FINRA has fined H&R Block Financial Advisors $200,000 for failing to supervise their advisors selling reverse convertible notes to its retail clients.
In addition, FINRA suspended Andrew MacGill, an H&R Block [HRB] broker, for making unsuitable sales of these notes to a retired couple, and ordered the firm to pay $75,000 in restitution to the couple for the losses they suffered.
A reverse convertible note is a structured product that usually consists of a high-yield, short-term note of an issuer and a put option that is linked to the performance of another asset, such as a single common stock, basket of stocks or an index.
When the note matures, the investor either receives his full principal investment or a predetermined number of the shares of the linked asset (which may be worth less than the principal investment) depending on the performance of the linked asset.
Generally, the higher the coupon rate the higher the expected volatility of the linked asset and the greater the chance that the investment will result in the payment of shares — even if the shares have depreciated or become worthless.
“Reverse convertible notes are complex instruments which, like many structured products, often entail significant risk of loss,” Richard Ketchum, the chairman and chief executive office of FINRA, said in a statement.
“They are among the most popular structured products with retail investors, primarily because of the high yields they offer. But they also involve terms, features and risks that can be difficult for retail investors who are buying them and the brokers who are selling them to evaluate,” he added.
Ketchum said advisors need to understand the risks and costs of these products and ensure they are suitable for a particular client before recommending them. Firms also need to monitor clients’ accounts to make sure there isn’t too high of a concentration of reverse convertible notes in their portfolios.
FINRA found that MacGill recommended that the retired couple in this case invest nearly 40% of their total liquid net worth in nine reverse convertible notes. The regulator said this was inconsistent with the couple’s investment objectives and risk tolerance and ultimately led to a substantial loss.
FINRA suspended MacGill from working at a FINRA-regulated firm for 15 days, fined him $10,000 and ordered him to give the $2,023 he made in commissions on the sale of the reverse covertible notes to the couple.
MacGill neither admitted nor denied the charges but consented to the entry of FINRA’s findings.
FINRA also found that from January 2004 until December 2007, H&R Block sold reverse convertible notes without having a system in place to monitor client accounts for over concentrations in these products. The firm also failed to provide its supervising managers with adequate training to assess the suitability of the notes for clients.
H&R Block did not respond to a call for comment by press time.
The case also seems to have spurred FINRA to release an investor alert on reverse convertible notes to educate retail investors about the nature of the product, as well as a regulatory notice to remind firms of their obligations when recommending such notes to clients.