Reverse Convertible Securities More Likely to Become Toxic as Market Swoons


The current free fall in the stock market is likely to activated the ticking time bombs that are hidden away in some investors’ portfolios. These time bombs are embedded in a type of structured product called Reverse Convertible Notes or Reverse Exchangeable Notes. The problem has to do with the way these products are structured.

A reverse convertible is a coupon note stuck onto a combination of long and short put options, which is linked to a reference asset, usually a single stock. The note seems attractive to income-oriented investors because provides above-market coupon payments and limited exposure to any gains in the stock. But the downside is that the product has an embedded “put option” that is rarely if ever explained and not understood by most investors. This put option puts the risk of unlimited loss back on the investor. The put option is triggered if the price of the reference asset falls below a predetermined level on “the final valuation date” or even at any time during the life of the note, depending on the terms of the product. If the put option is triggered, at maturity, unlike a true note, investors receive the depressed stock back instead of their principal!

The Financial Industry Regulatory Authority (FINRA) has warned its member firms 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.

Reverse convertibles are not easy to identify. Brokerage firms have given them some mind-boggling names, and none identify them on customers’ statements as what they really are. Examples include: UBS Yield Optimization Notes with Contingent Protection linked to the common stock of “XYZ, Inc.” due on ______, and HSBC Autocallable Optimization Securities-CP Linked to “XYZ, Inc.” due on ______.

The sellers of reverse convertibles have included Lehman Brothers, UBS, JP Morgan, Barclays, Morgan Stanley, Wachovia Securities, Royal Bank of Canada, and ABN AMRO.

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 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 45 occasions. Page Perry’s attorneys have extensive experience in representing investors in cases involving principal protected notes, reverse convertibles and other structured products. For further information, please contact us.