On FINRA’s website, under “Investor Alert,” they offer the following to investors; over the past few years, brokerage firms and banks have been issuing and marketing complex investments known in the industry as “structured products” to individual investors. These include “reverse convertibles,” also known as RCN, which are popular in part because of the high yields they offer. Also known as “revertible notes” or “reverse exchangeable securities”—and sold under a variety of proprietary names that may or may not use the term “structured” to describe the product—reverse convertibles are debt obligations of the issuer that are tied to the performance of an unrelated security or basket of securities. Although often described as debt instruments, they are far more complex than a traditional bond and involve elements of options trading. Reverse convertibles expose investors not only to risks traditionally associated with bonds and other fixed income products—such as the risk of issuer default and inflation risk—but also to the additional risks of the unrelated assets, which are often stocks.

 FINRA is issuing this alert to inform investors of the features and risks of reverse convertibles. They are complex investments that often involve terms, features and risks that can be difficult for individual investors and investment professionals alike to evaluate. If you are considering a reverse convertible, be prepared to ask your broker or other financial professional lots of questions about the product’s risks, features and fees and why it’s right for you.

 What Is a Reverse Convertible?

 FINRA says that a reverse convertible is a structured product that generally consists of a high-yield, short-term note of the issuer that is linked to the performance of an unrelated reference asset—often a single stock but sometimes a basket of stocks, an index or some other asset.

The product works like a package of financial instruments that typically has two components: 1.)a debt instrument (usually a note and often called the “wrapper”) that pays an above-market coupon (on a monthly or quarterly basis); and 2.) a derivative, in the form of a put option, that gives the issuer the right to repay principal to the investor in the form of a set amount of the underlying asset, rather than cash, if the price of the underlying asset dips below a predetermined price (often referred to as the “knock-in” level).

According to FINRA, when you purchase a reverse convertible, you’re getting a yield-enhanced bond. You do not own, and do not get to participate in any upside appreciation of, the underlying asset. Instead, in exchange for higher coupon payments during the life of the note, you effectively give the issuer a put option on the underlying asset. You are betting that the value of the underlying asset will remain stable or go up, while the issuer is betting that the price will fall. In the typical best case scenario, if the value of the underlying asset stays above the knock-in level or even rises, you can receive a high coupon for the life of the investment and the return of your full principal in cash. In the worst case, if the value of the underlying asset drops below the knock-in level, the issuer can pay back your principal in the form of the depreciated asset—which means you can wind up losing some, or even all, of your principal (offset only partially by the monthly or quarterly interest payments you received).

A reverse convertible might make sense for an investor who wants a higher stream of current income than is currently available from other bonds or bank products—and who is willing to give up any appreciation in the value of the underlying asset. But, in exchange for these higher yields, investors in these products take on significantly greater risks.

How Do Reverse Convertibles Work?

FINRA reminds us that the initial investment for most reverse convertibles is $1,000 per security, and most have maturity dates ranging from three months to one year. The interest or “coupon rate” on the note component of a reverse convertible is usually higher than the yield on a conventional debt instrument of the issuer—or of an issuer with a comparable debt rating. For example, some recently issued reverse convertibles have annualized coupon rates of up to 30 percent. A reverse convertible’s higher yield reflects the risk that, instead of a full return of principal at maturity, the investor could receive less than the full return of principal if the value of the unrelated reference asset falls below the knock-in level the issuer sets. For a reference asset that is a single stock, the knock-in level can be 20 percent or more below the original price.

Depending on how the underlying asset performs, you will receive either your principal back in cash or a predetermined number of shares of the underlying stock or asset (or cash equivalent), which amounts to less than your original investment (because the asset’s price has dropped). While each reverse convertible has its own terms and conditions, you will generally receive the full amount of your principal in cash if the price of the reference asset remains above the knock-in level throughout the life of the note. In some cases, you will also receive a full return of principal if the price of the reference asset ends above the knock-in level at maturity, even if it has fallen below it during the term of the investment—although in other cases, any breach of the knock-in level will result in your receiving less than the original principal. However, you typically will not participate in any appreciation in the value of the reference asset during the life of the note.

