Investor Alert: Are Reverse Convertible “Time Bombs” in Your Portfolio?


A recent article published by AARP aptly describes reverse convertible investments as a “time bomb” involving extreme risks for senior citizens and other investors. John F. Wasik’s article entitled “The Time Bomb in Your Nest Egg,” is a “must read” focusing on reverse convertibles and other structured product investments, which are being marketed to conservative fixed income investors seeking better yields. Sales are rising, and so are losses – $164 billion in the last two years, according to the article. As Mr. Wasik states at the outset, “They’re sold as supersafe investments’ [a]nd they’re not to be trusted.”

Reverse convertibles are featured in the article. Brokerage firms have given them some mind-boggling names, and none of them say what they really are. Examples include: UBS Yield Optimization Notes with Contingent Protection linked to the common stock of UNAMEIT due on ______, and HSBC Autocallable Optimization Securities-CP Linked to UNAMEIT due on ______.

So what are they? A reverse convertible is a coupon note stuck onto a combination of long and short put options, which is linked to a stock (or other reference asset). It provides limited exposure to any gains in the stock and unlimited exposure to the any loss if the stock price dips below a predetermined level. In fact, if the stock falls below the set price, at maturity, unlike a true note, investors receive the depressed stock back instead of their principal!

“[I]n effect, the investor in the reverse convertible is selling the issuer a put option on the reference asset in exchange for an above-market coupon during the life of the note. Generally speaking, the higher the coupon rate, the higher the expected volatility of the reference asset, which in turn means a greater likelihood that the knock-in price will be breached and the investor will receive less than a full return of principal at maturity.” (Source: Notice to Members 10-09, published by the Financial Industry Regulatory Authority (FINRA), the securities industry’s “self-regulatory” organization).

This is why FINRA says that reverse convertibles are unsuitable for investors who are not properly approved for options trading (not simply selling covered calls, but full-blown option trading) ? which hardly describes the primary target market for these products, namely, retired investors on a fixed income seeking a better but still reasonably safe yield.

The article is instructive in describing: “How brokers sucker you.” In a nutshell, we trust our banks. We complain to someone in our bank about low CD rates and get referred to an “expert” right there at the bank, who offers a high-yield, short-term “note” as the perfect solution with false assurances that the product is safe.

In addition, because no ordinary investor knows how to compute the intrinsic value of a reverse convertible, brokerage firms sell them to investors at extraordinary mark ups and receive considerably more in commission than they would by selling a regular coupon note.

“The big wave is yet to come?most people don’t know what they have yet,” Joseph P. Borg, director of the Alabama Securities Commission, who is investigating structured products sales abuses, was quoted as saying.

Investors who have purchased high-interest, short-term “notes” that are linked to a reference asset should carefully review their brokerage statement covering the month in which the “note” is scheduled to mature, to see if they now own the reference asset. If they do, they may have lost money and may have a compelling claim to recover their losses.

“We continue to receive inquiries from investors who acquired these reverse convertibles as a result of misrepresentations of them as a relatively safe note or bond investment,” said J. Boyd Page, a senior partner at Page Perry in Atlanta. “Our legal team continues to investigate and pursue arbitrations on behalf of investors who purchased these terrible products,” he added. The brokers who sold the structured products are not targets of investor claims.??Page Perry is an Atlanta-based law firm with over 125 years collective experience representing institutional and individual investors in reverse convertible and structured product cases 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.