Articles Posted in Reverse Convertibles


The U.S. Securities and Exchange Commission (SEC) said that UBS Financial Services (UBS) has consented to pay over $15 million to resolve civil charges accusing it of not adequately training and educating sales team members regarding complex financial products that were sold to retail investors.  According to the SEC’s order, UBS did not put into place procedures and policies that were reasonably designed to train and educate registered representatives about making suitable recommendations regarding reverse convertible note sales.  The purported lack of education and training caused certain firm representatives to fail to adequately understand the nature of the reverse convertible notes they were selling. 
The SEC is accusing UBS of inadequate supervision from 2011 through 2014. The regulator said that because of these supervisory issues, the firm did not prevent the resulting violations of securities laws through the wrongful sale of reverse convertible notes. It was during this time that UBS Capital Markets’ Structured Solutions unit structured about 2,500 reverse convertible notes that were based on 425 underlying stocks.  As a result, claims the SEC, UBS registered representatives sold about $548 million in reverse convertible notes to over 8,700 unsophisticated retail investors. As is typical with such consent judgments and settlements, UBS is neither admitting nor denying the SEC’s findings.

Reverse Convertible Notes 
Reverse convertible notes are complex structured note products that are not suitable for most investors.  They are often high risk and very volatile. The notion of implied volatility drives the performances of reverse convertible notes. They are debt obligations of the issuer and linked to the performance of a securities basket or an unrelated security. They are not for everyone and they come with certain risks. 

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According to Financial Industry Regulatory Authority EVP Susan Axelrod, the SRO’s examiners are reporting an increase in how many brokers appear to be taking part in questionable actions outside their firms or improperly selling securities. Speaking at the Securities Industry and Financial Markets Association’s complex products forum, she pressed brokerage firms to make sure its compliance programs will sniff out such violations.

Axelrod also said that FINRA examiners are noticing issues with the firms’ complex product sales, including those involving reverse convertibles and non-traded real estate investment trusts. For example, several firms did not conduct reasonable due diligence before selling non-traded REITs or make sure they were suitable for the investors. As for the reverse convertibles, examiners reportedly discovered an overconcentration of products in certain investor portfolios primarily due to poor recommendations. Failure to detect such problems appeared to have played a factor in this happening. Other problems discovered included inadequate training regarding products, product misrepresentation via sales and advertising, and failure to notify investors well in advance that products’ per-share estimated values had been repriced at figures significantly lower than the offering price.

In other securities news, Securities and Exchange Commission Chairman Mary Schapiro wants Congress to grant the SEC the power to impose penalties that are more reflective of the losses sustained by investors. Right now, the agency can only pursue ill-gotten gains’ disgorgement and impose per-violation penalties. Schapiro said that the Stronger Enforcement of Civil Penalties Act of 2012, which was introduced by Senators Jack Reed and Charles Grassley, would give the Commission the authority it needs to make violators “think twice” about abusing investors’ funds while allowing the regulator to recover significantly more for victims. She expressed her views at the New England Securities Conference last month.

To settle Financial Industry Regulatory Authority securities fraud allegations against one of its brokers, Wells Fargo Advisers will pay a $2M fine, as well as repay an unspecified amount to elderly clients that were defrauded. Over 21 senior investors were reportedly targeted by Alfred Chi Chen, who sold them reverse convertible notes even though the majority of them were retired and/or had never invested in this type of complex instrument. A number of investors were in their 80’s and 90’s.

FINRA says that Chen made over $1M in commissions even as the investors sustained losses. He also is accused of not giving discounts on Unit Investment Trust (UIT) transactions even when clients were eligible. As part of its settlement, Wells Fargo will pay restitution to those that should have but did not get the discounts and those that were sold unsuitable investments.

FINRA Executive Vice President and Chief of Enforcement Brad Bennett said that Wells Fargo did not review the reverse convertible transactions to make sure that they were suitable and that investors were harmed as a result. The SRO also determined that Wells Fargo did not give certain clients that were eligible breakpoint and rollover and exchange discounts when they bought UITs because the financial firm’s procedures and systems were not sufficient to properly monitor unsuitable reverse convertibles and ensure that clients got the discounts for which they were eligible. (Discounts should be offered on UIT sales when purchases go beyond certain thresholds or involve termination or redemption proceeds from another UIT during the initial offering period.)

By agreeing to settle, Wells Fargo is not admitting to or denying FINRA’s allegations.

