I Accidentally Played with the Big Boys and Won

May 14, 2010 3:26 PM

I did something extremely stupid in the stock market and got extremely lucky. Please help me sort through the consequences. I apologize that this is very long. Hopefully it is interesting.

Last week, on Thursday, I was bored at work and began compulsively checking my google finance account, where I track the mutual funds and ETFs in my retirement accounts. I caught the historic free fall in the markets as it was happening. When I noticed that one of the ETFs I own had dropped more than 99% to $0.10 per share, I decided on a lark to try to buy some more. I logged on to Charles Schwab, where my SAR-SEP (small business retirement fund) account is hosted. I had $5,000 in cash in my account from recent contributions, so I attempted to buy 10,000 shares of this ETF, thinking that best case I spend $1,000, the price rebounds and I make an instant fortune; worst case, the market corrects before the transaction occurs and I spend up to the $5,000 I had lying around in my account buying an ETF that I like for long-term investment purposes anyway. I don't have margin trading activated in my account, so it didn't occur to my that there was a possibility of spending more money than I had buying ETFs. I entered the order; the system gave me an estimated price of approximately $1,000 and asked me to confirm. I did. I knew that it was likely that all the high-falutin algorythmic trading systems would close the gap before the order from a peon like me was allowed to transact, but I assumed that if the price corrected between placing the order and the transaction occuring, the system would either reject the trade or limit my order to the amount of cash I had on hand.

Wrong.

Fifteen minutes later, I logged back into my Schwab account. I was shocked to discover that I had spent $630,000 buying 10,000 shares of this ETF at $63 per share rather than $0.10. The price had increased $2 per share in the minutes after I had bought, so I was "up" $20,000, but I was still in debt for the $630,000. I assumed it was a simple error, but I was freaked out enough to immediately call customer service, where I was connected to a broker who explained to me that yes, I really had spent $630k of borrowed money buying ETFs. Since the market was about to close, he recommended that I immediately sell everything, which I did. In the end, I cleared $17,000 in "profit" on this absurd turn of events.

At first, the broker told me that I would get to keep the profit. I pressed him if that was really true, and he put me on hold. When he came back, he told me that, in fact, Charles Schwab would keep all the profit because I had basically bet with their money. I asked what would have happened if the ETFs had lost value, and he told me that I would have been on the hook for the losses. I was too relieved to argue with the principal behind this, even though it sounded a little unfair. He went on to tell me that I could keep the profit if I was able to transfer $630,000 to cover the purchase price of the ETFs into my account before close of business Tuesday. I toyed with the idea of trying to round up the money from family or friends, but decided to let it go rather than admit my stupidity to anyone I know. It wasn't really my money anyway, I thought. I should just be grateful to get out of this all without mortgaging my future and take it as a lesson not to play with forces I don't understand.

Tuesday has come and gone. The $17,000 is still sitting in my account.

Here are my questions:

1) How was my trade allowed to go through? Was I naive to think that the system should prevent me from buying ETFs with money I don't have unless I have a margin account? In the past I've attempted to buy 10 shares of an ETF when I only had cash for 9; the system rejected the trade. Why didn't that happen here? A theory is that the transaction was approved when the ETF was trading for $0.10, but cleared after the price had rebounded to $63, and this gap provided a "blind spot" for the order to go through. Is there anything to that?

2) Can Charles Schwab really keep the "profits" that I made by accidentally betting with borrowed money, but pass on any losses? Are there laws that govern this, or is it controlled by my terms of service?

3) What does it mean that the money is still in my account? I don't want to get my hopes up, and I don't feel like I deserve it, but is there a chance I get to keep this $17,000?

Thank you for your general thoughts and advice on this situation. I want to mention that I normally follow a strictly buy-and-hold approach, acquiring diverse index funds and ETFs to hold long term and rebalance occasionally. I've never even placed an order during trading hours before. I feel stupid, lucky and humbled, but if there are more ways in which I was stupid that I've perhaps overlooked, feel free to point them out as well.

posted by anonymous to Work & Money (36 answers total)

Charles Schwab would keep all the profit because I had basically bet with their money.