Reverse convertibles can have complex pay-out structures involving multiple variables that can make it difficult to accurately assess their risks, costs and potential benefits. For example, a hypothetical payoff structure of a reverse convertible with common stock as the reference asset could result in the following scenarios:

Scenario	Stock Price Visual	At maturity, the investor gets
1. The stock price never declines below the knock-in level, but ends below the original price.		Full return of principal in cash (despite the decline in the stock price), plus any fixed coupon payments.
2. The stock price never declines below the knock-in level, and ends above the original price.		Full return of principal in cash, plus any fixed coupon payments, but no participation in the increase in the stock price.
3. The stock price ends below the knock-in level.		Predetermined number of shares of stock (or cash equivalent), worth less than the principal amount, plus any fixed coupon payments.
4. The stock price declines below the knock-in level, but ends between the original price and knock-in level.		Predetermined number of shares of stock (or cash equivalent) worth less than the principal amount, plus any fixed coupon payments; or full return of principal in cash, plus any fixed coupon payments, depending on the issuer and product.
5. The stock price declines below the knock-in level, but ends above the original price.		Full return of principal in cash, plus any fixed coupon payments, but no participation in the increase in the stock price.

According to FINRA, generally speaking, the higher the coupon rate the note pays, the higher the expected volatility of the reference asset. In turn, the more volatile the reference asset, the greater the likelihood that the knock-in level will be breached, and the investor could receive less than a full return of principal at maturity (as illustrated in cases three and four above).

The bottom line is that reverse convertibles come not only with the risks that fixed income products ordinarily carry—such as the risk of issuer default and inflation risk—but also with any additional risks of underlying asset. When the underlying asset is a stock, this means exposure to the business risks of the company as well as systemic equity market risks, including price volatility. If you are considering investing in reverse convertibles, it is critical that you look beyond the high coupon rate and focus on the risks of the underlying asset. Remember that even if the issuer of the reverse convertible is able to meet its obligations on the note—and even if the yield keeps pace with or surpasses inflation—you could wind up, when the note matures, with shares of a depreciated—or even worthless—asset that you otherwise would not have purchased.

Why Do Investors Buy Reverse Convertibles?

• High coupon rate or “stated yield.” Reverse convertibles can offer coupons from 7 percent to 30 percent. Typically, however, a higher coupon rate indicates higher volatility in the underlying stock or asset. This translates into a greater likelihood that the knock-in level will be breached during the term of the reverse convertible and that investors will receive stock (or the current cash value of the asset) at maturity worth considerably less than the full return of principal in cash. As a general rule, the higher the offered yield, the greater the risk of losing all or a portion of the principal invested.
• Expectation of flat markets. Investors who are betting that a stock price will be relatively flat may expect to do better with a reverse convertible than buying the stock itself. But remember, the coupon rates for reverse convertibles linked to relatively stable stocks may not be as high as for those linked to volatile stocks.
• Convenience for some investors. Some investors may have a specific strategy in mind that a reverse convertible can replicate. For example, an investor may believe that a stock will only trade within a certain range. Instead of buying options or futures separately that together would allow the investor to profit from that bet, the investor can buy a reverse convertible.

What’s the Downside?

• Exposure to asset-related risks. When you purchase a reverse convertible, you get all the risks that debt instruments ordinarily entail, plus the risks of the underlying asset. That is why it is so critical that you fully comprehend what is behind the higher coupons these products offer—and that you fully understand the product you are buying. Remember that purchasing a reverse convertible means you are either bullish on the underlying asset itself or you are betting that the asset’s volatility will be low for the term of the note.
• Embedded options. When investing in a reverse convertible, you effectively buy a note from the issuer and sell a put option to the issuer simultaneously. If you don’t have the risk tolerance for selling put options generally, you should question whether you want to invest in a security that contains an embedded one. If you are considering reverse convertibles, be sure you fully understand the complexities of the product and have the financial means to bear the risks.
• Fees. Issuers charge an up-front embedded fee to investors—typically ranging from less than 1 percent to 8 percent or more—for assembling and packaging a reverse convertible’s individual components. Prospectuses may call this fee “built-in costs” or “costs of hedging,” although the exact amount is not typically disclosed to the investor. Industry experts say that it is all but impossible for individual investors to determine the size of this embedded fee (and therefore whether the reverse convertible represents a good deal), because that would require dissecting the reverse convertible’s parts and determining what it would cost for the investor to obtain and assemble them.

