(Reuters) - Interactive Brokers LLC must pay $667,000 to a hedge fund after an arbitration panel found the discount brokerage firm’s system for selling securities from clients’ accounts to pay margin debt had backfired leaving the fund with hefty losses.
The hedge fund, Glen Lyon Long Term Options LP, filed the claim in 2012, seeking between $1 million and $3 million. It said the brokerage used a flawed “auto-liquidation” system, according to a Financial Industry Regulatory Authority (FINRA) arbitration panel ruling late Tuesday.
A spokeswoman for Interactive Brokers Group Inc could not be immediately reached for comment.
Interactive Brokers provides direct market access to traders of futures and options. Many of its customers trade on margin, borrowing from Interactive Brokers to buy more securities to boost performance, while putting up their portfolios as collateral.
Firms generally require the value of securities in margin accounts to stay above a certain amount. Many firms issue margin calls when an account’s value drops below that level, requiring customers to come up with cash or sell securities to cure the shortfall.
Interactive Brokers, however, requires customers to let the firm automatically liquidate securities to bridge the gap. It pitches the system as a bonus feature to help customers manage risk during periods of market volatility.
But Glen Lyon said the system backfired at least twice in 2011. In one instance, the hedge fund’s margin account was $20,000 in the red when the auto-liquidation kicked in. Interactive Brokers sold Glen Lyon’s securities at off-market prices and then revalued the rest of the hedge fund’s portfolio based on those values.
Glen Lyon’s margin account deficit, as a result, quickly ballooned to $200,000.
“When an auto-liquidation occurs at prices that are outside the market it can easily put an account into a death spiral,” said Craig McCann, an economist in Fairfax, Virginia, who testified for the hedge fund.
A lawyer for the hedge fund, Robert Kantas in Houston, said that Interactive Brokers has a right to protect itself when clients’ accounts do not comply with margin requirements. But he said the firm was obliged to liquidate the portfolio in a “commercially reasonable” manner.
Even though Interactive Brokers later manually re-priced the portfolio, fixing part of the problem, a large number of options contracts had already been liquidated, leaving the hedge fund with substantial losses, Kantas said.
The FINRA panel did not explain the reason behind its decision.
Reporting by Suzanne Barlyn; Editing by Charles Levinson; Editing by Steve Orlofsky