On March 22, 2019, the Securities and Exchange Commission announced that Merrill Lynch, Pierce, Fenner & Smith Incorporated will pay over $8 million to settle charges of improper handling of “pre-released” American Depositary Receipts (“ADRs”).
ADRs – 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. According to the SEC, 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.
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 tradeable securities, which resulted in abusive practices like inappropriate short selling and dividend arbitrage that should not have been occurring. 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.
The SEC advised that this is the ninth enforcement action against a bank or broker resulting from its ongoing investigation into abusive ADR pre-release practices, which, to date, has resulted in monetary settlements exceeding $370 million. Information about ADRs is available in an SEC Investor Bulletin.
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.