Investor Tip—Be Sure to Adjust for Annualized Yields

FINRA reminds us that while yields on reverse convertibles are often described on an annualized basis, fees are often expressed only for the term of the note. It is important that you consider how these numbers are described—and, if necessary, do a little math so you can make an apples-to-apples comparison of yields and fees. For example, a sales brochure for a 3-month instrument might boast a yield of 10 percent per year and a fee of 1.5 percent. This is not as attractive as it may sound, because a 1.5 percent fee on a 3-month product amounts to a 6 percent fee on an annualized basis. As a result, your actual annualized coupon would be 4 percent—or 1 percent over the term of the investment. You get the same result if you compare the yield for the term (here, 3 months) with the fee for the term: a 10 percent per year coupon provides a return of roughly 2.5 percent over the 3-month term, and 2.5 percent minus 1.5 percent is 1 percent

• Potential liquidity risk. As is the case with virtually all structured products, secondary trading for reverse convertibles will generally be limited—which means reverse convertibles can be highly illiquid. Even if the issuer of a reverse convertible states that it intends to maintain a secondary market, it is not required to do so. This means that you could have trouble selling reverse convertibles in a pinch and/or could lose money if you sell the reverse convertible prior to maturity. Finally, transaction costs in the secondary market for these products could be high.
• Credit quality. A reverse convertible is an unsecured senior debt obligation of the issuer, meaning that the issuer is obligated to make the interest payments and final payments as promised. These promises, including any principal protection, are only as good as the financial health of the issuer that gives them and that issuer’s ability to meet its obligations when they come due. While it is not a common occurrence that an issuer of a reverse convertible is unable to meet its obligations, it can happen.

Credit Ratings—They May Not Mean What You Think They Mean

Credit ratings are a way of assessing default and credit risk—in other words, the creditworthiness of the issuer. While the note component of a reverse convertible carries the issuer’s credit rating, that rating does not reflect the risk that the price of the unrelated underlying asset will fall below the knock-in level, resulting in a loss of principal. A reverse convertible packaged by a highly rated issuer could be linked to a poorly rated company—or to a highly rated company whose stock performs poorly.

• Tax considerations. The tax treatment of reverse convertibles is complicated and uncertain. Investors should consult with their tax advisors and read the tax risk disclosures in their prospectuses and other offering documents. Although these documents typically provide instructions on how investors should treat reverse convertibles on their tax returns, there is no guarantee that the IRS or a court would agree with that tax treatment. Little guidance in the way of court decisions or published IRS rulings has been issued on this topic. When considering the tax consequences of any investment, you may want to consult with a tax advisor.
• Call risk. Some reverse convertibles have “call provisions” that allow the issuer, at its sole discretion, to redeem the investment before it matures. If this is the case, you would not receive any subsequent coupon payments that you were promised for the term of the reverse convertible, and you would immediately receive your principal in either cash or stock. Also, if a reverse convertible is called, it might be difficult or impossible to find an equivalent investment paying rates as high as the original rate (which is known as reinvestment risk). You should carefully read the prospectus to learn whether there is a call provision and what its specific terms are.
• Loss of principal.While some other structured products may offer principal protection, reverse convertibles do not. Depending on whether the price of the underlying stock or asset breaches the knock-in level, you could lose some—or even all—of your principal. You may be told that, in a down market, you at least “walk away with something.” But don’t forget that the stock you receive in the case of a breach could, for example, be shares in a company that is about to declare bankruptcy—or that you don’t want to own or doesn’t make sense for your circumstances.
• Conflicts of interest. An issuer may conduct activities that could represent conflicts of interest with respect to investors of its reverse convertibles. For example, the issuer might engage in regular business activities with the company whose stock is the underlying asset, such as investment banking, asset management or other advisory services and writing research reports about the company. An affiliate of the issuer, for example, might publish research reports that are unfavorable to the stock and could hurt the performance of a reverse convertible that is linked to that stock.

