Securities Backed Lines of Credit (SBLOCs)

It lets you borrow without selling your investments, but if the account’s value falls, the lender may require you to add collateral or repay, and may sell your investments to cover the loan, which can mean selling at a loss. Owing money on an SBLOC, or losing money while one was open, is not by itself a claim. The key questions are whether the loan fit the investor and whether the professional who recommended it fulfilled their duties.

This May Not Be Your Fault

An SBLOC is often presented as a convenient way to get cash without selling investments or paying taxes on a sale. What can be missed is that the investments you pledge can be sold if their value drops, and the loan’s interest rate can change.

The professional who recommended it had a duty to explain those risks and to suggest the loan only if it fit your finances and goals. Depending on the facts, Regulation Best Interest and Financial Industry Regulatory Authority (FINRA) rules may apply to a recommendation to borrow against an account, and firms must supervise the advice their representatives give. When that does not happen, responsibility may belong with the broker and the firm.

How Securities-Backed Lines of Credit Work

According to FINRA, an SBLOC is a revolving loan: you typically make interest-only payments, can repay and borrow again, and can keep trading in the pledged account. A joint investor alert from the Securities and Exchange Commission (SEC) and FINRA explains where the risk lies:

• Maintenance calls. If your collateral loses value, you may have to post more collateral or repay within a short period, often just two or three days.
• Sales without notice. If you cannot meet the call, the firm can sell your securities and keep the cash. The alert warns that lenders often can do this without giving you any notice.
• Demand loans. Lenders may call the loan at any time.
• Variable interest. The rate can change every day, and unpaid interest may be added to your balance.
• Concentrated accounts. A portfolio with a few large holdings can drop sharply in a single event, which can trigger a call and force sales at low prices.
• Taxes. Forced sales may create capital gains taxes you were hoping to avoid.
• Hard to leave. Pledged assets generally cannot move to another firm until the loan is repaid.

Regulators also say SBLOCs are generally “non-purpose” loans, meaning the money usually cannot be used to buy or trade securities. They note some firms market SBLOCs as part of a retirement income strategy, which makes the risks above matter more for retirees.

Example: a retiree who borrows against an account to pay for a home repair may owe a growing balance at a changing rate, and a market drop could force the sale of investments they planned to keep for income, possibly with a tax bill attached.

If the value of your pledged securities falls, FINRA warns that the lender can sell them to cover a maintenance call, often without notice, and that you could owe capital gains taxes on those sales.

Common Examples of SBLOC Claims

• A line of credit recommended to a retiree or fixed-income investor who could not absorb a market drop or a higher interest rate, see Unsuitable Recommendations
• No clear explanation that investments could be sold, possibly without notice, if the account fell in value, see Misrepresentation and Omission
• A concentrated account pledged as collateral, leaving the investor exposed to one bad market event, see Overconcentration
• Loan money used to buy more investments, so a decline hits both the new purchases and the account that backs the loan, see also Margin Trading
• A recommendation shaped by what the broker or firm earns when a loan is opened, or by the firm’s interest in keeping your assets, rather than by your needs, see Regulation Best Interest
• A firm that did not review or monitor loans made against concentrated or older investors’ accounts, see Failure to Supervise
• A forced sale that created an unexpected tax bill no one had explained

How Can You Protect Yourself From SBLOC Losses?

Regulators publish ten questions to ask before pledging your investments. These are the ones that matter most:

• Ask who the lender is. It may not be your brokerage firm. Find out who sends the notices and answers your questions.
• Ask what happens if your account falls. How much room do you have, how fast must you respond, and will anyone warn you before your investments are sold?
• Ask how rising rates would change your cost. The rate can change every day, so ask how high it could go.
• Consider borrowing less than the maximum. The more you borrow against a concentrated account, the less it takes to trigger a sale.
• Ask how your adviser is paid on the loan. Compensation can shape a recommendation.

Signs Your SBLOC May Have Been Unsuitable

• You were told you could get cash “without selling,” but no one explained what happens if the market falls
• You received a maintenance call, or a notice that you had to add money or repay quickly
• Your investments were sold without you being asked first
• A forced sale left you with a tax bill you did not expect
• Your interest cost grew as rates changed, and your balance kept climbing
• Most of your account was in a few holdings when it was pledged as collateral
• You borrowed against savings that you depend on for retirement income
• Some of the loan money went back into investments
• You did not know who the lender was, or learned only later that you could not move your account without repaying the loan
• No one asked about your income, your tolerance for loss, or your plan for repaying