Customers of Interactive Brokers file class action complaint over management of portfolio margin accounts

Maria Nikolova

According to the plaintiffs, Interactive Brokers unlawfully provided portfolio margin treatment for Exchange Traded Notes, which resulted in losses for the broker’s clients.

The peculiarities of portfolio margin accounts are at the heart of a newly launched lawsuit against electronic trading firm Interactive Brokers LLC. The class action complaint was filed by two clients of the broker – Timothy Moss and Heather Hauptman, with the New York Southern District Court today.

The document, seen by FinanceFeeds, accuses the broker of unlawful management of a number of portfolio margin accounts.

The plaintiffs explain that “portfolio margin” generally allows for the use of higher leverage than standard “strategy-based” margin lending (commonly referred to as “Regulation T” margin lending). The United States Securities and Exchange Commission (SEC) and the regulatory predecessor to the Financial Industry Regulatory Authority (FINRA) amended FINRA Rule 4210 in 2007 to allow, for certain types of securities, portfolio margin trading in retail customer accounts. Rule 4210(g) provides that broker-dealers may use portfolio margin to calculate margin requirements using a “risk-based” model. However, this is allowed only in relation to specifically enumerated security types, such as equity-based securities, and derivatives on eligible equity securities — like options or warrants on equities.

According to the plaintiffs, Interactive Brokers disregarded this rule in administering its customers’ Portfolio Margin Accounts. Instead, the broker provided portfolio margin treatment for Exchange Traded Notes (ETNs), such as the Barclays Bank PLC iPath S&P 500 VIX Short-Term Futures ETN, traded under the symbol VXX. The plaintiffs argue that ETNs, and the VXX in particular, are not equities or (derivatives of equities), but instead are unsecured debt instruments. As unsecured debt instruments, ETNs – like the VXX – are not among the approved list of investment products eligible for portfolio margin.

Interactive Brokers is said to have been informed by both FINRA regulators and the Options Clearing Corporation that unsecured debt instruments such as the VXX are ineligible for portfolio margin and risk-based margining treatment. For instance, in an email to David Battan, General Counsel and Executive Vice President of Interactive Brokers, Steve Yannolo from FINRA Credit Regulation stated: “it was recently brought to our attention that the OCC is providing P/L for ETNs. Since these are debt instruments, they are ineligible for portfolio margin.”

The plaintiffs allege that by continuing to provide portfolio margin’s risk-based margining treatment for open positions in ETNs and options on ETNs – such as the VXX – the broker violated FINRA rules and breached its contractual agreements with its customers.

The plaintiffs – Mr Moss and Ms Hauptman, engaged the services of a financial advisory firm, Meridian Capital Advisors, LLC and provided the firm with discretionary authority over their investments. Their accounts with IB account included VXX positions and IB was improperly applying Portfolio Margin treatment to their VXX positions.

As of the end of day on August 21, 2015, the total value in Ms. Hauptman’s Portfolio Margin Account was in excess of $200,000. At the end of the day on August 21, 2015, Mr. Moss’ account was valued at approximately $186,000.

Over the weekend after August 21, 2015, events unfolding in the Asian markets led to a drop in US stock futures. At around 12:00 AM on the morning of August 24, 2015, Interactive Brokers changed the margin requirements, increasing the margin requirement for the VXX and VXX option positions for all of its clients, including the plaintiffs. When the market opened on August 24, 2015, the Dow index dropped 1,000 points and the price of the VXX spiked. As a result, the value of plaintiffs’ Portfolio Margin Accounts (and those of all similarly situated IB customers) dropped. Also, because the broker had increased the Portfolio Margin requirements, many customers were put into a margin deficiency situation.

In the month of August, Ms. Hauptman’s account lost over $175,000, primarily as a result of the VXX and VXX option trades that occurred using Portfolio Margin leverage. Likewise, in the month of August, Mr Moss lost around $150,000, with most of the losses due to VXX and VXX option trades that occurred using portfolio margin leverage.

Plaintiffs propose the following Class definition: All persons who held a Portfolio Margin Account with Interactive Brokers, LLC, containing a position or option in an ETN at any point from December 1, 2011 through the date of judgment, and whose ETN positions received Portfolio Margin treatment.

They accuse Interactive Brokers of, inter alia, Breach of Contract, Unjust Enrichment, and Breach of the Implied Covenant of Good Faith and Fair Dealing. The Plaintiffs seek injunctive and declaratory relief on behalf of themselves and all Class members, as well as damages in their individual capacity.

The case is captioned Hauptman et al v. Interactive Brokers, LLC (1:17-cv-09382).

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