The SEC on March 22, 2019 announced that Merrill Lynch, Pierce, Fenner & Smith Incorporated will be fined over $8 million to settle charges of improper handling of “pre-released” American Depositary Receipts, also known as ADRs.
ADRs, which are U.S. securities that represent foreign shares of a foreign company, require a corresponding number of foreign shares to be held in custody at a depository bank. The practice of “pre-release” allows ADRs to be issued without the deposit of foreign shares, provided brokers receiving them have an agreement with a depository bank and the broker or its customer owns the number of foreign shares that corresponds to the number of shares the ADR represents.
The SEC’s order found that Merrill Lynch improperly borrowed pre-released ADRs from other brokers when Merrill Lynch should have known that those brokers – middlemen who obtained pre-released ADRs from depositaries – did not own the foreign shares needed to support those ADRs. Such practices resulted in inflating the total number of a foreign issuer’s trade-able securities, which resulted in abusive practices like inappropriate short selling and dividend arbitrage that should not have been occurring.
The SEC’s order against Merrill Lynch found that its policies, procedures, and supervision failed to prevent and detect securities laws violations concerning borrowing pre-released ADRs from these middlemen.
This is the SEC’s ninth enforcement action against a bank or broker resulting from its ongoing investigation into abusive ADR pre-release practices, which has thus far resulted in monetary settlements exceeding $370 million.
“We are continuing to hold accountable financial institutions that engaged in abusive ADR practices,” said Sanjay Wadhwa of the SEC’s New York Regional Office. “Our action conveys the message that an entity like Merrill may not avoid liability by using another broker to obtain fraudulently issued ADRs on its behalf.”
Without admitting or denying the SEC’s findings, Merrill Lynch agreed to pay more than $4.4 million in disgorgement of ill-gotten gains plus over $724,000 in prejudgment interest and a $2.89 million penalty for total monetary relief of over $8 million.
The SEC’s continuing investigation is being conducted by Andrew Dean, Elzbieta Wraga, Philip Fortino, Joseph P. Ceglio, Richard Hong, and Adam Grace of the New York Regional Office, and is being supervised by Mr. Wadhwa.