So what? That's what margin buying IS. I'm no expert, but I think the 17k is your money.
posted by ctmf at 3:32 PM on May 14, 2010 [1 favorite]

ctmf, I don't think the anonmyous poster has a margin account.
posted by infinitywaltz at 3:43 PM on May 14, 2010

Just an FYI on future larks, I believe this is what limit orders are for.
posted by pwnguin at 3:47 PM on May 14, 2010 [3 favorites]

So because Schwab's system incorrectly (?) let OP do something that he/she had not enabled in his/her account (buy on margin), Schwab gets to keep the money? I'm not looking to investment firms to be paragons of ethics, but this is just confusing.
posted by supercres at 3:48 PM on May 14, 2010

This seems odd. Since you don't have a margin account, tt seems like it is their fault for allowing the trade to go through, rather than giving you back some message like "insufficient funds".
posted by jclovebrew at 3:49 PM on May 14, 2010

That's what I mean. Someone at Schwab may be in trouble for letting the trade happen, but that's not anonymous' problem. They got their margin money back already; taking the profit on the trade would just be spiteful and possibly illegal.

I'd just take out the 17k and say no more about it.
posted by ctmf at 3:57 PM on May 14, 2010

ctmf: "I'd just take out the 17k and say no more about it."

Keep in mind it's a retirement account; unless the account holder qualifies, they'll take a 10.5 percent tax hit on it and it counts as income.
posted by pwnguin at 3:59 PM on May 14, 2010

We do not have enough information about your terms of service to answer this question. You may be totally in the right and you should stick it to them to the extent your patience and resources allow, or you could be totally wrong and you would do best by just dropping it. I don't think the brokers you talked to on the phone should be believed or trusted. I have never said this before, because usually I don't think it's that helpful, but you need a lawyer.

Do not move the money until you have authorization to do so. This sounds like when your employer accidentally doubles your paycheck direct deposit- you are not entitled to that money if there is an error still pending, and you can be penalized for touching it.
posted by slow graffiti at 4:01 PM on May 14, 2010 [4 favorites]

I suppose they could get away with it; they'd have to void your trade on the grounds that you weren't allowed to do that and reset your account to the way it was before the trade. Then they'd have to call the trade an accidental investment made by the Schwab broker on the company's behalf, same as if a broker had screwed up a customer's order and traded the wrong thing. I'd still take out the 17k and make them ask for it back. Since it's still in your account days later, I'd say they just said, screw it, easier to leave as-is and no harm done.
posted by ctmf at 4:02 PM on May 14, 2010

This sort of happened to me when I accidentally duplicated a buy order. The amount I ended up ordering was more than was in my account, even though I don't have a margin account either. I sold the extra stock or whatever it was, but I also don't understand how that is allowed to happen with non-margin accounts. Maybe it's in the fine print?
posted by Dr. Send at 4:02 PM on May 14, 2010

Here is what FINRA has to say about margin trading. There may be other interesting stuff on the FINRA website for you to look at.
posted by yarly at 4:04 PM on May 14, 2010

At the very, very least you get the profits from the first 5K worth of stock bought. That should be considerable (because it didn't get back to 63 instantly or on your first purchase. A weekend in Vail or Aruba?)

Beyond that it does get iffy, and you really need a close reading of your agreement with Schwab and probably you need the advice from a real expert. I think that if you had lost 17K while unloading it, Schwab would have wanted every cent back, and to me that means they get nothing now.
posted by Some1 at 4:10 PM on May 14, 2010

It's not margin trading...it's how market orders work. As explained in this volatility disclaimer, they execute market orders at whatever price is available at the time the order gets processed. When you placed your order, all the Schwab site did was verify that you had the funds to cover it at the current market price. Once it goes to the traders, they no longer care whether or not you have the money for it, they just execute the order. Apparently you're not supposed to do market orders in a fast market...a limit order would have prevented this, I guess.
posted by cabingirl at 4:12 PM on May 14, 2010 [1 favorite]

Ok, here's what FINRA has to say about volatility and market orders!
posted by yarly at 4:18 PM on May 14, 2010

Might want to talk to a lawyer here.
posted by norabarnacl3 at 4:21 PM on May 14, 2010 [2 favorites]

This is a really interesting question, and I think that the answer is probably going to depend on the contract governing your account and maybe a few FINRA rulings.

I think that you will probably get to keep your money, though, as this is simply how a market order works. I very much doubt that they will be able to take the proceeds of the trade simply because you did not have the cash on hand available for an order they chose to fill. I am sure that you would have been liable if it gapped down from there.