The SRO has filed a separate complaint against Chen, who allegedly exposed clients to risks that were not in line with their investment profiles. As of June 2008, 172 of the accounts he worked with held reverse convertibles. 148 accounts had concentrations over the 50% of their total holdings. 46 accounts had concentrations of over 90%.

Reverse Convertibles
These interest-bearing notes involve repayment of principal connected to an underlying asset’s performance. The specific terms of reverse convertibles may vary. An investor risks loss if the underlying asset’s value drops under a certain maturity level or during the reverse convertible’s term.

It is important for many elderly investors that their investments not expose them to too much risk. For an elderly senior to lose his/her life savings because a financial firm or broker behaved irresponsibly, committed securities fraud, or made an avoidable mistake is unacceptable.

Wells to pay $2M to settle claims broker sold unsuitable investments to seniors, Investment News, December 15, 2011
Wells Fargo Fined by Finra Selling Structured Notes to Aged, Bloomberg, December 15, 2011

More Blog Posts:

Broker-Dealers are Making Reverse Convertible Sales That are Harming Investors, Says SEC, Stockbroker Fraud Blog, July 28, 2011
RBC Wealth Management Unit Ferris Baker Watts to Pay Investors Restitution Over Reverse Convertible Notes Allegations, Says FINRA, Stockbroker Fraud Blog, October 23, 2010
Wells Fargo Settles for $148M Municipal Bond Bid-Rigging Charges Against Wachovia Bank, Institutional Investors Securities Blog, December 8, 2011 Continue Reading ›

According to the Securities and Exchange Commission, the sales practices that broker-dealers engage in when structured securities are hurting investors. The SEC released this recent finding in a report this week. Structured securities products are derivatives whose value is determined from baskets of indexes, other securities, options, debt issuances, commodities, and foreign securities.

The SEC reached its conclusion after conducting a sweep examination of 11 broker-dealers. The Commission says that the financial firms may have guided clients toward complex products even though they were unsuitable for these investors. In certain instances, they also appear to have:

• Charged too high of prices • Failed to adequately reveal all risks involved
• Traded at prices that were not to the benefit of retail investors • Committed possible supervisory deficiencies

At the heart of the SEC sweep examination were reverse convertible notes, which is a security that has an embedded put option. RCN are considered among the riskiest structured products. According to the SEC report, there were clients who purchased RCN’ even though these financial products not in line with their investor profiles or stated goals. Many of these RCN investors sustained significant financial losses.

The SEC report is recommending that broker-dealers:
• Implement procedures and controls to detect and stop structured securities-related abuses • Reveal material facts about the structured product notes when offering them to investors • Make sure that supervisors and registered representatives undergo specialized training before they sell structured securities
• Properly list structured securities products on client statements
It was just recently that the Financial Industry Regulatory Authority Inc. warned investors to exercise caution when evaluating whether to buy complex investment products.

Our securities fraud lawyers represent investors that have suffered financial losses because they were encouraged to purchase financial instruments that were inappropriate for them.

SEC blasts B-Ds over sales of reverse convertibles, Investment News, July 27, 2011
Staff Summary Report on Issues Identified in Examinations of Certain Structured Securities Products Sold to Retail Investors, SEC, July 27, 2011 (PDF)

More Blog Posts:

RBC Wealth Management Unit Ferris Baker Watts to Pay Investors Restitution Over Reverse Convertible Notes Allegations, Says FINRA, Stockbroker Fraud Blog, October 23, 2010
Increase of Structured Notes with Derivatives Sales Seduces Retirees, Reports Bloomberg, Stockbroker Fraud Blog, September 25, 2010
FINRA Fines H & R Block Financial Advisors (Now Ameriprise Advisor Services) over Sales of Reverse Convertible Notes (RCN), Stockbroker Fraud Blog, February 17, 2010 Continue Reading ›

The Financial Industry Regulatory Authority and the RBC Wealth Management-acquired Ferris, Baker Watts LLC have agreed to settle charges that the latter engaged in the unsuitable sales of reverse convertibles to elderly clients in the 85 and over group, well as in the inadequate supervision of such notes to retail customers. By agreeing to settle, the investment firm is not agreeing with or denying the allegations.

The alleged misconduct took place prior to RBC acquiring Ferris, Baker Watts. As part of the settlement, the brokerage firm will pay close to $190,000 in restitution to 57 account holders for financial losses related to their purchase of reverse convertibles.

