Regulators Begin Investigations of Reverse Convertibles and Other Structured Products


The Financial Industry Regulatory Authority (“FINRA”) announced that it is conducting “targeted exams” known as “sweeps” of certain member brokerage firms in order to gather information about their advertising for a group of structured products called reverse convertibles, according to Zeke Faux’s Bloomberg article, “Finra Asks Brokers for Reverse-Convertible Marketing Materials.”

According to the article, FINRA sent a letter to certain member firms seeking copies of all advertisements, sales literature, and institutional sales material for reverse convertibles used between September and February. The letter also seeks to discover information about firms’ communications with customers regarding reverse convertibles, as well as supervisory approvals of such communications, offering documents, and pertinent written supervisory procedures. Brokers have until April 1 to comply, according to the article.

Last year, FINRA sent a notice to members (Notice to Members 10-09) reminding them of their obligation to ensure that marketing materials for the high-yield securities are “fair and balanced,” according to the article. That notice was apparently sent because the firms had ignored a previous notice issued in 2005 (Notice to Members 05-57).

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 their 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.

Reverse convertibles 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 the article.

Last year, FINRA fined two brokerage firms for failing to properly supervise sales of reverse convertible: Ferris, Baker Watts LLC, which was acquired by Royal Bank of Canada in 2008, was ordered to pay $690,000 in October, and H&R Block Financial Advisors Inc., acquired by Ameriprise Financial Inc. in 2008, was fined $200,000 in February.

Page Perry has over 125 years collective experience representing institutional and individual investors in reverse convertibles and structured product claims 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 30 occasions.