2019 and almost double what it was in 2010.   Trading Apps such as Robinhood have enticed younger people to engage in high risk, often complex trading activity by advertising self-directed trading accounts that offer zero commissions per trade. Yet, critics have expressed concern that the app engages in “gamification” by releasing green confetti after users make a trade. After accusations that confetti distracts its users, and makes a game out of the trading of real money, Robinhood announced the discontinuation of this feature earlier this year.

The nightmare story of college student Alex Kearns’ suicide following a Robinhood app misunderstanding highlights the dangers of self-directed trading with less sophisticated investment experience. While there may have been other unfortunate factors at play, 20-year-old Kearns took his own life after believing he had racked up a negative $730,165 cash balance in his accounts. In a note he left to his family, he thought that his investment plan was well thought out, but in actuality, he had ““no clue” what he was doing.”

Securities clinics across the country, including UM’s, are seeing a major spike in calls for assistance, and more of them are involving self-directed accounts. This is a glaring sign that we must take the time to educate ourselves. Rather than wait for the state and federal governments to introduce more financial literacy programs, there are resources we can take advantage of right now. In addition to sites like MyMoney.Gov and Investor.com providing educational resources for individuals interested in investing, FINRA regularly hosts informational webinars. This upcoming April 13^th, FINRA, in collaboration with St. John’s University, will be hosting “Smart Investing in Today’s Environment” to discuss investor education issues and intelligent ways to approach these self-directed trading platforms that can get investors into trouble. Sign up by visiting www.finra.org/lawschoolforum.

By Katie Johnson

Self-directed brokerage accounts are on the rise. In Q1 of 2020 alone, online brokerage firms Charles Schwab, TD Ameritrade, Etrade, and Robinhood all reported astronomical growth of as much as 170% in new account openings compared to Q1 2019. TD Ameritrade noted that its new investors generally “skew younger.” This corresponds to the increase in intakes we have seen in the Clinic: many potential clients are in their 20’s and 30’s with complaints against their online brokerage as opposed to a particular broker.

There is abundant fuel for this investment fire. Record breaking unemployment, a volatile stock market, and job insecurity have all driven people to seek low-cost investments to protect and grow their savings. In the midst of working from home, apps are easily accessible and let people avoid the face-to-face interaction with brokers. Similarly, many online platforms advertise commission-free trading. Often times, the advertising emphasizes the benefits of option and margin accounts (which are riskier) without giving equal airtime to the risks. The biggest issue with this is that when investors apply for these accounts, they sign account documents that were written largely to insulate brokerages from liability.

The Clinic’s recent intakes regarding self-directed accounts have two significant themes: investors who feel like brokerages should have noticed inflated income or investment experience through background checks or investigation; and investors who thought they calculated the risks but somehow lost more money than their calculated loss.

I inflated a number or two on my application to get approved for a higher level of options trading, but shouldn’t the firm have caught that when they did their due diligence?

The short answer to this is no. While FINRA requires that brokerages obtain certain customer information in order to approve them for an options account, investors are the ones filling out their information when applying for self-directed accounts. Theoretically, the investors are the most reliable source of that information. What’s more, the account contracts include a provision that says you the investor affirm that what you put down is true because you understand the brokerage is going to rely on that information.

How could I have lost so much more than the maximum loss that I calculated?

While many investors feel confident in their calculated losses, they are usually calculating how much they stand to lose if the stock price moves unfavorably to their position. However, investors don’t always realize that every disclosure says investors may stand to lose their entire investment. For example, the options disclosure on Charles Schwab’s website says that option customers “should clearly understand that there is no guarantee that option positions may be offset by either a closing purchase or closing sale transaction […]. In this circumstance, option grantors could be subject to the full risk of their positions until the position expires.” In other words, while you think you have done everything right, there is still the risk that everything could still go wrong. This is further detailed in the example below.

But I didn’t know what I was getting myself into.

