Finra charges Ferris, Baker with wrongful sale of reverse convertibles

By Susanna Moon

Chicago, Oct. 20 - The Financial Industry Regulatory Authority said it charged the former Ferris, Baker Watts LLC, acquired by RBC Wealth Management, with the inappropriate sale of some structured products to retail investors and elderly customers.

Finra said it fined the firm $500,000 for inadequate supervision of the sale of reverse convertible notes 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 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, according to a Finra press release.

From January 2006 to July 2008, Ferris, Baker Watts sold reverse convertibles to about 2,000 retail accounts without providing sufficient guidance to its brokers and supervising managers on how to assess suitability for recommendations of the notes, the release said.

The firm lacked a system to effectively monitor customer accounts for potential over-concentrations in reverse convertibles, and it made recommendations without a reasonable basis to believe that the investment was suitable for elderly customers and those with modest net worth, Finra said.

In one instance, the firm sold an 86-year-old retired social worker five reverse convertibles in the amount of $10,000 each. At various times, 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.

In concluding the settlement, the firm neither admitted nor denied the charges but consented to the entry of Finra's findings, the release noted.

"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," James Shorris, Finra executive vice president and acting chief of enforcement, said in the release.

"Ferris, Baker's inadequate written procedures resulted in recommendations of sales to customers for whom the purchase of these securities was not suitable, including elderly customers and investors who had very modest assets."

In most of the instances where the customers received the underlying stock at maturity, they 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, the regulator noted.

Finra is the largest non-governmental regulator for all securities firms doing business in the United States.

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