DIY investing leads to more than $100,000 in losses

Posted Thursday June 17, 2021

Category: Investments

Key lessons:

If you invest through a do-it-yourself account at an order-execution-only (OEO) firm, you can pay significantly less in fees than you would to an advisor. But, as a do-it-yourself investor, you take full responsibility for your investments and you accept the financial risk of your investing decisions. If you are a DIY investor, always:

  • inform yourself about the securities you purchase and stay informed about them, including when they go through unusual changes such as stock splits or consolidations.
  • remember that your OEO firm will not give you investment advice or recommendations and has no obligation to provide you with information about the securities you have invested in or help you minimize your financial losses
  • carefully analyze the risk of loss for your investments individually and as a portfolio and consider whether they are suitable for your personal circumstances, including your personal risk tolerance and ability to withstand losses
  • remember that borrowing to invest (margin investing) always increases your investment risk, since you can lose more money than you put in

Consumer chooses to invest on his own

Mr. C inherited $50,000 after his father died and wanted to invest it. He had limited investing knowledge and experience, but he had invested before and had existing savings of $84,000. His investment firm had provided resources he relied on to make informed trading decisions and better understand the market. Based on this experience, Mr. C felt confident about investing on his own.

In the spring of 2017, he opened an online account at an OEO firm, so he could make securities trades independently.

Shortly after he began trading in his account, Mr. C noticed a negative cash balance. He called the firm to find out why. During this phone call, the representative told Mr. C that his stock purchases had exceeded the funds available in his cash account and that some of his trades had not been completed due to his negative account balance. Mr. C asked if there was a way to keep a negative balance from interfering with his trades.

The representative said that Mr. C could apply for a margin account; it would allow him to borrow funds from the firm temporarily if he went into a negative balance while trading. She explained that all trades were subject to the firm’s approval, and that daily interest was calculated on the amount borrowed based on an annual interest rate until it was repaid.

Margin borrowing leads to significant financial loss

When Mr. C asked the representative why he needed approval, she said that certain conditions must be met before a client could use a margin account to purchase stocks. He asked about purchasing many different stocks with a margin account. Among the stocks that Mr. C asked about, the representative said that one of them, Stock X, was margin-eligible at a rate of 70%. This meant that if Mr. C provided $30,000 of his own money, the firm would loan him up to $70,000 to invest in Stock X.

Mr. C thought that Stock X must have good potential if the firm was willing to let him borrow to invest in it. In the summer of 2017, he applied to open a margin account, which was approved by the firm. Mr. C purchased several shares of Stock X once his account was active. He did not worry about covering the full purchase price because he could borrow the funds on margin.

After several months of trading in American and Canadian currencies, routinely borrowing to complete his trades and incurring interest for borrowing on margin, Mr. C had lost a considerable amount of his savings. When Stock X did not perform as well as he had anticipated, he also lost money on his shares.

In the spring of 2019, Mr. C requested that the firm revert his margin account back to a cash account. He claimed that a margin account was more suitable for a professional investor, not him. By the fall, Mr. C became worried about his financial loss, which had reached approximately $120,000. He thought the firm was responsible.

Firm refuses to compensate consumer

Mr. C complained to the firm that:

  • the firm did not explain that he had opened a do-it-yourself account or that he would not receive investment advice.
  • the firm should have rejected every trade that exceeded the funds available in his cash account and never allowed his account to go into a negative balance in the first place.
  • the representative should have realized that he was an inexperienced investor when he began asking several questions about trading and should have helped to protect him from losing money.
  • the representative should not have suggested a margin account to him because he had very little investing experience and could not sustain a significant financial loss.
  • the representative’s advice to purchase Stock X had been unsuitable for him.

He asked the firm to reimburse him for the full amount of his loss. The firm responded to Mr. C by reminding him that he had agreed to invest completely on his own, without the services of an advisor. They directed Mr. C to the documents he had signed and refused his request for compensation.

Upset by the firm’s response, Mr. C came to OBSI for help.

Our findings

During our investigation, we reviewed Mr. C’s file from the firm and interviewed him. We found that the firm had provided Mr. C with clear information disclosing that it would provide him with access to an online trading platform, but would not:

  • give him any investment recommendations, or reassurance of suitable investments;
  • consider his financial situation or risk tolerance;
  • assume any responsibility for his investment decisions or their outcomes; or
  • automatically reject orders when there were insufficient funds or a negative account balance in his account.

These terms and conditions were clearly outlined in the client agreement that Mr. C signed.

From our interview with Mr. C, we further confirmed that:

  • during his call with the representative, he had chosen to interpret her responses to his questions as investment advice.
  • Mr. C had signed the application form for a margin account, agreeing to the financial risks associated with using it.
  • he had not completely read the client agreement and disclosures provided by the firm.

Given the circumstances, we had no basis to recommend that the firm compensate Mr. C for his losses.

Related case study

Consumer alleges online investing app misled her about margin borrowing and interest obligations

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