Merrill Lynch will pay over $8 million to settle charges it improperly handled the “pre-released” American depositary receipts (ADRs).
ADRs are negotiable instruments that represent an ownership interest in a specified number of foreign securities that are supposed to be deposited with a depositary. ADRs may be traded on U.S. stock exchanges or over the counter.
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 depositary bank and the broker or its customer actually owns the number of foreign shares that corresponds to the number of shares the ADR represents.
Merrill Lynch, a subsidiary of Bank of America, improperly borrowed pre-released ADRs in 40,000 transactions between June 2012 and November 2014, the SEC said. Merrill brokers borrowed the ADRs from other brokers when “the broker-dealer 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,” the SEC said.
Such practices resulted in inflating the total number of a foreign issuer’s tradeable securities, which resulted in abusive practices like inappropriate short selling and dividend arbitrage that should not have been occurring, according to the SEC settlement.
The 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 so far have resulted in monetary settlements exceeding $370 million, the agency said.
“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,” said Sanjay Wadhwa, senior associate director of the SEC’s New York Regional Office.
“We are continuing to hold accountable financial institutions that engaged in abusive ADR practices,” Wadhwa added.
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.