Improper Handling of “Pre-Released” American Depositary Receipts (“ADRs”)
On July 20, 2018, the SEC announced that two U.S.-based subsidiaries of Deutsche Bank AG will pay nearly $75 million to settle charges of improper handling of “pre-released” ADRs.
The case, according to the SEC, stems from a continuing SEC investigation into abuses involving pre-released ADRs. In proceedings against Deutsche Bank Trust Co. Americas (DBTCA), a depositary bank, and Deutsche Bank Securities Inc. (DBSI), a registered broker-dealer, the SEC found that their misconduct allowed pre-released ADRs to be used for abusive practices, including inappropriate short selling and inappropriate profiting around dividend payouts.
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 depositary 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 depositary bank and the broker or its customer owns the number of foreign shares that corresponds to the number of shares the ADR represents.
In the order against DBTCA, the SEC found that it improperly provided thousands of pre-released ADRs over a more than five-year period when neither the broker nor its customers had the requisite shares. The order against DBSI found that its policies, procedures, and supervision failed to prevent and detect securities laws violations concerning borrowing and lending pre-released ADRs, involving approximately 850 transactions over more than three years.
Last year, the SEC announced settled charges against brokers ITG Inc. and Banca IMI Securities Corp., which at times obtained pre-released ADRs from DBTCA and other depositaries and lent them to other brokers, including DBSI. The SEC also charged a former managing director and head of operations at broker-dealer ITG for failing to supervise personnel on ITG’s securities lending desk who improperly handled pre-released ADRs.
Without admitting or denying the SEC’s findings, DBTCA agreed to return more than $44.4 million of alleged ill-gotten gains plus $6.6 million in prejudgment interest and a more than $22.2 million penalty, nearly $73.3 million in total. DBSI, also without admitting or denying the SEC’s findings, agreed to pay nearly $1.6 million, representing $1.1 million in disgorgement and prejudgment interest and a nearly $500,000 penalty. The SEC’s orders acknowledge each entity’s cooperation in the investigation and remedial acts.