One of the worst and most unsuitable investments we have ever come across is the reverse convertible. Like the Devil himself, they have so many names, and are not easy to recognize on brokerage statements. UBS calls them “Yield Optimization Securities.” They are also known as “revertibles,” “revertible notes,” “reverse exchangeable securities,” and so on. And they are devilishly popular ? brokerage firms sell a lot of them to elderly, retired, and on-the-brink of retired investors who need a way to generate sufficient income to live on without undue risk to their principal. The problem is that these investments are essentially put option contracts that do jeopardize principal, and brokers do not explain that critical fact.
Reverse convertibles are usually sold as safe income-producing investments. Unbeknownst to investors, however, these supposed income investments are complex option combinations that put principal at risk. These investments are, in reality, a series of put options, and the so-called interest payments on the notes are, in large part, put option premiums. These investments are so opaque and complex that no ordinary investment advisor can evaluate and explain their risk/reward characteristics.
According to Notice to Members 10-09, published by the Financial Industry Regulatory Authority (FINRA), which is supposed to regulate its member-broker’s sales practices, a reverse convertible is a structured product consisting of a high-yield short-term note linked to the performance of a reference asset, usually a stock or a basket of stocks. If the price of the reference asset stays above a predetermined “knock-in” level, the investor earns interest and receives his full principal back at maturity. But if the price of the reference asset dips below the “knock-in” level, the issuer can “put” the depressed (and possibly worthless) reference asset back to the investor in lieu of returning his principal in cash. “In 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.” FINRA Notice to Members 10-09.
None of this is explained to investors. According to FINRA, reverse convertibles “often involve terms, features and risk that can be difficult for individual investors and investment professionals alike to evaluate.” FINRA Notice to Members 10-09.
FINRA further states in its NTM that, given the put option component of reverse convertibles, firms that do not limit reverse convertibles to accounts approved for options trading “should be prepared to demonstrate the basis for allowing investors with accounts not approved for options trading to purchase reverse convertibles.” FINRA Notice to Members 10-09. In other words, if your account is not appropriately approved for put option selling, your broker should not be selling you a reverse convertible.
Take for example a product sold by UBS called “UBS YLD OPTZ NOTE-CP JP MORGAN CHASE.” The reference asset is JP Morgan Chase common stock. If the price of that stock breaches the “knock-in” level, you will see buried in your UBS statement for the month in which the “note” matured a transaction described as an “exchange” in which a quantity of stock of JP Morgan Chase is exchanged for a quantity of UBS YLD OPTZ NOTE-CP JP MORGAN CHASE. That means that instead of repaying your full principal a maturity, UBS has instead delivered the JP Morgan Chase stock to you.
If you have been sold an investment like that, you probably have a compelling claim to recover your losses.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions, and have aided clients who have been the victims of financial adviser abuse and scams. Page Perry’s attorneys are actively involved in counseling investors regarding their investment problems, including those involving reverse convertibles. For further information, please contact us.