FINRA says that between January 2006 and July 2008, Ferris, Baker Watts allegedly sold reverse convertible notes to about 2,000 retail investors while failing to properly supervise and guide its supervising managers and brokers on how to determine whether their recommendations of the notes were suitable for clients. The investment firm is also accused of not having a system in place that could effectively monitor, detect, and handle possible reverse convertible over-concentrations.

In its release announcing the settlement, FINRA cites one example involving Ferris, Baker Watts selling five reverse convertibles in the amount of $10,000 each to an 86-year-old retired social worker. These notes represented between 15% to 25% of her investment portfolio at different times. FINRA says that for another client, the investment firm sold five notes to a 20-year-old who was making under $25,000 a year. This investment was 51% of the client’s retirement account.

Related Web Resources:
FINRA Orders Ferris, Baker Watts to Pay Nearly $700,000 for Inappropriate Sales of Reverse Convertible Notes, FINRA, October 20, 2010

Finra fines RBC Wealth unit over brokers’ sales of ‘unsuitable’ investments, Investment News, October 20, 2010 Continue Reading ›

According to Bloomberg, the sale of structured notes (also known as principal protected notes, or PPN) that come with derivatives to thousands of individual investors has driven up their sale by 58% to $31.9 billion through August. Unfortunately, investors are often lured into making such purchases without fully comprehending the risks, and this can result in significant losses. This year, the US Securities and Exchange Commission’s enforcement division began a group concentrated on investigating structured products.

Banks create structured notes products by bundling privately negotiated over-the-counter derivatives with bonds. Because the Commodity Futures Modernization Act excludes most trades between institutions from oversight, banks can sell OTC derivatives to individuals as long as they are put together with bonds into hybrid securities. Individual investors, even though they lack the background and knowledge to fully understand the risks involved, are targeted for these notes to increase banks’ profit margins. Also, because structured notes aren’t standardized, brokers are paid more to sell structured notes than they are for selling some of the other financial products.

Structured notes have grown in popularity since the Federal Reserve has maintained its target rate for overnight loans between banks at 0% to .25%. With US interest rates close to 0%, investors are buying up the bonds. Reverse convertible notes has paid 13% interest on average in 2010.

Granted, investors can obtain higher returns if their bets work out, and principal-protected notes and some of the other products are not as risky as stocks because sellers guarantee that investors won’t suffer losses if the market falls. However, because there are variables outside the scope of interest rate movements, investors can lose money. Institutional Risk Analytics Managing Director Christopher Whalen has said that structured notes will likely become the next investment bubble.

Retirees Duped by Derivatives With Structured Notes Sale Surge, Bloomberg, September 22, 2010
Structured Notes Becoming New “Investment Bubble” on Wall Street, says Institutional Risk Analytics Director,, August 12, 2010
Shepherd Smith Edwards & Kantas LTD LLP Investigates Claims for Purchasers of Structured Notes, GlobalNewswire, August 11, 2010 Continue Reading ›

The Financial Industry Regulatory Authority (FINRA) has fined H&R Block Financial Advisors (now Ameriprise Advisor Services) $200,000 for failing to put in place the proper system to supervise its reverse convertible notes (RCN) sales to retail clients. FINRA also suspended H & R broker Andrew MacGill for 15 days while ordering him to pay a $10,000 fine and $2,023 in disgorgement for making unsuitable RNC sales to a retired couple. MacGill recommended that they invest close to 40% of their total liquid net worth in RCNs. Meantime, H & R Block has been ordered to pay the couple $75,000 in restitution for their financial losses. Without denying or admitting to the charges, the brokerage firm and MacGill consented to the finding’s entry.

According to FINRA, between January 2004 and December 2007, H&R Block sold RCNs without a system of procedures in place to properly monitor whether possible over-concentrations in RCNs were taking place in customer accounts. FINRA says that the brokerage firm relied on an automated surveillance system to monitor client accounts and review securities transactions for unsuitability but that the system was not set up to monitor RCN placement in customer accounts or RCN transactions. This caused H & R Block to miss signs of when there were potentially unsuitable levels of RCN in client accounts. Furthermore, FINRA says that the firm failed to provide guidance to its supervisors regarding the assessment of suitability standards related to their agents’ recommendation of RCNs to the firm’s clients.

This is FINRA’s first enforcement action over RCN sales.

Brokers are once again getting behind structured products, hoping that investors will bite. While sales of structured products during 2008’s 4th quarter-at $5.8 billion-was down 75% from the year’s 1st quarter, sales are starting to go up. One reason for this is that certain structured products, such as return-enhanced notes and principal protected notes, are considered safer than reverse convertibles, which led to some of the worst losses for investor.