Options are an iceberg of complexity and self-directed investors are the Titanic, full steam ahead. Many account opening documents include things like “By signing, you acknowledge you have reviewed X, Y, and Z disclosures and understand their terms and conditions.” Every account contract includes the same incorporation of the Options Clearing Committee’s (OCC) “Characteristics and Risks of Standardized Options”—a 188-page document outlining, as it says, the characteristics and risks of options. One, it’s jarring that it takes 188 pages to outline the characteristics and risks. Two, while it’s unlikely that investors read every page, they still sign the account documents saying they did in fact read the hefty document and that they understood what it told them. While this does not absolve brokerages of liability when they improperly approve investors for higher levels of risk and/or margin trading, it certainly adds a hiccup to the dispute resolution process.

The Clinic’s options-related intakes center around the issue of truly understanding the nature of options. If the 188-page disclosure didn’t make it clear, options are complicated and even the risks are difficult to understand. For example, the OCC Disclosure says that implementing a spread strategy may reduce your risk exposure, but then later says spreads are complex and “complexity not well understood is, in itself, a risk factor.” The Disclosure goes on to suggest consulting with someone who is “experienced and knowledgeable with respect to the risks.”

Here is an illustration of how quickly things can go wrong, some common misconceptions about options, and some suggestions for protecting yourself as an investor.

Let’s say you execute a call spread—a commonly used two-part strategy where you buy and sell a call option on a particular stock.

The call you sell means, if the buyer exercises their option, you have to sell 100 shares of the stock at the agreed upon price per share (the strike price). In general, a buyer only exercises their option if the strike price is lower than the stock’s market price (the option is “in the money”) because the option lets them buy the shares for a bargain. When you sell an option, you collect a premium, the price paid for the option itself. If the buyer exercises, then in addition to the premium you collected, you earn the strike price multiplied by the 100 shares you are obligated to sell. Many investors sell options to collect premiums.

The call option you buy gives you the right to buy 100 shares at the strike price. The spread lets you avoid buying the stock up front because the option you sold acts as an “offsetting position.” In other words, if the option you sold is exercised and the shares get called away from you, you can use the option you bought to call away the stock from someone else in order to satisfy your obligation to sell. Alternatively, you could purchase the shares if the market price is in between the strike prices of the options you bought and sold.

The benefits of a spread are that you don’t have to buy the stock up front and you collect the difference in the premium you collected vs the premium you paid. If the market price goes above the two strike prices, you still buy the stock for a bargain, but you sell it for an even bigger bargain – therefore, you only lose out on the difference of those two prices. This is the “maximum loss” that you calculate.

But the mechanics of options and the options exchange are not widely known and misunderstanding them can get newer investors into significant trouble.

So, you implemented a spread strategy earlier in the week. On Expiration Friday at 4pm ET (market close), the market price is below the strike price, so you think that the options have both expired out of the money. This demonstrates Misunderstanding #1: the options exchange does not close when the stock market closes at 4pm ET. The options exchange closes 5:30pm ET, 90 minutes after the stock market.

At 4:30pm, good news breaks and the stock price goes up. The option you sold is exercised because it’s a bargain. To exercise their option, the option-buyer tells their brokerage to exercise it, who then tells the OCC about the exercise order, then the OCC tells your brokerage, and your brokerage then tells you that you need to sell. Inherent in any game of telephone are delays in communicating vital information like “hey, you need to exercise the option you bought ASAP because the price is going up and you are obligated to sell.” Herein lies Misunderstanding #2: investors don’t get immediate notice of option assignment and you could find out once it’s too late to stop the bleeding.

So, you find out the following Monday morning that you were obligated to sell 100 shares that you didn’t own because you never exercised your option. Your brokerage stepped in and loaned you the shares to sell, but now you have to pay them back. You do this by buying the shares at market price. But, your right to buy at a bargain has since expired as of midnight ET on Friday. Now you’re stuck purchasing the stock at the much higher market price.

Time for some numbers:

Let’s say that the call option you sold had a strike price of $100. This means that your account gained $10,000 when you sold the shares your brokerage loaned you (100 shares for $100 each). Let’s also assume that after that sale, your account balance is $20,000.

Misunderstanding #3: If the market price of the shares is now $140, all you have to do is purchase the shares at $14,000, right? Unfortunately, it’s not that easy. Brokerages have equity and maintenance requirements. When the brokerage loaned you the shares to sell, you became required to keep 150% of the sale proceeds as the “equity requirement”—150% of $10,000 is $15,000. Even more, you have to keep 30% of the current market value of the shares, the “maintenance requirement”—30% of $14,000 is $4,200. [Note: Margin/maintenance requirements vary by broker and brokers can change them whenever they feel like it].

