Published on:

FINRA Fines RBC for Reverse Convertibles Sales

According to the Financial Industry Regulatory Authority (“FINRA”), RBC Capital Markets, LLC (“RBC”) has agreed to a Letter of Acceptance, Waiver and Consent (“AWC”) concerning its sales of complex reverse exchangeable securities commonly called “reverse convertibles.”  RBC is a brokerage firm that is indirectly owned by the Royal Bank of Canada.

A reverse convertible is a structured investment product that typically consists of a high-yield, short-term note that is tied to the performance of some other asset, typically a stock or basket of stocks, an index, or some other instrument.  The underlying asset is usually unrelated to the issuer.  Most reverse convertibles have a $1,000 minimum investment, with maturity dates ranging from three months to one year.  Reverse convertibles carry considerable risk, because if the value of the underlying asset falls below a certain level, the investor could receive an amount that is less than the investor’s original investment upon maturity.  Because of the added risk, the coupon rate on the note component of a reverse convertible is usually higher than the yield on a conventional debt instrument of the issuer with a similar maturity, or of an issuer with a comparable debt rating.

According to the AWC, RBC consented to FINRA’s findings that RBC did not have an adequate surveillance system in place to ensure compliance with securities laws and its own internal guidelines concerning the suitability of transactions in which reverse convertibles were sold to RBC’s customers. According to FINRA, RBC had written supervisory procedures establishing the suitability guidelines for the sale of reverse convertibles.  Specifically, RBC’s guidelines restricted reverse convertible sales to investors with the following profile: $100,000 or more in annual income; at least $100,000 in liquid assets; a net worth of $250,000 or more; and at least two years of prior investment experience. The problem, according to FINRA, was that RBC’s electronic surveillance system did not flag the reverse convertible transactions where the customer did not meet RBC’s established criteria for purchasing reverse convertibles.  FINRA identified 364 unsuitable transactions of reverse convertibles in 218 customer accounts during the period between 2008 and 2012.  The customers incurred losses in those transactions of $1.1 million.

RBC did not admit or deny the findings in the AWC, but consented to the entry of FINRA’s findings and to payment of a $1,000,000 fine and $434,000 in restitution to its customers.