FINRA Tells Us How to Protect ourselves

• Be wary of any advertisements or sales literature suggesting that reverse convertibles are safe and suitable for investors seeking high yields. These sales pitches may play up the high yield on the note and play down the risk of the derivative component.
• If you are considering a reverse convertible, you face at least two risks—that the stock or other asset will go down in value, and that the issuer will be unable to repay its obligation on the note. Before taking on these risks, be sure to ask your broker plenty of questions, such as:
  • Can you review the prospectus, prospectus supplement or offering circular for the product with me? (The prospectus will contain a more extensive and balanced discussion of the risks involved. You should always carefully review the prospectus prior to making any investment decision.)
  • Given my investment objectives, is this product suitable for my account?
  • Do I get interest or other cash payments, and if so, how much and how often? What are the risks that I might not receive them?
  • What are the risks of the underlying asset? How volatile has this asset been recently? Be aware that while past performance can never guarantee future results, looking at historical price information (to the extent it is available) can help you assess the volatility of the underlying asset.
  • What is the likelihood that the reverse convertible breaches the knock-in-level, such that I might receive the underlying asset (or cash equivalent) instead of the return of my principal at maturity? If I end up owning the asset, how does that asset fit in with my investment objectives?
  • Is there an active market in this security if I need to sell it before its maturity? If so, what risk of loss might there be?
  • Can this product be called? If so, what will I receive?
  • Are there any other risks related to this product?
  • What are all the fees and expenses associated with this product?
  • How is the investment treated for tax purposes, and what are the effects on my taxes of any principal and interest payments?
• Always remember:
  • Higher yields go hand-in-glove with greater risk. Reverse convertibles are complex, risky products that do not offer principal protection. They are not plain vanilla bond investments, and they are not right for every investor.
  • Consider whether you would independently invest in the underlying asset. Remember that you are effectively giving the issuer a put, allowing the issuer to return your principal in the form of the depreciated asset if the asset’s value goes down. If you are not comfortable with the concept of writing a put option—and if you would not independently want to purchase the underlying asset—then think twice about investing in a reverse convertible.
  • Read the prospectus, offering circular and sales literature very carefully. Reverse convertibles are complex financial instruments that vary from product to product.
  • Make sure you are comparing apples with apples when you are sizing up the fees and stated yields. If yields are described on an annualized basis, be sure to do the math to determine the actual amount of the fees on the same basis. When annualized, yields tend to sound higher.
  • Typically the stated yield that is advertised is the maximum return that you could achieve on the product in the best circumstances—not a guaranteed return or even a likely return. In particular, you might not achieve the stated yield if you end up receiving stock instead of cash. Be sure you understand what the advertised yields or returns really mean.
  • For the typical retail investor, it would be unwise to put a significant portion of life savings into riskier structured products such as reverse convertibles. These types of products are not for everyone. Make sure you stick with the bedrock principle of diversification.
  • If you do not fully understand the product, reconsider your decision to invest in it.

 This extremely valuable information comes to us from the FINRA website.

Have you or a family member become a victim of the sale of risky Reverse Convertible Notes or RCNs by your broker or brokerage?  If so call a Securities Arbitration Lawyer for a free consultation on how to potentially recover your losses.  To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com.

Soreide Law Group, PLLC., representing investors nationwide before FINRA  the Financial Industry Regulatory Authority.

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Soreide Law Group, PLLC, is currently investigating the sale of TiVo reverse convertible notes (RCN).  The Wall Street Journal published an article in March, 2011, titled Complex Bond Faces Regulators’ Scrutiny; ‘Reverse Convertible Notes’ Can Tumble Along with Stock.   In the Wall Street Journal article it states that, “Securities regulators have broadened their probes into whether Wall Street sold a complex type of bond without fully disclosing the drawbacks to individual investors.”  According to the Wall Street Journal, the SEC is investigating whether Wall Street firms that developed the bonds allegedly failed to properly disclose the risks and fees to investors before they bought the notes. The SEC is also examining the disclosure of potential conflicts of interest, such as a bank selling a note linked to the stock of a company it is advising.  The Wall Street Journal reported that the SEC is investigating reverse convertible notes issued last year by J.P. Morgan Chase & Co. and Barclays PLC linked to TiVo, Inc.

The article also states that the total return on the TiVo notes was less than $600 per $1,000 invested. TiVo shares dropped after the company lost a court ruling in May, 2010, in a patent dispute.  The prospectuses for the RCNs contained disclosures on risk factors, but didn’t refer to the pending TiVo court ruling.

Reverse convertible notes or RCNs pay a fixed interest rate and guarantee the investor’s initial investment after a specified period, unless the linked stock falls below a certain point. If that should happen, the notes often pay back just a fraction of the original investment. RCNs typically have high commision fees and are considered by some money managers to be highly risky and even toxic assets.

