JP Morgan Reverse Convertibles "Knock Out Investors in the First Round"
The extreme risk of reverse convertibles was dramatically demonstrated recently when such a note issued by JPMorgan Chase, which promised 64 percent annualized interest, plummeted in value just three days after being sold, according to Zeke Faux in his May 17th Bllomberg article titled “JP Morgan’s 64 Percent Note Shows Risks of Reverse Convertibles.”
A Reverse Convertible (also referred to as reverse exchangeable securities, revertible notes, and the like) is a structured product. Structured products are complicated financial instruments. In very general terms, a structured product is an investment whose value is derived from (or based on) the performance of a reference asset, market measure or investment strategy, which may include equity or debt securities, indexes, commodities, interest rates, foreign currencies, and so on, as well as baskets of them.
The JP Morgan structured notes promised to pay interest of 10.7 percent over a two-month term, as well as a return of principal, as long as shares of a reference asset known as TiVo Inc. did not decline more than 25 percent. TiVo declined 42 percent on May 14 triggering a provision that allows JP Morgan to return the possibly depressed stock TiVo at maturity instead of the investors’ principal. JPMorgan reportedly sold $800,000 of the TiVo-linked products.
The 64 percent interest rate on the TiVo linked product was the highest offered on any reverse convertible in months, according to Craig McCann, a Fairfax, Virginia-based litigation consultant who is preparing a study of the market.
The purchase price of the securities included a 1.75 percent sales commission, of which JPMorgan received 0.75 percentage point, according to the prospectus. That amounts to 10.5 percent on an annualized basis, which is far higher than the commission charged on comparable investments, according to Seth Lipner of Deutsch & Lipner, a Garden City, New York-based law firm. “A 10.5 percent commission is ridiculous,” Lipner was quoted as saying. “The cost would be much lower” for investors to make the same kind of market bet using various options rather than reverse convertibles,” he said.
JPMorgan and other banks, including Morgan Stanley and Barclays Plc, have sold $656 million of reverse convertibles in the U.S. in the last month alone, according to the article. Structured products are popular and often pitched to income-oriented investors, who do not understand the risks, as higher-yield alternatives to more conventional income investments.
Many burned investors have filed lawsuits and arbitration claims related to the products.
The Financial Industry Regulatory Authority (“FINRA”), which is charged with policing broker sales practices, said in a recent Regulatory Notice: “These firms should be prepared to demonstrate the basis for allowing investors with accounts not approved for trading options to purchase reverse convertibles.” Firms also are reminded that approving an account to trade reverse convertibles is not a substitute for a thorough suitability analysis,”
“FINRA knows its members well.” said J. Boyd Page, senior partner of Page Perry, LLC of Atlanta. “We look forward to hearing how FINRA members try to justify allowing investors with accounts not approved for trading options to purchase reverse convertibles.”
Page Perry, LLC and Deutsch & Lipner are law firms with over 175 years collective experience representing investors in securities-related litigation and arbitration that regularly collaborate on cases. For further information, please contact us.