So, where your balance looks like you gained $10,000 on the sale of the options, you are actually required to maintain a minimum balance of $19,200 ($15,000 + $4,200). That means while you see $20,000 in your account, you only have $800 to spend. Purchasing the new shares for $14,000 requires dipping into your required minimum. Because you can’t afford the stock, your brokerage issues a margin/maintenance call. Unless you fund the account with additional money, your brokerage will liquidate your account positions to make sure the minimum $19,200 is there and/or purchase the shares in your account until they are paid back in full. Brokerages don’t have to tell you when or how they’re doing this, nor do they have to ask for permission; these are things you agree to in the account agreements.

Your obligation to sell as the option-seller is there regardless of whether you exercised your “offsetting” right to buy. So, while you chose a spread strategy to limit your risk and avoid up-front costs, you were effectively left with an uncovered option – a security with infinite risk that you would likely not have been approved for in the first place. Ways of limiting the “assignment risk” can be found on the OCC’s educational website mentioned below.

What can you do as an investor?

I am not going to tell you to not trade options. Options have undeniable advantages (e.g., letting investors avoid up-front costs of purchasing stocks outright). However, because the good always seems to follow the bad, here are some suggestions for things to keep in mind if you’re considering trading options with a self-directed account:

• Read the disclosures included in your account opening information. Some of them are only a page long. Know what the brokerage has the right to do—like liquidate your positions—in the event that you can’t afford to pay them back. Look for key words like risks, exercises, liquidation, and maintenance. This isn’t an exhaustive list, but those words will direct you towards finding information about what your rights and obligations are and what your brokerages rights are as well.
• Don’t inflate your numbers. Make honest representations about yourself so your brokerage doesn’t give you too much room to run. FINRA requires your brokerage to ask about your assets, net worth, and investment experience in order to protect investors. If you aren’t approved for the higher levels of risk, then theoretically the guardrails are working. If you aren’t approved for the higher levels of risk, you won’t be able to use riskier strategies. This could prevent you from getting into too deep of trouble. While brokerages aren’t necessarily off the hook if the risk level is still inappropriate, it’s almost always easier to argue “I did nothing wrong” as opposed to “I did something wrong, but the brokerage did something more wrong!”
• If the 188-page disclosure is too daunting, use the table of contents to find the risks that are relevant to you and read them. I wouldn’t direct you to a massive PDF if I didn’t think it was worth it. The OCC Disclosure is particularly helpful as it includes examples of how things often go wrong and ways to avoid those common mistakes.
• Similarly, the OCC—the ones that wrote the 188-page disclosure—created optionseducation.org, which details common strategies, risks, mistakes, ways to avoid those mistakes, and even has a chat function. Both the OCC Disclosure and Options Education website address the common misunderstandings I mentioned in earlier in the example.
• Lastly, sometimes things go wrong even when you do everything right. Maybe your broker gave you too much room to get yourself into trouble. Make sure to keep copies of account opening documents and communications with your brokerage in case you need someone to tell you whether there was any wrongdoing. Generally, the better kept your books are, the easier it is to advise you.

By Giancarlo Cueto

They’re risk-averse. They distrust institutions. They want transparency. These are a few of the traits attributed to millennials in a recent Fidelity study. As millennials, or those born between 1980 and 1997, approach their peak earning years, who will manage their hard-earned cash? If history is any indication, traditional portfolio managers, advisors, and brokers would be salivating over the opportunity, given that millennials are now the most populous generation in the U.S. However, the Great Recession dissipated millennials loyalty to history and tradition, opening the doors to the new wave of asset management—Fintech.

Financial technology, or Fintech, is used to describe technology that facilitates and modernizes the delivery and use of financial services. Originally, Fintech referred to technology implemented at financial institutions to manage their operations and processes. But this definition has taken on a new consumer-oriented focus with the rise of the smartphone generation. According to EY’s 2017 Fintech Adoption Index, “one-third of consumers utilize at least two or more Fintech services.” Notably, the explosive growth of Fintech has left some of the antiquated finance giants to play catch up as they lose clients to flexible start-ups aimed at simplifying investing and expanding financial inclusion. Among the key selling points for Fintech start-ups like FutureAdvisor, Betterment, and Wealthfront, are low fees, little to no account minimums, snapshots of your portfolio on your smartphone, and very limited human interaction.

