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Merrill Faces Lawsuit for Alleged Misuse of Margin Account

By Miriam Rozen March 4, 2021

Merrill Lynch is being sued for allegedly misusing the margin account of a Scottsdale, Ariz.-based individual.

Robert White filed the lawsuit on February 26 before a Manhattan federal court, alleging breach of contract and negligence on the part of the wirehouse.

The lawsuit’s allegations stem from White’s purchase in June 2020 of $906,935 worth of Telsa and IBM shares. Those purchases “should have been funded” initially by equity in White’s account at Merrill and thereafter by margin borrowing, the lawsuit alleges.

Instead, Merrill used $808,848 of margin loans, the complaint alleges. The $397,989 of equity in White’s account was “not used in violation of Regulation T,” the lawsuit claims, referring to the Federal Reserve Board Regulation T. The rule allows securities brokers and dealers to lend clients as much as 50% of the total purchase price of a margin security for new, or initial, purchases.

A few days following his stock purchases, White’s account declined in value and Merrill issued a margin call and sold off $92,758 worth of the account’s securities, triggering a loss of $192,920, which would not have occurred if the brokerage had followed Regulation T, the lawsuit alleges.

Merrill’s handbook on margin accounts states “that margin borrowing would not occur until all equity in Plaintiff’s account had been used,” a clause “consistent with the requirements of Regulation T,” the lawsuit alleges.

White incurred a “loss of $397,989 of his account’s principal, significant margin interest and loss of equity” because of the margin call, the lawsuit alleges. White is seeking a $500,000 judgment plus interest, costs and lawyers’ fees against Merrill.

Two lawyers representing White and a Merrill spokesperson declined to comment about the case for this story.

According to the lawsuit, "[a]t all times relevant to this action Plaintiff maintained a retail stock brokerage account at Merrill." One of the plaintiff’s lawyers tells FA-IQ she doesn’t know if White remains a Merrill client.

‘Uphill battle’

The lawsuit highlights how much discretion regulators allow brokerages on their use of clients’ margin accounts, which will likely reduce the odds that White will prevail in the lawsuit, according to two lawyers not involved in the case.

“Margin agreements give the broker-dealer complete discretion as to what to sell; the customer could have chosen not to trade on margin,” says Jacob Frenkel, a lawyer at law firm Dickinson Wright in Washington, D.C., and chair of its government investigations and securities enforcement practice.

The lawsuit’s underlying premise misinterprets the meaning of Regulation T, says Thomas Lewis, a lawyer and shareholder at Lawrenceville, N.J.-based law firm Stevens & Lee, who thinks the plaintiff “has an uphill battle.”

Regulation T requires that brokerages lend “no more” than 50% of the total purchase price, he says.

“‘No more’ is a very important component,” Lewis says, adding the regulation doesn’t say the brokerage must use 50%.

“There has to be some discretion used by Merrill as to what does ‘no more’ than 50% means, and to me it means that Merrill can make its own business judgment call that it may not want to extend 50% margin for purchase,” Lewis adds.

Dickinson Wright’s Frenkel predicts the discretion that brokerages have with margin accounts will trump the arguments in the plaintiff’s lawsuit.

"Margin agreements give the broker-dealer complete discretion as to what to sell,” Frenkel says.

Merrill’s first step will likely be to ask the court to compel White to move the dispute to arbitration, based on the brokerage’s standard agreements with clients that call for conflicts to be resolved in such a forum prior to going to a public court, both Frenkel and Lewis say.

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Tags:  Client retention , Regulatory/legal issues , Investment strategies , Portfolio management , Merrill Lynch , IBM

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