What TiVo and JP Morgan teach us about Reverse Convertibles
Reverse convertibles are short term, unsecured notes issued by brokerage firms including JP Morgan, Barclays, Citigroup, Morgan Stanley, Wachovia, Lehman Brothers, and RBC that pay less than the notes' face value at maturity if the price of the reference stock or the level of the reference stock index declines substantially during the term of the note. The SLCG study finds that brokerage firms overcharge for reverse convertibles so significantly that the expected return on these complex investments is actually negative and that reverse convertibles continue to be sold at inflated prices only because investors do not fully understand these products.
The SLCG study reports that despite substantial overpricing in the offerings and the significant losses on the reverse convertible notes in 2008 and 2009, there have been a substantial number of new issues of these dubious investments by JP Morgan, Barclays and many others brokerage firms in 2010. The study illustrates its main themes with JP Morgan's May 14, 2010 TiVo-linked reverse convertible.