Stefanie O’Connell, the 29-year-old author of The Broke and Beautiful Life, offers some insight to recent trends. “When millennials see baby boomers doing their finances, they worry . . . in their eyes, boomers are the ones who created the problems to begin with.” Some of the industries heavy hitters seem to agree. Back in 2015, BlackRock—the world’s largest asset manager—acquired FutureAdvisor, a robo-advisor start-up based out of San Francisco. “We didn’t think we had enough retail and millennial DNA, [but] if we could find the right firm to bring into BlackRock, we could accelerate our plans,” says Robert Fairbairn, senior managing director at BlackRock. In the end, the fight to manage millennials money will bring either competition or partnerships from the incumbents themselves. In 2015, Charles Shwab launched their Schwab Intelligent Portfolios, a robo-advisor that builds and manages your account. More recently, Goldman Sachs announced a partnership with Betterment, the largest robo-advisor with $10 billion in assets under management, founded by millennial entrepreneur Eli Broverman.

But why the change now? In a survey by LinkedIn and Ipsos, nearly 70% of millennials said they were open to trying financial products and services from nonfinancial brands while only 47% of Gen Xers said the same. This should come as no surprise considering that millennials grew up during peak technological disruption thanks to the likes of Steve Jobs at Apple, and Larry Page and Sergei Brin at Google. Whether this sentiment is a result of more user friendly products or simply trustworthiness compared to big-banks is still up for debate, but millennials certainly seem to lack trust in the financial infrastructure of old.

By Julia Osmolia

The U.S. Treasury Bond Market issued a warning three months ago about a possible recession. A recession is defined as “a period of significant economic downturn that lasts longer than two consecutive quarters.” During a recession everyone is subject to risk, but the level of risk varies depending on how much a person has invested and the strategies used for those investments.

On August 14, 2019, the U.S. Treasury Bond market experienced an inverted yield curve where the 2-year short-term bonds paid more interest than the 10-year long-term bonds. The last inversion occurred in December 2005, two years before the Great Recession in 2007 and three years before the financial crisis in 2008. Since 1985, there have been three inversions, each preceding a recession by 13 to 17 months. As a result, the inverted yield curve is widely regarded as a warning sign that a recession is looming.

An inverted yield curve, however, is just that—a warning sign. It does not mean a recession will happen or indicate how long a recession will last. When an inversion occurs, investors should not panic and make rash decisions about their investments. Instead, investors should evaluate their portfolios to assess any possible damage if a recession occurs.

Below are some ways investors can protect themselves against a possible recession:

• Evaluate Investment Strategies & Define Achievable Goals – Investors should evaluate and discuss with their financial advisors their investment goals, asset allocation, risk tolerance, and time horizon. Someone close to retirement may want more conservative investments in the wake of a recession, whereas younger investors may have different goals and higher risk tolerances because they likely have more time to recover from losses suffered from an economic downturn.
• Understand Potential Risks – Investors should know or ask their financial advisor what their portfolio looks like amid an economic downturn to understand the risk they are taking on.
• Diversify Your Portfolio – Investors can mitigate damages suffered from a recession by diversifying their portfolios. Diversification reduces the volatility of the portfolio because different assets react differently during a recession.
• Calculate Personal Cash Flow – Calculating personal cash flows helps investors determine how much cash they should have during a recession. This decreases the chances of investors having to sell their investments at the worst possible time to scrape up some extra cash.
• Confirm Your Broker or Financial Advisor Made Any Necessary Changes to Your Accounts – Investors should contact their financial advisors to ensure the necessary changes have been made to their accounts and that these changes are documented. If a financial advisor completed documents, read through and confirm that the information on the forms is correct before signing any documents.

There is no telling when a recession will happen or how long it will last when it does. Therefore, if you’re concerned about a possible recession, the best safeguard is to ensure you have an investment plan that is tailored to your specific needs to decrease potential losses.

