Margin Loans Have you lost money though a MARGIN LOAN?

The thought I was having, Chris, was what happens when a FP is wary of been bankrupted by a burned client, and advises too much the other way?

Hypothetical - Say a FP advises their client into a portoflio that is so risk averse (because they are worried about being sued and losing their licence to practice and thus support their family), and when a decent recovery or bull market comes along, the client majorly underperforms the market. Their fixed interest bonds etc are returning them 10-15% under what all their friends are now earning - so the client sues FP for loss of earnings potential and poor advice !!

Call it a far out scenario...but I just think we a getting closer and closer to a US style legal liability system.

Rgds, Chris


ps. Exercise caution if you reply to this post. I disclaim myself from any liability should you injure your wrists through any sort of repetitive typing movement, or any other ill-effects of computer use, either real or percieved.

 

Are you suggesting we organise a lynch mob to run the lawyers out of town? Because I'm free on Friday's



It would sorta be cool if the legal system was a bit like Judge Judy, where the two parties with grievance rock on a specific day, bring the documents they think are relevant and then the judge just interrogates them for 15 - 20 mins, then passes down a "reasonably" fair judgment, not based on who has the best lawyers or who knows the law the best.

It'd be hilarious to hear judge Judy preside over this margin loan case. I can just see her ripping into both parties for being stupid but probably siding with the financial planner as long as he wasn't being deceptive about anything.

The system would be SOOO much cheaper and we could all spend our money on meaningful purchases.

 

many financial advisers are purely salesmen

Many financial advisers are purely salesmen selling products. They push the products that bring THEM the highest returns, with very little concern as to the level of risk for their clients. There are currently people who are at risk of losing the roof over their heads due to margin loans.

I note that when financial advisers stop being financial advisers, they generally take SALES jobs, and not finance jobs; I find this very telling.

http://www.asic.gov.au/asic/asic.nsf/byheadline/02%2F365+Melbourne+man+sentenced+to+seven-years+jail+following+$5.4+million+theft?openDocument

smh.com.au - The Sydney Morning Herald

ECCCL failure claims third adviser

 

But the same people sung their praises in a rising market... you can't love someone when they are on top then kick them when they are down.

That said I will concede that many in the FP industry are in essence salesmen pushing certain products, and that the why the payment structure is setup it actually encourages them not to look out for te best interests of their clients, but I don't think that means ALL the blame should be on those FPs, the clients and regulators needs to take a big chunk of the responsibility.

 

Storm Investors may not be Alone: by Tony Martin SC

STORM INVESTORS MAY NOT BE ALONE
By Tony Martin SC

Mr Martin is an experienced commercial barrister practising at the Sydney Bar​

The hapless plight of the Storm clients is distressing. They are facing significant losses and, in many cases, financial ruin as a consequence of an aggressive gearing strategy recommended to them by their financial adviser, Storm.

If the reported settlement with the margin lender, CommBank, proceeds, hopefully that will restore some sense of financial stability and dignity in their otherwise shattered lives.

But is this disaster confined only to the Storm investors? Probably not.

The core problem is to be found in the aggressive gearing strategy promoted by Storm that involved margin lending. A margin loan enables you to borrow money to invest in shares, using existing investments as security. Borrowing money to invest in shares in this way, also known as “gearing”, can result in higher returns relative to your equity in the share portfolio, but it can also magnify the your potential losses if the value of the share portfolio falls.

When an investor enters into a margin loan to buy shares, the margin lender takes security (i.e. a mortgage) over the share portfolio so that in the event of default the shares can be sold to repay the loan. The investor is exposed to the risk the shares might fall in value because the share market can rise and fall frequently and rapidly.

If this happens, as it has occurred in the current financial crisis, the shares would be worth less than the loan creating a shortfall in the security for the margin lender.

To protect themselves against the possibility of a shortfall, margin lenders limit the borrower’s level of gearing to a set percentage (known as the loan-to-value ratio or LVR) of the value of the share portfolio. Usually, the LVRs are set at a maximum of 70%. This means that the borrower has to contribute the difference (i.e. 30%) from their own money. This difference is called the “margin”.