Ideally, structured products are supposed to provide sturdy profits, while limiting losses, and brokers like them because the commissions are high. However, representatives must still account for why these products haven’t delivered the way investors were told they would. Many investors that bought structured products from Lehman Brothers, such as the Lehman principal-protected notes, incurred some large losses. Some of these notes were bought through a UBS Financial Services office in Houston, Texas.

Until the bear market struck, structured products did incredibly well, and sales almost doubled to $105 billion in 2007 before dropping to $70 billion last year when structured products, collateralized debt loans, and credit default swaps played a huge role in the global financial collapse.

Reverse convertibles are considered the most high-risk structured product-short-term bonds with a large interest that can seriously hurt investors if the underlying stock drops dramatically. Investors can end up with shares with a value far below the principal. For example, 78-year-old Dominic Annino says he invested $300,000 in IndyMac shares and JetBlue shares and lost money after the stocks fell. He filed an arbitration complaint with FINRA and claims that the broker that sold him the Wells Fargo reverse convertibles never fully explained to him what he was getting himself into. Still, brokers are hoping that last year’s stock market fiasco won’t discourage investors from trying structured products again.

Twice Shy On Structured Products? Wall Street Journal Online, May 28, 2009
Understanding Structured Products, Investopedia Continue Reading ›

A year ago, a Wall Street Journal article warned about the risk of investing in “reversible convertibles.” Now, these risks have become a reality for many investors, who have experienced substantial losses due to these products.

It began with Wall Street tempting investors who were hungry to make money with these risky complex securities while boasting of their potentially extravagant yields. These securities, which are usually linked to a single stock’s performance, can result in yields of 7% to 25% or greater.

In the past couple of years, sales of these notes soared, while yields for numerous fixed-income investments dropped. For example, in 2007, Arete Consulting LLC reported that small US investors purchased about $8.5 billion in reverse convertibles-an 81% increase from the year prior.

Morgan Stanley, ABM AMro Holding NV, and Barclays PLC are among the firms that have issued reverse convertibles, while firms including Wells Fargo and others were also active in the sales of these securities. These products are supposed to offer small investors a high level of income in return for a minimal investment. However, if the stocks drop dramatically, investors can lose most of their investment-especially if they didn’t take part in any of the underlying stock’s gains.

Reverse Convertibles
A reverse convertible is usually sold in notes of $1,000 increments that provide regular interest payments during the investment term. Upon the maturity of the note, an investor will receive their full original investment back in cash-except when certain conditions tied to a set “barrier” level apply.

However, if the underlying stock price drops under that level during the note’s term and finishes under the initial stock price, the investor doesn’t get cash and instead receives beaten down stock shares. This can be very dangerous for investors when reverse convertibles are linked to stock shares.

Reverse convertible buyers, who are selling a “put” option on the underlying stock, are obligated to purchase the shares if they go below a certain amount. The more high risk the stock, the greater the put option, and the higher the yield that investors can get paid.

Reverse convertibles also come with other challenges. An investor who tries selling a reverse convertible before it matures may have problems recovering his or her original investment.

In 2007, the Financial Industry Regulatory Authority sent inquiries to structured providers about their sales and marketing practices. Regulators wanted issuers to better monitor how they market reverse convertibles to small investors.

Issuers stand to gain financially from selling this product, which usually come with substantial fees (generally in the 2% or 3% range) and are priced into the yield that investors are getting. The issuer’s profit will depend on how it hedges against the risk of issuing the note.

Brokerage firms have been known to compare reverse convertibles to investments that are typically safer. FISN INC. lists reverse convertibles on its Web site under “CD Alternatives”-even though CD’s come with a lot less risk. The NASD, in 2005, recommended limiting the sale of structured products to investors who have options trading approval. Yet even sophisticated investors can run into problems with reverse convertibles.

With the markets becoming more volatile, the March 2008 WSJ article warned that circumstances could get “rougher”. Yet at that time last year, issuers were still claiming that even with the risks, reverse convertibles were still a good bet for investors.

Reverse convertibles have left investors with beaten-down shares. For example, investors who purchased reverse convertibles linked to Countrywide Financial Corp. (whose share prices sank over 70%) lost over 50% of their money by the time the notes matured.

Related Web Resources:
Risky Strategy Lures Investors Seeking Yield, The Wall Street Journal, March 28, 2008
Reverse Convertibles Can Turn The Tide On Investor Returns, Investopedia Continue Reading ›

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