By Arda Barlas

Recent Development

On August 8, 2019, the Securities and Exchange Commission (“SEC”) announced a proposal for amendments to update Regulation S-K. The new set of rules is intended to simplify compliance efforts of registrants and improve disclosures for investors. The rationale behind these new rules is the dramatic change in the world economy and markets over the past 30 years when public companies’ business disclosure rules were adopted.

The SEC plans to achieve this rationale by modernizing the description of business, legal proceedings, and risk factor disclosures under Regulation S-K.

According to the proposal, the SEC considered input from comment letters received in response to these disclosure modernization efforts, the staff’s experience, and changes in the regulatory and business landscape since the adoption of Regulation S-K.

What Does the Proposal Say?

Mainly, the proposal foresees amendments for the following items:

General development of the business (101(a))

The proposed revision for Item 101(a) requires the disclosure of a topic to the extent such information is material to an understanding of the general development of a registrant’s business. In such cases, the information will be deemed material if there is a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision.  Moreover, providing a prescribed time frame for this disclosure is intentionally avoided. Also, the proposed revision for Item 101(a) provides a non-exclusive list of the types of information that a registrant may need to disclose.

Another important update is that the proposed revision for Item 101(a) allows a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business that focuses on material developments in the reporting period. However, such update should be accompanied with an active hyperlink to the registrant’s most recent filing and along with the update, the full discussion of the general development of the registrant’s business must be present.

Description of the business (101(c))

The proposed revision for Item 101(c) includes human capital resources as a disclosure topic. This topic includes any human capital measures or objectives that management focuses on in managing the business. Again, the extent of such disclosures are limited to materiality. Moreover, the regulatory compliance requirement was extended, as against being limited to environmental provisions, by including new material government regulations.

Legal proceedings (103)

The revision proposed for Item 103, which deals with legal proceedings is designed to encourage registrants to avoid duplicative disclosure. The required information about material legal proceedings may be provided by including hyperlinks or cross-references to legal proceedings disclosures located elsewhere in the document. This will provide more reader-friendly legal proceedings sections and reduce the complexity or confusion significantly.

Moreover, the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to is proposed to be raised to $300,000. The rationale behind this threshold raise is to adjust for inflation.

Risk factor (105)

The proposal requires a new structure for risk factors to be organized under relevant headings, along with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption. Also, the disclosure standard is proposed to be changed from the “most significant” factors to the “material” factors. Also, if the risk factor section is longer than 15 pages, the summary risk factor disclosure will be required to be disclosed.

By Katie Black

Investors often face overwhelming decisions in deciding if and how to enter the market. In addition to the types of investments in which they might be interested, retail investors must also determine who they trust to help them invest their money. By adopting changes to its program of Regulation Best Interest, announced as of June 2019, the United States Securities and Exchange Commission (“SEC”) is working to implement industry-wide protocols that give investors more security in and knowledge of the firms with which they might choose to invest. Set to go into effect on September 10, 2019, the new Regulation Best Interest rule bolsters the standard of conduct broker-dealers owe their retail investor customers through a two-pronged “general obligation” of requiring heightened protection of their customers’ best interests, while also mandating thorough disclosure policies regarding broker-dealer conflicts of interest.

Though the Regulation Best Interest rule acknowledges the fundamental conflict of interest that occurs given the commissions received as compensation in the relationship between a broker-dealer and their investor customers, the rule endeavors to mitigate conflicts of interest that arise when broker-dealers recommend specific investment-related actions for their clients. More specifically, the SEC breaks the Regulation Best Interest rule down into four “component obligations”: disclosure, care, conflict of interest, and compliance.

The disclosure component requires broker-dealers to be up-front with their customers about any investment recommendations, as well as the relationship that broker-dealer has with the customer they are advising. Relative to this process, broker-dealers must disclose costs, services, and limitations regarding their position as investment brokers. Further, the disclosure obligation facilitates enforcement of the conflict of interest and compliance obligations, which call for the creation of and strict adherence to protocols and procedures to disclose and mitigate any conflicts of interest that exist regarding broker-dealers and the investment recommendations they may make.

