SEC continues ADR clampdown as Merrill Lynch agrees to $8 million settlement

The US SEC has collected monetary settlements exceeding $370 million relating to its investigation into improper handling of pre-released ADRs.

By Joe Parsons

The US Securities Exchange Commission (SEC) has reached a $8 million settlement with Merrill Lynch for improper handling of ‘pre-released’ American Depositary Receipts (ADR).

It 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 resulted in monetary settlements exceeding $370 million.

The single biggest settlement relating to improper ADR practices was dealt to JP Morgan in December of $135 million.

ADRs, which allow US investors to trade in foreign stocks, require a matching number of foreign shares to be held at a custody or depositary bank, but can be ‘pre-released’ if a broker or customer owns the underlying stock.

The SEC order found that Merrill Lynch improperly borrowed ADRs from other brokers when Merrill Lynch should have known that those brokers – middlemen which obtained pre-released ADRs from depositaries – did not own the foreign shares needed.

The practice resulted in inflating the total number of foreign issuer’s tradeable securities, which also encouraged inappropriate short selling and dividend arbitrage.

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.

“We are continuing to hold accountable financial institutions that engaged in abusive ADR practices,” said Sanjay Wadhwa, senior associate director 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 $2.89 million for total monetary relief.

BNY Mellon, Citi, Deutsche Bank and JP Morgan are among those banks that have settled charges of improper handling of pre-released ADRs with the SEC.