The aggressive gearing strategy employed by Storm amounted to “double gearing”. It involved the investor borrowing to buy shares using the equity in their homes as the security for that loan. They would then use those shares as security for entering into a margin loan to buy additional shares; that is, to effectively “double up” the gearing. This had the effect of further increasing the gains and further magnifying the losses that would otherwise have been obtained under a normal margin loan.

The strategy worked like this: an investor would borrow $50,000 to buy shares using the equity in their home. They would then use those shares as security to take out a margin loan for another $50,000 to buy further shares. As a result, they would have shares at a value of $100,000 but funded by a corresponding debt of $100,000, which required servicing.

To say the least, this “double gearing” strategy was inherently risky. It was riskier than just entering into a normal margin loan. By increasing the “gearing” level, the “risk” of the investment was also correspondingly increased. These increased risks were at least threefold.

Firstly, there would usually be no equity in the investment from the outset. The investor would have usually borrowed 100% of the value of the share portfolio. This meant that the investor was exposed to the risk that any fall in the initial value of the shares would put the investor immediately in a “negative equity” position.

Secondly, the “double gearing” strategy increased the risk for the investor of their losses being magnified in a market downturn beyond that which they would have suffered if they had just entered into a normal margin loan.

Thirdly, the “double gearing” strategy increased the impact on the investor of a margin call received in the event of a market downturn. The investor would need to meet the call from their own additional financial resources or otherwise sell part of their underlying share portfolio. The selling of any part of their portfolio in a falling market would immediately crystallise their losses.

ASIC has recently stated that it believes that the “double gearing” strategy used by Storm has “not been widely used”, but nonetheless is “directing resources to assessing other planners and advisers” to confirm this. Perhaps it will be found that there are relatively few investors in the position of the Storm clients who had margin loans using the “double gearing” strategy. However, in the light of past experience in circumstances where opportunities for financial gain existed in an unregulated market, it would be surprising if these gearing practices were not more widespread than is currently apprehended.

The fundamental problem in Australia is that margin lending is unregulated as a financial product. However, what is clear is that any investor embarking upon a margin loan needs to be fully aware of the risks involved before entering into that transaction. When the risks of the margin loan are further compounded by the use of the “double gearing” strategy, the need for the investor to be aware of the additional risks associated with that strategy is exacerbated.

In Australia, a large number of investors who entered into margin loans did so on the advice of their financial advisers. As part of their obligations to their clients, the financial advisers must warn the investor of the risks involved before entering into such a transaction. This is particularly so when the investor employed the “double gearing” strategy. The investor must warn of all of the additional risks associated with such a strategy. The investor must also be advised that they should have available other financial resources to meet any margin call in the event of a market downturn. If those other financial resources were not readily available, this type of investment would probably not have been suitable for that particular investor.
If the financial adviser did not give these warnings, that would probably constitute a breach of their duty of care to the investor. In those circumstances, the financial adviser would be liable to compensate the investor for any losses that result from that breach. The question now is how long it will take before these actions begin to surface for determination in the courts.

 

Unfortunately it is distressing to see another lawyer making money off other peoples misery. Though this is how the world goes around

A few (I think I counted 5 or so) dodgey FPs out of 15,000...That's not a huge %. I think a few of us have seen dodgey accountants and solictors as well (how many times have you read an accountant or solictor hasn't done their tax return for 10 years???). Unfortunately the regulators are too relaxed and need to pull their socks up.

Fortunately nowadays I think potential clients are a little wiser, thinking more about Whats In It For Me (WIIFM) whereas when the market was going up year after year they would automatically expect potential capital gains.

Cheers,

Dan

 

If you think it's depressing that lawyers will make money out of this, just wait and see how much hedge funds will make from shorting Australian banks when these chickens come home to roost :-D (once the ban is lifted, of course)

If I was a significant holder of CBA shares I would be thoroughly ticked off with the recklessness of the margin lending in the Storm case.

Personally I think that it is a very positive step to get the lawyers involved. Margin lending is clearly in need of greater regulation and this should be a catalyst for that occurring.

 

"......when these chickens come home to roost :-D (once the ban is lifted, of course)"
Tora...Tora...Tora..