Did you or a family member invest in TiVo Reverse Convertible Notes, or were you sold other risky RCNs by your broker or brokerage?  If so, call Soreide Law Group, PLLC, for a free consultation on how to recover your losses.  To speak with a Securities Arbitration Attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com.

Soreide Law Group, PLLC., representing investors nationwide before FINRA  the Financial Industry Regulatory Authority.

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Reverse convertibles notes (RCNs), sometimes referred to as “reverse convertibles,” “reverse converts,” “knock-in notes,” or “revcons,” are short-term, unsecured bonds that are issued by banks and financial institutions. These notes are often linked to the performance of a well-known stock and may pay double-digit yields. Once the notes mature, investors should get their full principal investment back. However, if the value of the underlying stock falls to a certain point, sometimes referred to as the “knock-in” or “barrier” level, investors get shares of the devalued stock in lieu of their full principal investment.

The more the price goes down, the more money the issuer can make. They will “swap” your note at some point, for shares of stock, worth far less than the principal value of the note. That is why the interest rate you receive, at times as much as 18%, is the enticement to get you to buy the notes.  There may be some unscrupulous brokers who really want you to buy their reverse convertible notes because they allegedly believe the underlying stock will go down. The brokers should almost never consider individuals who wish to take below average, average or even above average risks with their investment dollars for RCNs. They should never be considered appropriate for retirees or other income oriented investors. Don’t let the high yields entice you.

It has been reported that some brokerage firms may have been allegedly charging fees on reverse convertible notes that equal or exceed the securities’ highest possible yield.  There are also many undisclosed costs, making it very difficult for the typical individual retail investor to determine whether the reverse convertible represents a good investment. The Financial Industry Regulatory Authority or FINRA, has recently made sales of reverse convertibles one of its priorities for the examination and enforcement divisions.

Have you or a family member been a victim of the sale of risky Reverse Convertible Notes or RCNs by your broker or brokerage?  If so call a Securities Arbitration Lawyer for a free consultation on how to recover your losses.  To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC., representing investors nationwide before FINRA  the Financial Industry Regulatory Authority.

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Yesterday, in an article from Bloomberg News, we learn that Banco Santander SA, Spain’s largest bank, will pay $2 million to resolve U.S. regulatory claims that its Puerto Rico-based brokerage improperly sold risky structured financial products to retail customers including the elderly.

“Santander Securities failed its customers through significant deficiencies in its systems and procedures, which allowed unsuitable recommendations of concentrated positions in risky reverse convertibles,” Brad Bennett, Finra’s chief of enforcement, said in a statement. Santander resolved the claims without admitting or denying the allegations, Finra said.

It was reported that Santander Securities, which has reimbursed customers for more than $7 million in losses on so-called reverse convertible notes, failed to properly train brokers as sales grew in 2007 and 2008, the Financial Industry Regulatory Authority said today. The Washington-based regulator said last month that it was conducting a sweep to survey advertising for the securities.

These reverse convertibles, generally marketed to individuals, are short-term bonds that convert into stock if a company’s share price plummets. They offer high interest rates, with notes paying 13 percent on average last year, according to data compiled by Bloomberg. Banks sold $6.76 billion of the securities to U.S. investors last year, the data show.

Santander recommended in November, 2007, that a retired couple in their 80s, with a moderate risk tolerance and long- term growth objective, invest more than 85 percent of their account and more than half of their net worth in a single reverse convertible position, Finra said. The couple, who has since been reimbursed, lost $88,000 of a $100,000 investment on the deal, the regulator said.

Also, some brokers recommended that customers use funds borrowed from the firm’s banking affiliate to purchase the securities, claiming it would enable them to profit on the interest-rate spread between the instrument and the loan, Finra said. Those recommendations substantially increased the clients’ risk, and some people who lost money then owed additional funds to the bank when the notes lost value, the regulator said.

Ferris, Baker Watts LLC, which was acquired by Royal Bank of Canada in 2008, was ordered to pay $690,000 to resolve Finra’s claims that it failed to supervise reverse-convertible sales for these products. H&R Block Financial Advisors Inc., acquired by Ameriprise Financial Inc. in 2008, was fined $200,000 for a lack of supervisory systems. Neither brokerage admitted wrongdoing.

