SEC Report Reveals Serious Abuses in the Sale of Structured Securities


On July 27, 2011, the Staff of the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations published a report entitled “Staff Summary Report on Issues Identified in Examinations of Certain Structured Securities Products Sold to Retail Investors.” This report was based on the Staff’s review of eleven broker dealers that sell various structured securities: three large firms affiliated with bank holding companies that are issuers structured securities, on wholesale seller of structured securities issued by third parties, and seven smaller retail firms that also sell structured securities issued by third parties.

The SEC Staff made two major observations: (i) firms’ representatives engaged in sales practice abuses by making unsuitable recommendations to investors to buy structured securities, as well as to buy and sell them in a secondary market at “disadvantageous prices,” and (ii) representatives were untrained and not effectively supervised as firms’ supervisory and compliance procedures for structured securities were deficient or nonexistent.

The SEC Staff examined a broad variety of structured securities including notes that promised full or partial principal protection and reverse convertibles. The report states: “Reverse Convertibles linked to a single entity” are perhaps the riskiest structured securities available to retail investors. The reasons for that have to do with the fact that these notes have a put option embedded in them that gives the issuer the right to return the linked security at maturity instead of the investors’ cash principal if the linked security declined below a set “trigger/knock-in” price at any time during the life of the note. ” These equity-linked Reverse Convertibles are equivalent to the investor writing/selling a put option on the underlying security,” according to the SEC Staff.

The Financial Industry Regulatory Authority (FINRA) has published notices addressed to its member firms recommending that reverse convertibles not be sold to investors whose accounts are not properly approved for options trading, which is a very risky form of speculation. For the most part, however, brokerage firms have ignored that and other warnings from FINRA about their sales practices with regard to structured securities.

More specifically, the SEC Staff found numerous instances of sales of reverse convertibles that were not compatible with the investors’ investment objective and financial profile. In addition, the SEC Staff found that firms solicited purchases of reverse convertibles without disclosing the real risks associated with them. SEC Staff interviewed some investors who purchased reverse convertibles and found that they did not understand them. It also appeared that some firms failed to conduct any sort of supervisory review of these recommendations.

Moreover, the SEC Staff found that structured securities were inaccurately listed on account statements as “Preferred Securities” or “Preferred Stocks.”

The SEC Staff said that they will continue, along with other regulators, to review this area for sales practice abuses. Let’s hope that the review will result in needed enforcement actions to curb abusive conduct.

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.