How Do You Know if You Have a Reverse Convertible Note – and Why You Should Be Concerned

Brokerage firms use a myriad of complex terms to describe the reverse convertible notes being hawked to retail investors. For example, UBS sells reverse convertibles under the name Yield Optimization Notes. Other firms that sell very similar products, use very different terms.

As a result, some investors are not aware that the structured note that they own is a reverse convertible note. Unfortunately, regardless of the fancy name provided to you by the brokerage firm, these are effectively sold as bond surrogates and, in reality, they are often rogue products that are not consistent with the best interest of the retail investor.

While investors continue to fare well with FINRA arbitration claims against UBS for its overzealous sale of 100 percent principal-protected notes and other structured products to fixed income investors, the Securities and Exchange Commission has been looking into the problematic and widespread sale of reverse convertibles to the same group of fixed income investors.

While selling unsecured promissory notes as 100 percent principal protected may have been one of the most misleading product sales pitches to come along in a good while, the sale of reverse convertibles may be one of the most unsuitable and rogue product sales campaigns to come along in a good long while.

The underlying concept for both principal-protected notes and reverse convertibles is disturbing.  Specifically, in recommending the types of structured notes described above, your trusted financial advisor firm or wealth management firm is advising you, the client, to loan money to it – or one of its brethren on Wall Street – on an unsecured basis as the best investment idea for you.

Keep in mind that these same firms summarily fire individual financial advisors who borrow money from a client regardless of the return on the loan being offered to the client. Similarly, regulators such as FINRA, the Financial Industry Regulatory Authority, regularly investigate and punish individual financial advisors who borrow money from a client.   Thus, the very concept of a brokerage firm borrowing money from its own clients on a widespread basis highlights the firm’s willingness to disregard the massive conflict of interest embedded in these structured note products.

Wall Street firms such as UBS – which use terms such as “Yield Optimization Notes” to refer to “reverse convertibles” – are preying on fixed-income investors looking for low-risk products with better returns than are now available from traditional fixed income products.

Similar to non-traded REITs, the sales pitch for structured notes focuses on the returns and downplays the risks and the conflicts of interest. In fact, last month the SEC examined the reverse convertible sales practices of more than ten broker-dealers and raised “suitability,” pricing, risk disclosure, and misrepresentation concerns about the firms’ sales and maintenance of reverse convertibles in client accounts.

These products are so complicated – they include an option-like component as part of the structure – that regulators have concerns that many individual financial advisors may not even fully understand the product they are recommending. Regarding the complexity, see FINRA regulatory notice 10-09. In fact, even the anemic FINRA regulators stated years ago that reverse convertibles should only be recommended to investors who are approved to do option trading.   NASD ( FINRA) Notice to Members 05-59.

If you are being pitched structured notes that are not FDIC insured, consider that the issuers and salespeople are requesting your money to fund their own operations or operations of another big Wall Street firm. In other words, they have decided they would rather borrow money from you on an unsecured basis than borrow money from a bank or institutional lender. In our opinion, they aren’t doing this to provide you with a wonderful opportunity, but rather they’re doing it because the issuers and selling firms believe they can squeeze a better deal out of you than they can from a banker or professional lender.

As class actions relating to the sale of Lehman principal-protected notes are winding their way through the system, Courts are also recognizing problems with the sales of structured notes.  For example, just last month, New York Federal Judge Lewis Kaplan stated the following in an opinion in one of the Lehman Brothers related class actions:
“[The pricing supplements mention] 100% principal protection at least four times on the first page.  By contrast, the risk that investors could lose their principal if Lehman went bankrupt is not mentioned on that page at all.  The rest of each pricing supplement continues this trend, frequently mentioning principal protection, but rarely or obliquely disclosing the risk that Lehman would not repay.”

Reverse convertibles, like principal-protected notes, will soon show that Wall Street firms are again pursuing their own greedy interests while failing to protect the interests of the investors they ask to trust them.

Chris Vernon, a founding partner of the Vernon Litigation Group law firm, is an investor advocate who represents clients around the nation in securities fraud arbitration and financial litigation. Contact the Vernon Litigation Group law firm at or call (239) 319-4434.