The Spanish bank, Banco Santander SA, agreed to pay $2 million to resolve charges that its Puerto Rico-based brokerage improperly sold a group of structured products known as reverse convertibles to retail customers, including the elderly. (“Sale of reverse convertibles dings another B-D,” InvestmentNews, April 12, 2011).
Reverse convertibles are sold to income-oriented investors (often retirees on a fixed income) as short-term bonds or notes that provide an enhanced return. In reality, they are a complex combination of (a) a loan to the issuer and (b) a combination of long and short put options on a reference or “linked” security. The so-called “yield” on these so-called “bonds” or “notes” is really a premium on the put option and interest on the investor’s loan to the issuer.
It is impossible for an ordinary investor to evaluate these products. Unbeknownst to most investors, reverse convertibles put investors’ principal at risk. That is because, if the price of the reference security falls more than a predetermined amount, at maturity, the selling firm can return the possible depressed reference security instead of the investors’ principal.
But many retirees are facing a terrible dilemma. They have a limited pot of money to live on, and interest rates on CDs and money market accounts are less than 1%. They need to generate more income to live, but are properly afraid to put that money at risk, since it cannot be replaced.
Reverse convertibles are offered as a solution to that problem. They paid 13 percent on average last year, and FINRA member firms sold U.S. investors $6.76 billion of reverse convertibles last year, according to Bloomberg.
The Financial Industry Regulatory Authority (FINRA) has issued notices to brokers “suggesting” that reverse convertibles should not be sold to anyone but the most speculative and financially sophisticated clients who are approved for options trading, but the firms ignored those suggestions.
The results have been disastrous. Many aggrieved investors have filed arbitration claims to recover their losses in these terrible products that never should been sold to retail investors. That got FINRA’s attention and finally spurred it to take some action against some selling firms.
“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, was quoted as saying.
FINRA fined two brokerages last year over the products: Ferris, Baker Watts LLC, which was acquired by Royal Bank of Canada in 2008 and H&R Block Financial Advisors Inc., acquired by Ameriprise Financial Inc. in 2008.
The Securities and Exchange Commission is reportedly investigating whether Wall Street firms that created and sold reverse convertibles failed to disclose the risks to investors before they bought them. FINRA has announced it was conducting “sweeps” of certain firms to gather information about their advertising for these structured products. But so far, FINRA has not announced any action against the big Wall Street sellers of reverse convertibles.
Atlanta investor attorney J. Boyd Page of Page Perry noted that “we’ve been hearing that foreign investors were major victims of reverse convertibles abuses. We think that the Santander situation is just the tip of the iceberg. Many firms targeted foreign investors for sale of this garbage. I hope that they recognize their rights before it is too late.”
Page Perry has over 125 years collective experience representing institutional and individual investors in reverse convertibles litigation and arbitration 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 45 occasions.