Broker to Pay $35 Million for Improper Handling of ADRs in Continuing SEC Crackdown
Last Friday, the SEC announced that broker Banca IMI Securities Corp. (BISC), an indirect, wholly-owned U.S. subsidiary of Italian bank Intesa Sanpaolo SpA, has agreed to pay more than $35 million to settle charges that it violated federal securities laws when it requested the issuance of and received American Depositary Receipts (ADRs) without possessing the underlying foreign shares.
ADRs are U.S. securities that represent shares of a foreign company, and for all issued ADRs there must be a corresponding number of foreign shares held in custody at a depositary bank. Under “pre-release agreements,” brokers such as BISC may obtain ADRs without depositing corresponding foreign shares provided the broker owns or takes reasonable steps to determine that the customer owns the number of foreign shares that corresponds to the number of shares the ADR represents.
The SEC’s order finds that BISC obtained pre-released ADRs and lent them to counterparties without satisfying the proper requirements. BISC’s improper handling of ADRs, which lasted from at least January 2011 to August 2015, made it possible for such ADRs to be used for inappropriate short selling or inappropriate profiting around dividend record dates. In certain countries, demand for ADR borrowing increased around dividend record dates so that certain tax-advantaged borrowers could, through a series of transactions, collect dividends without any tax withholding. Pre-released ADRs that were improperly issued were used to satisfy that demand.
Earlier this year, broker ITG settled charges for similar misconduct.
“U.S. investors who invest in foreign companies through ADRs have a right to expect market professionals to create new ADRs only when they are backed by foreign shares so that the new ADRs are not used to game the system,” said Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office. “As our order finds, BISC’s actions left the ADR markets ripe for potential abuse.”
The SEC’s order finds that BISC violated Section 17(a)(3) of the Securities Act of 1933 and failed reasonably to supervise its securities lending desk personnel. Without admitting or denying the SEC’s findings, BISC agreed to be censured and pay more than $18 million in disgorgement plus more than $2.3 million in interest and a $15 million penalty. The SEC’s order acknowledges BISC’s cooperation in the investigation and its remedial actions.
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