In addition to the disclosure-related obligations is the new care obligation, which creates a heightened standard of “diligence, care, and skill” in broker-dealer engagements with their investor clients. Moreover, under Regulation Best Interest, broker-dealers are charged with a renewed duty to consider their clients’ exposure to risk, balance that against the potential for reward, and factor in the potential costs that may come of any investment recommendation.

Ultimately, the Regulation Best Interest rule serves to better inform investors, as well as ensure broker-dealer compliance with higher standards of care relative to their clients. Broker-dealers must comply with this Regulation Best Interest mandate by June 30, 2020 at the latest, which gives broker-dealers just over a year from the rule’s announcement to bring their practices into compliance with the new standards.

By David Hoy

This year is on track to be the hottest on record due almost exclusively to climate change. With a warming planet comes rising sea levels, severe storms, and drought. While governments are taking steps to prevent, or at least mitigate climate change, asset managers are looking for new investment opportunities. Fund managers now join politicians and business leaders at international climate summits and invest in technology that tracks and predicts significant climate events.

Climate events significantly impact national and local economies. In 2018, more than 1.8 million acres of California land was affected by wildfires which resulted in $24 billion in damages. The damages stemming from the floods in the midwestern United States earlier this year are still unknown, but some estimates put the total losses at least $12 billion. The total long term effects of unencumbered climate change cannot be quantified. Potential profits for those who can model climate trends and invest accordingly, however, can and are being monitored carefully.

Investor response to climate change has come in three forms. There are those who invest in mitigation technology like electric cars and solar panels, those who invest in disaster prevention (think sea walls and disaster kits) and those who place bets on how climate events will impact industries and economies. To a certain extent, the last category encompasses the first two.

In the short term, climate change will hurt some communities and benefit others. Some asset managers have capitalized on this trend by investing in real estate away from the coast because they anticipate that local governments will struggle to provide the infrastructure needed to mitigate the reported one- to four-foot increase in sea level within the next century.

Other professional investors are skeptical that there is enough time to reverse the effects of climate change, but still believe that sound investing can help mitigate its most severe consequences. These firms seek to align their capital with companies that try to reduce the amount of carbon dioxide in the atmosphere and prevent deforestation.

It is essential for clients of large mutual funds and private wealth management firms to be aware of the policies those firms have toward climate change and to understand where their money is going. Some may even opt for climate-sensitive mutual funds that primarily invest in energy efficiency and battery storage. Investors should discount any potential effects that their positions have on the planet from profits made by climate-agnostic firms. Everyday investors should seek to align themselves with asset managers that are climate hopefuls. If they are unsure of how to do so, they should, at the very least, express their concerns to their brokers.

By Brandon Mantilla

Margin trading, although common practice in the investing community, can make or break your investment portfolio. Many investors, however, do not understand how margin loans work or why they can be so dangerous when not properly utilized or understood. Margin can vastly increase the profit in an account if the leveraged securities increase in value. On the other hand, investors can also lose more money than they put in if the securities perform poorly.

A “margin account” is a type of brokerage account in which the broker-dealer lends the investor cash, using the account as collateral, to purchase securities. There are several inherent risks investors should be aware of before agreeing to trade on margin. Pursuant to margin agreements, it is usual that firms can force the sale of securities in your accounts to meet a margin call. This means that a brokerage firm does not need permission to sell off securities when it determines an account-holder’s equity in the account is too low. Often firms are also not required to contact the investor when securities are being sold, although they often do. Another surprising aspect of margin calls, as these sell-offs are called in the industry, may be that investors do not have a right to choose which securities or assets are sold in the event of a margin call or to receive an extension of time. Lastly, firms reserve the right to change their margin requirements, or minimum amount of equity as a percentage of current market value, on any security, position, or account at any time without advance notice to account holders.

Despite the heavy risk involved in using margin, you can protect yourself from some of these risks by fully understanding the situation you are getting into when you open a margin account. Firstly, you should always make sure you fully understand how margin accounts work by reading about them in materials from reliable sources such as FINRA or the SEC before opening a margin account. Reading the margin rules, FINRA Rule 4210 and Regulation T, as well as your firm’s margin agreement and policies can also go a long way toward preventing any catastrophic consequences that commonly result from a poor understanding of margin trading.

