Broker's Call: Definition and Example

In the world of finance, a "broker's call" is a term that can be misleading due to its similarity to other financial terms like "margin call" or "house call." However, a broker's call specifically refers to a situation where a brokerage firm demands that an account holder deposit additional funds or assets to cover a shortfall in the account balance. This demand typically arises when the value of investments bought on margin falls below the required maintenance margin level.

What is a Broker's Call?

A broker's call is essentially a demand by a brokerage firm to restore the minimum required deposit in a margin account. This situation often follows losses in the investments purchased using borrowed funds from the brokerage firm. The maintenance margin is the minimum equity an investor must hold in the margin account after the purchase has been made. If this requirement is not met, the brokerage firm may liquidate the securities in the customer's account to cover the shortfall.

How Does it Work?

When an investor buys assets on margin, they borrow money from the brokerage firm to multiply their potential gains. However, if the investment tanks and the value of the securities falls below the required maintenance margin, the brokerage firm issues a broker's call. This call is not a suggestion but a demand for the investor to deposit more cash or sell other assets in the account to meet the minimum requirement.

For example, let's consider an investor who buys 100 shares of Apple on margin. The brokerage firm allows up to 50% of the purchase price to be borrowed, according to Regulation T of the Federal Reserve Board. If the stock price falls significantly, the investor's account balance may drop below the maintenance margin requirement. In this scenario, the brokerage firm would issue a broker's call, requiring the investor to deposit additional funds or sell some of the securities to meet the minimum requirement.

Real-World Examples

Margin calls have dramatically impacted investors during key market events. For instance, during the 2008 financial crisis, many investors saw their portfolios lose value rapidly. Those who had used margin faced broker's calls they couldn't meet, resulting in forced sales at large losses. The widespread selling amplified the market's decline and worsened the crisis.

Another example is the 2021 GameStop short squeeze. Many investors who had borrowed money to short sell GameStop shares were caught off-guard when the stock's price surged unexpectedly. Unable to meet broker's calls, they were forced to close their positions, often taking significant losses in a short time.

Broker Margin Call Policies

Each brokerage firm has specific policies on how and when margin calls are issued. Some brokers may give more time to meet a margin call, while others may act faster to sell off assets. It's crucial to review your broker's terms so you know the margin requirement and what to expect if a broker's call occurs.

For example, Fidelity Investments has a margin maintenance requirement that ranges from 30% to 100%, and its broker's call allows an account holder five business days to sell margin-eligible securities or deposit cash or margin-eligible securities. After that, the firm will start liquidating securities. Charles Schwab has a maintenance requirement that is usually 30% for equities, and house calls are due "immediately" to this firm.

Conclusion

Understanding how broker's calls work and the policies of your brokerage firm can help you manage risks and avoid surprises. Always be familiar with the regulations and broker terms before using margin in your investing strategy.