Small Investors Get Stung by Short Selling

Stockbroker Law - Thursday, July 12, 2012
Small Investors Get Stung by Short Selling

The FINRA Office of Dispute Resolution has reported the filing of a number of claims by investors who have sustained losses as a result of short selling strategies recommended by their brokers. 

So, what is a short sale anyway? Short selling involves the sale of shares of a stock in a publicly-traded corporation in a customer’s account under circumstances in which the customer does not even own those shares in the first instance. 

So, why then would a customer sell shares of stock he or she does not even own? Typically, brokers will suggest that the shares of a certain corporation are about to plummet in value, thereby providing a customer’s account with a $1 gain per share for every $1 drop in value.

So, how does the customer sell shares of stock he or she does not own? This is accomplished by having the customer sign a margin agreement or other pledged capital agreement whereby the existing assets in the client’s accounts are pledged to cover the re-purchase of sales which have been sold short – at an as-yet-to-be-determined price.

Is this a safe or dangerous strategy? It is clearly dangerous.  Let us suppose you sell 1000 shares of ABC stock at $10.00, hoping to profit from its decline in price.  If, however, the shares of ABC stock rise to $25.00 per share, you will owe an additional $15.00 per share for each share sold short, or a total of $15,000.00, an amount secured by the existing securities, monies and assets in your account at the time of the short sale.

Many unsuspecting customers who have been recommended short selling strategies have seen their entire accounts wiped out by foolish short selling strategies recommended by reckless and often inexperienced brokers.  In most instances, short selling is not a strategy for small investors, and the risks are very high.

If you feel you have been victimized by an improper short selling strategy, please give our offices a call for a free initial consultation.

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