FINRA Fines H&R Block Financial Advisors for Inadequate Supervision of Reverse Convertible Notes Sales and Issues Guidelines for the Sale of These Products
The Financial Industry Regulatory Authority (FINRA) announced its first enforcement action involving the sales of reverse convertible notes (RCNs) — fining H&R Block Financial Advisors, Inc., (n/k/a Ameriprise Advisor Services, Inc.) $200,000 for failing to establish adequate supervisory systems and procedures for supervising sales of RCNs to retail customers. FINRA also fined and suspended H&R Block broker Andrew MacGill for making unsuitable sales of RCNs to a retired couple. The firm was ordered to pay $75,000 in restitution to the couple for losses they incurred.
At the same time, FINRA released an Investor Alert, Reverse Convertibles - Complex Investment Vehicles, to educate retail investors about how these products work, what risks they involve and what factors to consider before investing in an RCN. FINRA also issued Regulatory Notice 10-09, reminding firms of their sales practice obligations when recommending or selling RCNs to retail investors.
An RCN is a structured product that typically consists of a high-yield, short-term note of an issuer and effectively a put option that is linked to the performance of an unrelated, or "linked," asset - usually a single common stock, but sometimes a basket of stocks, an index or some other asset. As a general rule, upon maturity of an RCN, the investor will receive either his full principal investment or a predetermined number of shares of the linked equity (which may be worth less than the principal investment), depending on the performance of the linked equity. Generally speaking, the higher the coupon rate, the higher the expected volatility of the linked equity and the greater the likelihood of the investment resulting in payment of shares. Reverse convertibles not only come with the risks that fixed income products ordinarily carry, such as issuer default and inflation risk, but with additional risks of the underlying asset, which can depreciate or even become worthless. The initial investment for most RCNs is $1,000 per unit and most RCNs have maturity dates ranging from three months to one year.