Legal Question in Investment Law in California

Re: Why can a broker sell off stock without warning?

You apparently had a so-called "margin loan" against your shares. This is a loan in which you are the borrower, the stockbroker is the lender, and your shares are the collateral. Margin loans are widely used to allow a speculator to hold more shares than he can afford based on the cash he has......he buys 100 shares, then uses the first 100 shares to borrow funds to buy a second 100 shares (in effect). Margin loans are also an easy and low-cost way to borrow for other purposes, sometimes being very competitive even with home equity loans.

Because of the possibility of speculative abuse, margin lending is highly regulated under federal securities laws. The loan-to-equity ratio is always specified and is subject to change by the regulators. Frequently, it hovers around 50%. That means, you can borrow up to 50% of the market value of the eligible securities in your account. If your portfolio is worth $100,000, you can borrow up to $50,000 when the so-called margin requirement is 50%.

So, if you have borrowed $50,000 under a 50% margin requirement, and your portfolio's market value drops to $90,000, your loan suddenly exceeds what's permissible by $5,000.....you are entitled only to a $45,000 loan. You have the choice of putting up another $10,000 of stock collateral or of reducing your borrowings by $5,000.

What your broker did was to make a "margin call," i.e. contact you to inform you of the shortfall and ask your instructions. When you failed to put up the $10,000 (or whatever) additional collateral, the broker did what he must under the rules and sold enough collateral (shares) to pay down your loan.

Although in practice I have seen some brokers bend the rules and give their clients a day or two of slack, they are not required to do so and in truth are not permitted to do so. What your broker did was not only legal, it was required.

There is some possibility your broker sold more shares than necessary -- if so you would have a valid complaint -- and you should discuss the entire matter with the broker and obtain a satisfactory explanation. But keep these margin rules in mind.