In the event that you do choose to open a margin account, it is critical to actively manage your margin account by regularly reading account statements to understand exactly what is happening in the account. Finally, as any wise advisor might say, you should not put all of your eggs in one basket. In other words, do not put all of your available money in a margin account. Although a financial professional may want to maximize your margin use to raise funds for the firm on interest, keeping safety net funds outside of the account is integral to maintaining your financial well-being.

By Shawn Wilborne

On June 5 2019, the U.S. Securities and Exchange Commission (SEC) adopted a package of rules and interpretations relating to its Regulation Best Interest, including the Form CRS Relationship Summary (Form CRS). Form CRS is designed to increase transparency and decrease confusion surrounding investment relationships. Form CRS requires broker-dealers and registered investment advisors to provide retail investors with clarity and understanding. For example, firms are required to provide the nature and scope of services offered, the type of fees the investor will incur, any conflicts of interest, and the firm’s disciplinary history.

In the interest of simplicity, the Form CRS has a two-page limit. Dual registrants — firms operating as both a broker-dealer and an investment adviser — are permitted to combine the forms, but it must not exceed four pages. The format of the form is question-and-answer to promote standardization and to allow the SEC to easily compare filings. Initially, the Form CRS filings will be under close review by SEC staff “to help ensure that the relationship summary fulfills its intended purpose.”

Indeed, clarity and transparency are key elements that the SEC wants to preserve for retail investors. The SEC defined retail investor as any “natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.” This definition includes potential and existing customers. In addition, the retail investor definition applies to natural persons regardless of assets or net worth. In pertinent part, the SEC found that “all individual investors would benefit from clear and succinct disclosures regarding key aspects of available brokerage and advisory relationships.”

Individuals participating in 401(k) and other employment retirement plans are also included in the Form CRS requirements. However, the SEC noted that participants making ordinary plan elections and not selecting a firm or brokerage or advisory service, fall outside the definition of retail investor and the Form CRS delivery obligations.

Moreover, brokerage firms and registered investment advisors must include on their websites an introductory paragraph with a link to the SEC’s investor education website. The SEC and its staff will also develop additional education content to increase the information available to investors.

The deadline for firms to file initial Form CRS’s is June 30, 2020.

By Mariano Scialpi

Senior citizens have found themselves in the cross-hairs of scammers and fraudsters throughout the United States. Financial exploitation occurs when a person misuses or takes the assets of a vulnerable adult for his/her personal benefit. This exploitation frequently occurs without the explicit knowledge or consent of a senior or disabled adult, depriving him/her of vital financial resources for his/her personal needs. New data has shown that senior citizens become increasingly vulnerable to all forms of frauds as they age. This data is concerning for a class of people that hold “83% of the wealth in America.”

The numbers are even more alarming in the securities industry where the AARP recently reported “victims lose $3 billion annually or more than $120,000 per household.” The losses reported by the AARP symbolize the life savings of a generation who can longer work to maintain a household. The Investor Rights Clinic has represented many seniors who have lost their life savings due to financial exploitation. Although the work the Clinic performs provides essential relief to victims of exploitation, changes in policy are necessary to protect a vulnerable class of citizens.

Before 2018, the numbers from the AARP report were aggravated by the lack of statutory language protecting whistleblowers in the industry. Luckily, in May, senior citizens could applaud the first anniversary of the Senior Safe Act (SSA). SSA, a federal program modeled on a program by the same name in Maine, has attempted to empower financial service providers to “identify warning signs of common scams and help prevent senior citizens from becoming victims.” More specifically, the act “addresses barriers financial professionals face in reporting suspected senior financial exploitation or abuse to authorities.” The act addresses these barriers by allowing broker-dealers the opportunity to train their employees on how to detect and report “senior financial exploitation.” Broker-dealers who train their employees are provided immunity provisions from liability in any civil or administrative proceeding, particularly regarding violations of privacy requirements.

Although the SSA represents an important step towards protecting elderly citizens, a lot more can be done in terms of policy. One financial advisor advocates for quizzing clients over 60 on their decision-making abilities. Basic tests might be a simple way to ensure that senior citizens are fully aware of the decision they are making regarding their finances. One thing is sure, financial exploitation of the elderly is a problem that will not go away in the future, and only Congress has the power to protect its constituents from further abuse.