Margin Deficiency and the Close-Out Decision
A retail client at Harborline Securities holds a margin account with $180,000 of long market value in a concentrated position in a single small-cap stock and $95,000 of debit balance. The firm's house maintenance requirement is 30%, and the regulatory minimum is 25%. The stock has fallen 35% over two weeks and is thinly traded, with average daily volume of 40,000 shares against the client's 60,000-share position. The client has missed a margin call issued five business days ago. The branch manager wants to extend the call another week because the client is a long-standing customer and the stock "looks oversold." The firm's margin clerk notes that a forced sale of 60,000 shares could move the price.
1. Calculate the current equity, maintenance excess or deficiency, and the minimum market value required to cure the call at both the house and regulatory requirements.
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Equity = long market value − debit = $180,000 − $95,000 = $85,000.
House maintenance requirement = 30% × $180,000 = $54,000. Equity of $85,000 exceeds the house requirement by $31,000, so at current prices the account is not in deficiency. Regulatory requirement = 25% × $180,000 = $45,000; excess is $40,000.
However, the call was issued five business days ago, which means the account was in deficiency at the time of the call. If the stock has fallen 35% over two weeks, reconstruct the prior position. If the current market value is $180,000, the prior value was about $180,000 / 0.65 = $276,923. Assuming the debit stayed at $95,000, prior equity was $181,923. House requirement at the prior value was $83,077, so the account was not in deficiency then either, unless the debit was higher or the position was larger. The scenario implies the call arose from a deficiency; the key point is that a call must be based on the actual deficiency at the time.
To cure a house deficiency, equity must equal 30% of market value. With debit D and market value M, equity = M − D, and the requirement is 0.30M. If the client deposits cash C, (M − D + C) ≥ 0.30M. At M = $180,000 and D = $95,000, C ≥ $54,000 − $85,000 = negative, so no deposit is needed now. If the deficiency is measured at the time of the call, the client needed to deposit the shortfall or sell securities. The minimum market value at which equity equals 30% with a fixed debit of $95,000 is M where M − $95,000 = 0.30M, so 0.70M = $95,000, M = $135,714. At the regulatory 25%, 0.75M = $95,000, M = $126,667. The stock can fall to about $135,714 in market value before a house call, a further 24.6% decline.
2. Evaluate the branch manager's request to extend the call. What rules and risks apply, and what should the firm do?
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Extending a margin call for a long-standing customer because the stock "looks oversold" is not a permissible basis. Margin calls are credit decisions governed by the firm's written margin policy and by dealer member rules and Regulation T/ FINRA requirements. A firm may grant an extension only under specified conditions, typically a written extension of time for good cause, documented and approved at the appropriate level, and generally not more than a limited number of days. The extension must not be used to avoid recognizing a loss or to favor a customer.
The concentration and liquidity risks are material. The client holds 60,000 shares against average daily volume of 40,000, so the position is 1.5 days of volume. A forced liquidation could depress the price and increase the loss. The firm should consider a liquidation plan that sells in tranches, uses limit orders, and coordinates with the trading desk to avoid moving the market. The firm also should assess whether the position creates market risk for the firm if the client defaults.
The branch manager's request creates a conflict of interest and potential preferential treatment. The credit or margin department, not the branch, should decide. The firm should document the deficiency, issue a written demand, set a hard deadline, and if unmet, liquidate sufficient shares to cure the deficiency, selling only what is needed. The firm should also review whether the account should be restricted from new positions and whether the client's concentration limits were breached at origination. Escalate to compliance and the credit committee.