The Financial Industry Regulatory Authority (FINRA) ordered RBC Capital Markets (RBC) to pay a $1 million fine and approximately $434,000 in restitution to customers for alleged supervisory failures resulting in sales of unsuitable reverse convertibles.
As a background, a reverse convertible is an interest-bearing note where repayment of the principal is tied to the performance of an underlying asset, such as a stock or basket of stocks. Investor risk of loss comes from changes in the value of the underlying asset. If the asset falls below a certain level at maturity or during the term of the reverse convertible the investor can suffer losses. In February 2010, FINRA issued a regulatory notice on reverse convertibles emphasizing the need for firms to perform a suitability analysis in connection with sales of reverse convertible because they are complex product.
FINRA and the SEC have both expressed alarm at the growing popularity of complex products. Complex securities include, but are not limited to equity-indexed annuities, leveraged and inverse-leveraged exchange traded funds, reverse convertibles, alternative mutual funds, exchange traded products, and structured notes. A 2012 SEC study on investor financial literacy found that retail investors, and particularly the elderly and minorities, lack basic financial literacy skills. Combining a general lack of financial literacy with an investment product landscape that increasingly focuses on ever more complex product offerings and investors are more reliant on their advisers than ever. Accordingly, retail investors do not always fully appreciate the risks involved with these.
Brad Bennett, FINRA Executive Vice President and Chief of Enforcement was quoted in FINRA’s press release stating that “Securities firms must ensure that their brokers understand the inherent risks associated with the complex products they are selling, and be able to determine if they are suitable for investors before recommending them to retail customers. When the firm establishes suitability guidelines, it must police the transactions to ensure they appropriately meet their own criteria.”
FINRA found that RBC failed to have supervisory systems reasonably designed to identify transactions for review when reverse convertibles were sold to customers. While FINRA found that RBC did establish suitability guidelines for the sale of reverse convertibles by setting specific criteria for customer investment objectives, annual income, net worth, liquid net worth and investment experience. The firm failed to detect the sale by 99 of its broker’s 364 reverse convertible transactions in 218 accounts that were unsuitable for those customers. FINRA found that these customers incurred losses totaling at least $1.1 million. Subsequently, RBC made payments to numerous customers pursuant to the settlement of a class action lawsuit but in its action FINRA ordered restitution to the remainder of affected customers.
The attorneys at Gana Weinstein LLP represent investors in securities arbitration matters concerning a variety of investment related claims, including unsuitable investments. Our consultations are free of charge and the firm is only compensated if you recover.