Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Friday, October 22, 2010

FINRA Fines Former Ferris Baker Watta for Unsuitable Sales of Reverse Convertible Notes

FINRA announced earlier this week that it fined the former Ferris, Baker Watts LLC, acquired by RBC Wealth Management, $500,000 for inadequate supervision of sales of reverse convertible 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.  The firm was ordered to pay nearly $190,000 in restitution to the 57 account holders for net losses incurred as a result of purchasing reverse convertibles.

Reverse convertibles are notes with a coupon interest rate set for a fixed duration – three, six or twelve months –  that 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 of the instances where customers received the underlying stock at maturity, the customer 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 with the additional risk that the value of the underlying asset can significantly depreciate.

FINRA found that during the period January 2006 to July 2008, 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, the firm did not have a system to effectively monitor customer accounts for potential over-concentrations in reverse convertibles.  

In concluding this settlement, the firm neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

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