Perhaps it seemed like a good idea at the time - selling reverse convertible notes to octogenarian customers - but not to FINRA, which hit Ferris, Baker Watts for $690,000 in fines and restitution.  Former FBW, acquired by RBC Wealth Management, was cited for inadequate supervision of sales of these complex securities 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 will pay a $500,000 fine and nearly $190,000 in restitution.

"Reverse convertibles":  Notes with a coupon interest rate set for a fixed duration – 3, 6, 12 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.

From January 2006 to July 2008, Ferris, Baker sold reverse convertibles to approximately 2,000 retail accounts, under the following circumstances:

• it failed to provide sufficient guidance to its brokers and supervising managers on how to assess suitability in connection with their brokers' recommendations of reverse convertibles.  
• it didn't have a system to effectively monitor customer accounts for potential over-concentrations in reverse convertibles.
• it failed to detect and respond to indications of potential over-concentration in reverse convertibles.
• it made recommendations without a reasonable basis to believe that the investment was suitable for elderly customers and those with modest net worth.
  

    Examples of Inappropriate Sales:   (i) Firm sold a retired social worker, 86, five reverse convertibles in the amount of $10,000 each.  At times, these represented between 15% and 25% of her investment portfolio.  (ii) Firm sold a clerk, 20, making less than $25K annually five reverse convertibles in his Roth IRA and regular accounts - these securities represented 51% of the IRA account, 44% of the regular account's value.   [FINRA News, 10/20]