The Inherent Risks of Securities-Backed Lines of Credit

For investors seeking quick—and virtually unrestricted—cash without having to sell their investments, securities-backed lines of credit (“SBLOC”) have emerged as an exceedingly popular option.

The SBLOC concept is simple. For monthly interest-only payments, brokerage firms extend to investors a revolving line of credit that is collateralized against assets in the investors’ portfolios. With SBLOCs, investors can access the value of their investments without the tax consequences associated with liquidation—all while continuing to buy and trade securities.

Wells Fargo notes that its customers commonly use SBLOCs for “home renovation,” “real estate purchase,” to purchase a “[b]oat, car, or other luxury purchase,” “business opportunity” and for “expenses such as taxes.” Morgan Stanley pitches SBLOCs to clients “…to secure the capital you need, when you want it, so you can catch your dreams…” and to purchase, for example, “[a] 1963 Ferrari GTO, just because.”

The appeal and convenience of SBLOCs often overshadow the inherit risks. In a volatile market, investors’ portfolios can quickly dip below the collateral threshold set by the brokerage firm. When this happens, if borrowers are unable to pay back the loan in a matter of days or offer additional collateral to meet the threshold, brokerage firms often have the right to “call the account” and unilaterally liquidate investors’ securities—choosing which securities to sell at their own discretion. One bad day on Wall Street can gut lifelong investment portfolios and leave investors with crippling tax liability. Importantly, pursuant to the SBLOC agreement, brokerage firms are not even required to notify the SBLOC investor when the account is “called” and the firm begins to liquidate securities. In many instances, the SBLOC investor learns about the account call and the subsequent liquidation the next time they check the performance of their brokerage account.

The risks associated with SBLOCs have prompted regulatory scrutiny by the Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”). The SEC issued an investor alert cautioning investors that “market volatility can magnify your potential losses, placing your financial future at greater risk.” FINRA, in its 2015 Annual Regulatory and Examination Priorities Letter, highlighted the risks inherent in SBLOCs as “exactly the risk[s] we are focused on.”

Broker-dealers accused of engaging in aggressive SBLOC marketing and sales tactics have been subjected to enforcement actions. For example, Morgan Stanley, accused of pushing SBLOCs and burying the risks, settled with a Massachusetts regulator for $1 million.

If your broker has recommended an SBLOC and you have lost money, you may have a claim for recovery in FINRA arbitration. Please contact Donnell Much, Esq. at 215-875-4667 or [email protected] or Michael Dell’Angelo, Esq. at 215-875-3080 or [email protected] for a confidential and no-cost consultation.

By |2021-06-28T15:21:19-04:00June 28th, 2021|Uncategorized|