A subsidiary of the Industrial and Commercial Bank of China has agreed to pay more than $42 million to settle charges by the Securities and Exchange Commission (SEC) of improper handling of “pre-released” American Depositary Receipts (ADRs). It is the largest recovery against a broker in the SEC’s ongoing investigation of ADR practices, which has resulted in settlements totaling more than $414 million with 10 financial institutions.
The SEC’s order alleged that the Industrial and Commercial Bank of China Financial Services LLC (ICBCFS) improperly obtained pre-released ADRs from depositary banks when it should have known that neither the firm nor its customers owned the foreign shares needed to support those ADRs.
ADRs require an equal number of foreign shares to be held at a depositary bank, and the practice of pre-releasing ADRs allows them to be issued without the deposit of foreign shares, as long as the 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 ADRs represent.
Improperly obtaining the pre-released ADRs inflates the total number of a foreign issuer’s tradeable securities, and the SEC’s order said that as a result of its actions, ICBCFS facilitated short selling and enabled the settlement of trades with ADRs that were not actually backed by ordinary shares.
“With these charges, ICBCFS is being held accountable for its unlawful ADR practices,” said Sanjay Wadhwa, senior associate director of the SEC’s New York regional office. “By falsely representing that the firm or its customers owned the foreign shares to support pre-release transactions, ICBCFS often played the role of middleman between depositary banks and other market participants in the issuance of what amounted to phantom securities.”
The SEC said that ICBCFS’s securities lending desk personnel also engaged in hundreds of prerelease transactions involving the sponsored ADRs of foreign issuers that were scheduled to pay dividends. It said the brokers who lent ICBCFS the pre-released ADRs sought to profit by holding ordinary shares in a tax-advantaged situation if the tax savings were higher than the costs of borrowing or acquiring the ordinary shares at dividend time. ICBCFS, in turn, allegedly profited from these transactions by lending the pre-released ADRs at a higher rate than the rate at which it obtained the ADRs.
“ICBCFS failed to establish and implement effective policies and procedures to address whether ICBCFS’s associated persons complied with the firm’s obligations in connection with pre-release transactions,” said the order. “As a result, ICBCFS’s supervisory policies and procedures were not reasonably designed and implemented to provide effective oversight of associated persons to prevent and detect their violations of Securities Act.”
Although the bank neither admitted nor denied the SEC’s findings, it agreed to be censured, return nearly $24 million in ill-gotten gains, and pay $4.4 million in prejudgment interest on top of a $14.3 million penalty.
In a separate case, ICBCFS also pleaded guilty to an antitrust charge and was sentenced to pay a criminal fine of more than $3 million for its involvement in a bid-rigging conspiracy involving certain financial instruments, according to the US Department of Justice. As part of a guilty plea, ICBCFS admitted that for more than two years, it conspired with other institutions and individuals to submit rigged bids to borrow pre-released ADRs.