Citibank to Pay $38.8 Million for Improper Handling of ADRs

SEC alleges bank profited from ‘industry-wide fraud.’

Citibank has agreed to pay nearly $39 million to settle Securities and Exchange Commission (SEC) charges that the bank allegedly improperly handled American Depositary Receipts (ADRs), which resulted in “abusive practices.” 

The SEC said Citibank 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. This resulted in inflating the total number of a foreign issuer’s tradeable securities, which the regulator said led to inappropriate short selling and dividend arbitrage that should not have been going on.

“Our charges against Citibank are the latest in our ongoing investigative effort to hold accountable Wall Street institutions that participated in an industry-wide fraud,” said Sanjay Wadhwa, senior associate director of the SEC’s New York Regional Office.  “Our investigation into these practices has revealed that banks and brokerage firms profited while ADR holders were unaware of how the market was being abused.”

ADRs require a corresponding number of foreign shares to be held in custody at a depositary bank, and a “pre-release” allows ADRs to be issued without the deposit of foreign shares as long as 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. 

However, according the SEC’s cease-and-desist order, Citibank pre-released ADRs to brokers in circumstances where the bank was negligent as to whether the brokers, or the parties on whose behalf the pre-released ADRs were being obtained, actually owned the corresponding number of ordinary shares.

The SEC said that at least several of the largest brokers that regularly received pre-released ADRs from Citibank failed to take reasonable steps to ensure that they or their counterparties complied with the pre-release rules.

“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 Citibank provided to the pre-release brokers were not actually backed by ordinary shares.”

The SEC said the Citibank case is the second action against a depositary bank, and the sixth action against a bank or broker resulting from the regulator’s ongoing investigation into abusive ADR pre-release practices. 

Without admitting or denying the SEC’s charges, Citibank has agreed to pay more than $20.9 million in disgorgement of ill-gotten gains, plus over $4.2 million in prejudgment interest, and a civil penalty of nearly $13.6 million for a total of approximately $38.8 million.

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