Reverse Convertibles Feel Wrath of SEC
Reverse convertible notes are at the center of a sweep examination conducted by the Securities and Exchange Commission (SEC) into the retail structured securities products business of 11 broker/dealers. Among its findings, the SEC says that the 11 broker/dealers, which represent a cross-section of the industry, may have:
- Recommended unsuitable structured securities products to retail investors;
- Traded at prices disadvantageous to retail investors;
- Omitted material facts about structured securities products offered to retail investors; and
- Engaged in questionable sales practices with customers.
The report says that the SEC also observed potential supervisory deficiencies. In particular, there appears to be a lack of training requirements for supervisors and registered representatives who market structured products to their customers.
“Sales of structured products to retail investors have increased over recent years and may continue to increase as they are marketed as a higher return investment alternative,” said Carlo di Florio, Director of the SEC’s Office of Compliance Inspections and Examinations. “This report could help companies strengthen their compliance programs to better address the issues we observed during our sweep and in subsequent exams.”
As reported July 27 by Investment News, one of the riskiest structured products cited in the SEC’s report is the reverse convertible note, or RCN. An RCN is a structured security that comes with an imbedded put option.
The report highlights several areas in which broker/dealers need to focus on in the future. Those areas include:
- Having adequate procedures and controls to prevent and detect possible abuses in the secondary market for structured securities products;
- Disclosing material facts regarding the structured securities products being offered;
- Requiring registered representatives and their supervisors to complete specialized training in structured securities products before selling these products to customers; and
Accurately listing structured securities products on customer statements.