Private investors who lost money through disputed margin calls in the coronavirus market shock have started preparing possible legal action against banks and wealth managers in an attempt to recover losses.
For banks active in wealth management, including Swiss-based UBS and Credit Suisse, as well as JPMorgan Chase and Goldman Sachs of the US, margin loans are standard products.
The clients buy a slice of an investment with their own money — say 25 per cent — borrow the rest from the bank, and reap 100 per cent of the gain, minus costs, if prices rise.
But when prices fall, the leverage goes into reverse, sometimes with devastating effects. When the investors’ own money — the margin — falls below agreed levels, clients face urgent margin calls, for cash or other assets usable as collateral. If they do not stump up, the bank can normally liquidate the position.
When stock markets plunged by 20 per cent and more as the coronavirus pandemic took hold in February and March, bankers liquidated some clients’ debt-financed positions, imposing heavy losses.
Lawyers say bankers gave investors too little flexibility in refinancing investments and predict the eventual claims could match or exceed those generated by the 2008 global financial crisis.
Matthias Gstoehl, a banking disputes partner at Lalive, a Swiss-based law firm, said: “Since the markets began to feel the full impact of the Covid-19 pandemic, enquiries relating to margin calls from our investor clients have at least quadrupled, and they continue to grow on an almost daily basis.”
Andrew Wass, a litigation partner at London-based Withers, said: “This is a seismic event in the market. We can say with confidence that the last couple of months will produce a lot of litigation.”
Investment contracts give banks clear rights to liquidate positions. But lawyers say there still can be scope for making claims if banks act too quickly or mishandle a liquidation and impose bigger losses than would otherwise have been crystallised.
They say there are risks that, in the often-heated conversations that come with a disputed margin call, things might be said which contradict the contract wording and create opening for legal claims.
Mike Hawthorne, legal director at Pinsent Masons, said: “The danger for banks and brokers is that, in the course of the potentially confrontational discussions around the margin call, something might be said which the customer could misinterpret as an agreement to allow more time to provide the margin or before closing out the account.”
Recent market shocks, including the 2015 depegging of the Swiss franc from the euro, and the 2016 Brexit referendum result, as well as the 2008 hurt investors relying on margin loans. Mr Wass said: “The risks which leveraged investors are taking should have been obvious by now.”
In a landmark case in the London High Court in 2013, Norwegian billionaire Alexander Vik lost an $8bn claim against Deutsche Bank relating to the liquidation during the 2008 crisis of a complex foreign exchange investment — financed on margin.
The judge ordered Sebastian Holdings, Mr Vik’s investment company, to pay Deutsche $235m plus interest and costs and warned of the dangers of margin trading saying: “At the risk of appearing simplistic or unduly moralistic, it is plain that those who bet know that they run the risk of loss as well as gain.”
Lawyers add that the 2008 shock, and the consequent disputes, encouraged banks to ensure investment contracts were made even more stringent to withstand future claims.