If you feel you have been an alleged victim of  your brokerage or broker selling you Banco Santander reverse convertible notes, call a Securities Arbitration Lawyer for a free consultation on how to recover your losses.  To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC., representing investors nationwide before FINRA  the Financial Industry Regulatory Authority.

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Reverse convertible notes offer a high coupon in return for the risk of getting shares valued at under the initial principal. Richard Ketchum, FINRA chief executive and chairman, has noted that it is not recommended for a client to place a significant chunk of one’s life savings into these kind of high risk, complex investments. FINRA has issued Notice to Members 10-09 cautioning the entire brokerage community about their sales practice obligations to the investing public when it comes to RCNs and other risky “Complex Investment Vehicles.”  

Many financial advisors sold structured investments that were pitched as 100% safe and secure.  In reality, these investments were of a high risk and the true risks were not made clear to investors.  Many of the structured products targeted at retail investors were reverse convertibles based upon “blue-chip” and “household-name” stocks that comprise the S&P 500 or the NASDAQ-100 indexes.   Brokers at H&R Block, Ameriprise and Morgan Stanley, Ferris, Baker Watts (acquired previously by RBC Wealth Management) and other firms were heavy sellers of these investments.  FINRA Enforcement has already taken regulatory actions against some of the brokerage firms for selling these notes to unsophisticated, elderly, retired or otherwise conservative investors.    The advantages of the investments were allegedly principal protection, superior risk-adjusted returns and access to hard-to-reach investment sectors.  Unfortunately, these representations were often false.  In reality, these investments had extraordinarily high risks and the true risks were not fully disclosed to investors in violation of the state securities acts.  These investments were unsuitable for many of the clients who purchased them.  Large sums of client assets and/or retirement portfolios were put into these investments.  We feel these were grossly unsuitable and inappropriate investments for many of the people who were sold them and more importantly, the true risks were not made clear.  Some of the sellers of RCNs were large banks and firms like RBS, Citigroup Inc., Barclays PLC and ABN Amro Holding NV. Citigroup brought out new versions linked to name a few, Johnson and Johnson, Apple Inc. and Celgene Corp. paying around 11% over one year. There are also reverse convertibles with stocks like Intel, Pfizer, Hess Corp., Yahoo Inc., Mexico’s Cemex SAB and SanDisk Corp. 

Another major seller of the reverse convertibles was Morgan Stanley Smith Barney and the Revcon notes. Morgan Stanley issued the Morgan Stanley Reverse Convertible Bond on AT&T, Apple (AAPL), Deere & Company (DE), Foster Wheeler (FWLT), Amazon (AMZN), Texas Instruments (TI), AMEX Gold Bugs, Citigroup (C), Consol Energy (CNX), Lehman Brothers (LEH), Range Resources Corporation (RRC), Freeport-McMoRan Copper & Gold, Inc.(“FCX”), Norfolk Southern Corp., Western Union Co. (“WU”), Whole Foods Market Inc. (“WFMI”), Toll Brothers, Western Union (WU), Spiders (SPDR), Ebay, Sunoco (Sun), The Goldman Sachs Group (GS), Valero Energy Group (VLO), Baker Hughes Incorporated (“BHI”),Monsanto Company (“MON”), Southern Copper Corporation (“PCU”), Amylin Pharmaceuticals, Inc.(“AMLN”), National Semiconductor (NSM), Baker Hughes Incorporated (“BHI”), Southern Copper Corporation (“PCU”), Arch Coal, Inc. (“ACI”), Joy Global Inc. (“JOYG”)

Most major brokerage firms were selling structured products and reverse convertibles. H&R Block, UBS, Morgan Stanley Ameriprise, Merrill Lynch and others actively sold them to retail clients.  We feel this will cause arbitration claims and lawsuits to skyrocket in the next 6-12 months.     

