Professor Seth E. Lipner has a regular column in Forbes called “Intelligent Investing” that is always a worthwhile and interesting read. His column titled “Don’t Count On The Government To Save You From The Sharks” is a good example. The subject is a group of structured products known as reverse convertibles. Reverse convertibles are complex structured products with embedded options linked to a “reference asset” like a stock or index. If the price of the reference asset falls below a predetermined level, at maturity, a “put” option kicks in and the investor receives the depressed asset instead of his principal. Investors usually don’t know when that happens because it has not been explained to them. That would be bad for sales.
Mr. Lipner points out that the Financial Industry Regulatory Authority (FINRA), which is supposed to police brokerage firms, has “alerted” investors about reverse convertibles and gently suggested to firms (twice now) that they “should consider” only selling them to sophisticated clients who are properly approved for options trading. FINRA issued such a mealy-mouthed Notice to Members back in 2005, and the firms ignored it. So, instead of doing something about it, FINRA issued another weakly worded notice in 2010. It reminds me of a incident I witnessed long ago, followed by the victim’s parents saying: “Now Chuck, we’ve told you before ? you shouldn’t hit your little brother in the face with a brick.”
Mr. Lipner finds it odd that FINRA is issuing investor alerts about abusively sold investments instead of taking a harder line at brokerage firms that sell them. The reality is most investors don’t visit FINRA’s web site to read its alerts. Most investors trust their brokers’ advice, just like they trust their doctor’s advice. They don’t have the education or time to get in a position to question it. And they should not have to. FINRA has been on record since at least 1940 that brokers are fiduciaries ? meaning they stand in a position of trust and confidence with their clients, and must always put their clients’ interests first.
If FINRA is going to issue investor alerts instead of cracking down on the firms that sell reverse convertibles, they should be clearer, and free of graphs and equations. Here is what the alerts would say if Mr. Lipner wrote them: “Folks who bought these things seeking income got a rude awakening in 2008 when stock prices plummeted. Suddenly they found that instead of owning an income-producing investment, they owned a stock or basket of stocks at a depressed price. Not exactly what an income-seeking investor was looking for. And if, for example, the reference stock was Fannie Mae, the investor was wiped out in one day. You should stay away from this stuff.”
Page Perry has over 125 years collective experience representing institutional and individual investors in structured product and reverse convertible matters all over the country. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 40 occasions.