The Financial Industry Regulatory Authority announced Wednesday it fined the former Ferris, Baker Watts LLC, which was acquired by RBC Wealth Management, $500,000 for inadequate supervision of sales of reverse convertible notes to retail customers.
FINRA also sanctioned the company for 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 convertible notes are complex investments that often entail significant risk of loss and also involve terms, features and risks that can be difficult for retail investors to evaluate," said James Shorris, an executive vice president at FINRA and acting chief of enforcement. "Ferris, Baker's inadequate written procedures resulted in recommendations of sales to customers for whom the purchase of these securities was not suitable.”
Reverse convertibles are notes with a coupon interest rate set for a fixed duration 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.
FINRA found that from 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 one instance, the firm sold an 86-year-old retired social worker five reverse convertibles in the amount of $10,000 each. These represented between 15% and 25% of her investment portfolio. In another instance, the firm sold a 20-year-old clerk making less than $25,000 annually five reverse convertibles in his Roth IRA and regular accounts. These securities represented 51% of the IRA account and 44% of the regular account's value.
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