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Reverse Convertibles Cited In FINRA Fine

Reverse convertible notes were tied to a $500,000 fine levied by the Financial Industry Regulatory Authority (FINRA) against former Ferris, Baker Watts LLC, acquired by RBC Wealth Management. FINRA imposed the fine in October, citing inadequate supervision of sales of the notes to retail customers, as well as unsuitable sales of reverse convertibles to 57 accounts held by elderly customers who were at least 85 years old and customers with a modest net worth.

“Reverse convertible notes are complex investments that often entail significant risk of loss and also involve terms, features and risks that can be difficult for retail investors to evaluate,” said James Shorris, FINRA Executive Vice President and Acting Chief of Enforcement. “Ferris, Baker’s inadequate written procedures resulted in recommendations of sales to customers for whom the purchase of these securities was not suitable, including elderly customers and investors who had very modest assets.”

Reverse convertibles are notes with a coupon interest rate set for a fixed duration of three, six or 12 months. The products themselves are tied to the performance of a particular stock. If the price of the underlying stock drops below a certain level during the duration of the reverse convertible, the customer receives a predetermined number of shares of the stock at maturity of the note.

Conversely, if the underlying security maintains its price level, at maturity, the customer receives return of the dollar amount invested and a final coupon payment. In most instances in which customers received the underlying stock at maturity, they ended up with an investment loss. Reverse convertibles not only come with the risks associated with fixed-income products, such as issuer default and inflation, but also have the added risk that the value of the underlying asset can significantly depreciate.

During the period January 2006 to July 2008, FINRA found that that Ferris, Baker engaged in sales of reverse convertibles to approximately 2,000 retail accounts without providing sufficient guidance to its brokers and supervising managers on how to assess suitability in connection with their brokers’ recommendations of reverse convertibles.

Additionally, FINRA says the firm did not have a proper system in place to effectively monitor customer accounts for potential over-concentrations in reverse convertibles. The firm also made recommendations without a reasonable basis to believe that the investment was suitable for elderly customers and those with modest net worth. Finally, FINRA says the firm failed to detect and respond to indications of potential over-concentration in reverse convertibles.

If you’ve suffered losses in Reverse Convertibles, please contact our securities fraud team. We can evaluate your situation to determine if you have a claim.

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