Consider it either a very, very good or good lesson about why you should be careful with market orders in volatile markets.
posted by iknowizbirfmark at 4:23 PM on May 14, 2010

Different brokers rules may vary, but it is possible to buy shares in a cash account even if you don't currently have the funds on deposit. This is because stock trades don't actually settle until three days later. The broker assumes that you will wire in sufficient money to cover the trade within the three-day period. So there was nothing wrong with your broker letting the purchase go through even for a cash account.

However, in your case you sold the shares before the settlement date and never deposited the funds to cover your purchase ($630,000). This is known by the SEC as a freerider violation because you sold the shares before you put up the cash for the original purchase.

The SEC freerider rule says nothing about the profits on your trade. It simply means that, by law, there is a 90-day freeze on your account. You can still trade during the freeze but your broker must require you to have cash up front before any further trading. It is like being on probation. So you still may be due the profits. You can try fighting this but it is possible that your broker has their own contractual rules about freerider violations separate from the SEC. You should ask your broker to show you their written rules regarding this rather that just taking their word on it. The SEC doesn't require forfeiture of the profits.

In the future, to avoid these sorts of surprises, always use a limit order instead of a market order. Then you will know exactly how much your trade will cost in advance.
posted by JackFlash at 4:43 PM on May 14, 2010 [5 favorites]

It simply means that, by law, there is a 90-day freeze on your account. You can still trade during the freeze but your broker must require you to have cash up front before any further trading.

Sounds like this is the state of affairs that anonymous wanted in the first place.

Thanks for this post. Thanks to it I will probably never use a market order to buy securities.
posted by grouse at 4:52 PM on May 14, 2010

This really depends on the fine print of your agreement with your broker - pull it out and read it end to end.

Don't move the money (I'm not an expert, but I wouldn't) - because not only is this a possible error on their part, it's also a possible error on the market at large, which may have all kind of corrective consequences that might filter down.


Specifically, look for the fine print regarding liability and market orders.... there is a time delay between them electronically verifying that you can cover a market order and the actual trade, and *someone* is liable for that inherent risk - the terms are probably spelled out relatively clearly in your contract with your broker - they have been at other brokers I've investigated.

And as others have said - use limit orders! They were designed specifically to prevent the kind of situation you are in now...
posted by TravellingDen at 4:53 PM on May 14, 2010

By the way, the fact that the money is still in your account a week later, long after the settlement date suggests to me that they are letting you keep your profits. Have you checked that the buy and sell confirmations are in your account? Print them out and keep them.

Also, expect a letter from your broker telling you about the freerider freeze. It is not a big deal. It just means that you will have to have settled cash in your account before trading for the next 90 days. Settled cash means that even if you sell another stock, you will have to wait three days for the settlement before buying something else. Normally you can sell one stock and buy another on the same day. You won't be able to do that for the next 90 days.
posted by JackFlash at 4:56 PM on May 14, 2010

Man, just being able to tell that story is worth $17K. You stared $630K in the eye and came out on top. If I heard you tell this in a bar, I'd buy you a drink.
posted by obiwanwasabi at 5:04 PM on May 14, 2010 [40 favorites]

2) Can Charles Schwab really keep the "profits" that I made by accidentally betting with borrowed money, but pass on any losses? Are there laws that govern this, or is it controlled by my terms of service?

Who knows? But with $17,000 at stake, I'd say it's worth spending a few hours with a lawyer to try to find out.
posted by A Thousand Baited Hooks at 5:48 PM on May 14, 2010 [1 favorite]

N-thing calling a lawyer.
posted by ewiar at 5:53 PM on May 14, 2010

One other option, since it's a retirement account, is to do nothing. Watch and wait. If the money is still there in a year or two, it's likely staying there.
posted by yclipse at 6:32 PM on May 14, 2010

Professional legal counsel will be necessary.

Please let us know how this turns out, though!
posted by beardlace at 6:33 PM on May 14, 2010 [2 favorites]

No need to get a lawyer. He has the $17,000 in his account. Until he sees that money disappear or else gets notification of the cancellation of the trade confirmations, there's nothing to complain about. He is well past the settlement date. If it shows in the account as settled funds, he can assume its his.
posted by JackFlash at 6:59 PM on May 14, 2010

good god, limit orders my man, limit orders
posted by nathancaswell at 8:15 PM on May 14, 2010

Don't do anything now. If the money disappears then call a lawyer. Let's face it, wall street is hardly a well run place, Even if they told you over the phone that you wouldn't get to keep the profits, they might not do anything. Removing the money now would probably require doing something manual and they may just forget about it.

If they do take the money, then talk to a lawyer. But a lawyer specializing in this kind of law might be pretty expensive.

