BNY Mellon to Pay More than $54 Million for “Pre-Released” ADRs

SEC says ‘improper practices’ allowed banks and brokerage firms to ‘profit handsomely.’

Bank of New York Mellon has agreed to pay more than $54 million to settle charges brought by the Securities and Exchange Commission (SEC) for the alleged improper handling of “pre-released” American Depositary Receipts (ADRs). 

A cease and desist order from the SEC said that BNY Mellon improperly provided ADRs to brokers in thousands of pre-release transactions when neither the broker nor its customers had the foreign shares needed to support those new ADRs.  According to the SEC, this resulted in inflating the total number of a foreign issuer’s tradeable securities, which led to abusive practices such as inappropriate short selling and dividend arbitrage that should not have occurred.

ADRs 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.

The charges against the bank were part of the SEC’s ongoing investigation into abusive ADR pre-release practices. 

“BNY Mellon is the seventh bank or broker being held accountable for improper practices that allowed banks and brokerage firms to profit handsomely while market participants were unaware of how the market was being abused,” Sanjay Wadhwa, senior associate director of the SEC’s New York Regional Office, said in a statement.   

The SEC’s order said that from at least June 2011 through June 2016, BNY Mellon pre-released ADRs to brokers in thousands of transactions. It also said that several of the largest brokers that obtained pre-released ADRs from BNY Mellon failed to take reasonable steps to ensure that they or their counterparties complied with the pre-release obligations. It also said those brokers falsely certified to BNY Mellon that they were complying with the pre-release agreements.

“Instead, these pre-release brokers loaned the ADRs they received in the pre-release transactions to other parties pursuant to loan agreements that did not require compliance with the pre-release obligations,” said the order. “As a result of these transactions, many of the ADRs that BNY Mellon provided to the Pre-Release Brokers were not actually backed by ordinary shares.”

Without admitting or denying the SEC’s findings, BNY Mellon agreed to disgorge more than $29.3 million in alleged ill-gotten gains, including $4.2 million in prejudgment interest as well as a $20.5 million penalty.