 The Financial Industry Regulatory Authority (FINRA) has fined H&R Block Financial Advisors (now Ameriprise Advisor Services) $200,000 for failing to put in place the proper system to supervise its reverse convertible notes (RCN) sales to retail clients as one example. FINRA also suspended H & R broker Andrew MacGill for 15 days while ordering him to pay a $10,000 fine and $2,023 in disgorgement for making unsuitable RNC sales to a retired couple. MacGill recommended that they invest close to 40% of their total liquid net worth in RCNs. Meantime, H & R Block has been ordered to pay the couple $75,000 in restitution for their financial losses. Without denying or admitting to the charges, the brokerage firm and MacGill consented to the finding’s entry. According to FINRA, between January 2004 and December 2007, H&R Block sold RCNs without a system of procedures in place to properly monitor whether possible over-concentrations in RCNs were taking place in customer accounts. FINRA says that the brokerage firm relied on an automated surveillance system to monitor client accounts and review securities transactions for unsuitability but that the system was not set up to monitor RCN placement in customer accounts or RCN transactions. This caused H & R Block to miss signs of when there were potentially unsuitable levels of RCN in client accounts. FINRA says that the firm failed to provide guidance to its supervisors regarding the assessment of suitability standards related to their agents’ recommendation of RCNs to the firm’s clients. This is FINRA’s first enforcement action over RCN sales.

Have been a victim of the sale of risky RCNs by your broker or brokerage?  If so call a Securities Arbitration Lawyer for a free consultation on how to recover your losses.  To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC., representing investors nationwide before FINRA  the Financial Industry Regulatory Authority.

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Firm to Pay Restitution of $189,723 for Unsuitable Sales

WASHINGTON — On October 20, 2010, The Financial Industry Regulatory Authority (FINRA) announced that it fined the former Ferris, Baker Watts LLC, acquired by RBC Wealth Management, $500,000 for inadequate supervision of sales of reverse convertible notes to retail customers as well as unsuitable sales of reverse convertibles to 57 accounts held by elderly customers who were at least 85 years old and customers with a modest net worth. 

Also, the firm was ordered to pay nearly $190,000 in restitution to the 57 account holders for net losses incurred as a result of purchasing reverse convertibles.

 ”Reverse convertible notes are complex investments that often entail significant risk of loss and also involve terms, features and risks that can be difficult for retail investors to evaluate,” said James Shorris, FINRA Executive Vice President and Acting Chief of Enforcement. “Ferris, Baker’s inadequate written procedures resulted in recommendations of sales to customers for whom the purchase of these securities was not suitable, including elderly customers and investors who had very modest assets.”

FINRA explains that reverse convertibles are notes with a coupon interest rate set for a fixed duration – three, six or twelve months –  that are tied to the performance of a particular stock. If the price of the underlying stock drops below a certain level during the duration of the reverse convertible, the customer receives a predetermined number of shares of the stock at maturity of the note.

 If the underlying security maintains its price level, at maturity, the customer receives return of the dollar amount invested and a final coupon payment. In most of the instances where customers received the underlying stock at maturity, the customer ended up with an investment loss. Reverse convertibles not only come with the risks associated with fixed income products, such as issuer default and inflation, but with the additional risk that the value of the underlying asset can significantly depreciate.

 Also, FINRA found that during the period January 2006 to July 2008, Ferris, Baker engaged in sales of reverse convertibles to approximately 2,000 retail accounts without providing sufficient guidance to its brokers and supervising managers on how to assess suitability in connection with their brokers’ recommendations of reverse convertibles.

 The firm did not have a system to effectively monitor customer accounts for potential over-concentrations in reverse convertibles. The firm also made recommendations without a reasonable basis to believe that the investment was suitable for elderly customers and those with modest net worth. The firm also failed to detect and respond to indications of potential over-concentration in reverse convertibles.

 One example, the firm sold an 86-year-old retired social worker five reverse convertibles in the amount of $10,000 each. At various times, these represented between 15 percent and 25 percent of her investment portfolio. In another instance, the firm sold a 20-year-old clerk making less than $25,000 annually five reverse convertibles in his Roth IRA and regular accounts. These securities represented 51 percent of the IRA account and 44 percent of the regular account’s value.

 The firm neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

This information was obtained from FINRA’s website.

If you feel you are a victim of these alleged fraudulent schemes of Ferris, Baker, Watts, LLC, or RBC Wealth Management, call a Securities Arbitration Lawyer for a free consultation on how to recover your losses.  To speak with an attorney, call 888-760-6552, or visit www.stockmarketlawsuit.com. Soreide Law Group, PLLC., representing investors nationwide before FINRA  the Financial Industry Regulatory Authority.

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