Also, next time do a limit order if you want something at or below a certain price.

Actually if you had got the stock at 0.01, the price trade would probably have been canceled.
posted by delmoi at 8:19 PM on May 14, 2010

I'm with JackFlash on this--nothing actionable has happened that calls for a lawyer, yet.
posted by disillusioned at 9:19 PM on May 14, 2010

I would do nothing, say nothing, unless the money disappears. Don't draw attention to it; the computers might just let it slide. Right now is the situation you want; causing a human being to look at it will just be bad.

In the meantime review all the agreements you have between you and your brokerage, in case the money disappears. If it does, then it might be lawyer time, unless you simply have no leg to stand on based on your agreements.

But you're past the settlement date, it sounds like, so you may have more or less gotten away with it. And if you do, consider your entire life's worth of financial market-timing luck gone.
posted by Kadin2048 at 9:28 PM on May 14, 2010 [1 favorite]

Charles Schwab also has their own bank; this is established more for the benefit of retirees, heirs and trust fund recipients to write checks out of an IRA to pay bills. As it's an established bank, one open to their clients, the funds will gain interest the savings, and can also be used for reinvesting. Whether one has money in the bank or not, as long as they're a client of Schwab, part of the money [in an IRA or even through trading] can be used as collateral for loans taken from Schwab.

In effect, you were automatically approved for a $630k loan, as Schwab felt comfortable in assuming the risks involved. (Regardless to say, there is a lot of fine print in their paperwork and on their website cautioning about the client's presumption of risk in independent trading. If you want to take the plunge, they can only go so far in trying to stop you, but when you bet with their funds, they'll take the matter quite seriously.)

While not a Schwab representative nor a partner, I have some friends who are clients; they routinely receive updates from the company with boilerplate warnings about liabilities in trading. As you were using six figures' worth of cash on ETFs, a good portion of that $17,000 could be considered on par with the exchange fees for trading and selling - practices any investment agency would likely include in their rates.

My advice to you is to arrange with an appointment with a regional representative of Schwab, to speak with one of their financial advisers. In this capacity, the company is better suited to helping you with buying and selling plans, particularly in the face of rallying trends. Talking over the phone to a broker limits your perspective of the larger picture, and can lead to the mishaps similar to what you experienced, or worse. Companies like Schwab will work with partner companies which specialize in portfolio management, and could handle some of the heavy lifting for you, so you may not need to day-trade as much; should you feel you'd like more shares from a particular market, you could work it out directly with them, and they'd check with Schwab if any conflict would arise in terms of the exchange of funds, and so on. In any case, the loss of $17,000 is a very small price to pay in terms of life lessons.
posted by Smart Dalek at 5:04 AM on May 15, 2010

I meant to say, Schwab felt comfortable in assuming your awareness of the risks involved.
posted by Smart Dalek at 5:07 AM on May 15, 2010

A lot of last week's crazy transactions were canceled.

Last week, the NYSE and Nasdaq agreed to cancel trades that were 60% or more away from a designated price during Thursday's trading, in which the Dow Jones Industrial Average dropped by nearly 1,000 points before making up much of that ground.


WSJ
http://online.wsj.com/article/SB10001424052748704879704575236752132638846.html?mod=WSJ_hpp_MIDDLENexttoWhatsNewsTop

Sounds to me like your 17k might have been forgotten. I'm with those who say sit tight and stay quiet and see what happens.
posted by CunningLinguist at 5:46 AM on May 15, 2010

As an antidote CS's computer systems were acting really odd that day. It would not surprise me if trades that ordinary wouldn't have gone through did, and it wouldn't surprise me if they have no idea about your extraordinary profits. You were not "automatically" approved for a $630k loan, and if you wouldn't have sold those shares they probably would have automatically been sold for you pretty quickly. I say don't mention it again. If they don't take the money back after a few statements, odds are they never will (I have no idea what the legal answer is, this is the practical one). Like people above have said, they would have definitely held you responsible if you had lost 17k.
posted by An algorithmic dog at 4:58 PM on May 15, 2010

Mod note: Comment removed. It's fine to link and if necessarily blockquote an external article if it's answering the question, but don't plop several paragraphs into a thread or skip attribution please.
posted by cortex (staff) at 9:16 AM on May 16, 2010

I would do nothing. Watch and wait. Do nothing and know nothing.
posted by xammerboy at 7:39 AM on May 19, 2010