Beware of Reverse Convertible Notes (and Bonds)

Posted on March 26th, 2020 at 4:39 PM
Beware of Reverse Convertible Notes (and Bonds)

From the Desk of Jim Eccleston at Eccleston Law LLC:

Reverse convertible notes (“RCN”) are complex investment vehicles that have been sold as an alternative to stocks and bonds.  Also known as “revertible notes” or “reverse exchangeable securities”, the investments are not suitable for most investors.

RCNs are high coupon-bearing products, but are linked to the performance of an underlying stock.  RCNs consist of a debt instrument and a put option in the underlying stock.  During the life of the RCN, the investor receives a steady income in the form of payments of a set coupon rate.  The coupon rate is influenced in part by the volatility of the underlying stock.  A greater potential volatility of the underlying stock will result in a greater coupon rate.  At maturity, which can range from three months to two years, sellers focus on the fact that the investor may receive his/her original investment back, without adequately disclosing the risks.

One risk is that, instead of the investor receiving the original investment back, the issuer has discretion to issue a predetermined number of shares of the underlying stock. That “naked put” on the company assets may be worthless and/or illiquid.  Another risk or negative factor is that issuers charge an up-front, embedded fee to investors which can be as high as 8% or more – creating a large hurdle for any investor to break even, let alone earn a return.  There also is a call risk, enabling the issuer to redeem (by cash or company shares) the investment before it matures.

The big brother to the RCN is the RCB.  Reverse convertible bonds are the same, just with a longer maturity (unless called). 

Be wary of both RCNs and RCBs.

The attorneys of Eccleston Law LLC represent investors and advisors nationwide in securities and employment matters. The securities lawyers at Eccleston Law also practice a variety of other areas of practice for financial investors and advisors including Securities FraudCompliance ProtectionBreach of Fiduciary DutyFINRA Matters, and much more. Our attorneys draw on a combined experience of nearly 65 years in delivering the highest quality legal services. If you are in need of legal services, contact us to schedule a one-on-one consultation today.

Related Attorneys: James J. Eccleston

Tags: eccleston, eccleston law, james eccleston, reversible convertible notes, reverse exchangeable securities

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