JPMorgan to Pay $135 Million for Improper ADR Handling

Settlement is the SEC’s eighth action against a bank or broker in its ongoing ADR investigation.

JPMorgan Chase Bank has agreed to pay more than $135 million to settle SEC charges that alleged the bank improperly handled “pre-released” American Depositary Receipts (ADRs).

According to the SEC’s cease-and-desist order, JPMorgan 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 the new ADRs.  The SEC said 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.

ADRs require a corresponding number of foreign shares to be held in custody at a depositary bank. However, 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 ADR represents.

However, according to the SEC, JPMorgan pre-released ADRs to brokers when the firm was negligent as to whether the pre-release brokers, or the parties for whom the ADRs were being obtained, beneficially owned the corresponding number of ordinary shares.

“The result of this conduct was the issuance of ADRs that in many instances were not backed by ordinary shares as required by the ADR facility,” said the SEC in its order, adding that the conduct violated Section 17 of the Securities Act.

The SEC said JPMorgan conducted pre-release transactions that were often outstanding for periods of time that would not result from typical inter-jurisdictional settlement disparities. For example, it said that between late 2011 through mid-2014, among more than 14,600 pre-release transactions, 7,000 were outstanding for more than five days; over 1,300 were outstanding for more than 30 days; and more than 400 were outstanding for over 100 days.

“Based on the durations of its pre-release transactions and the manner in which the transactions were closed, JPMorgan should have recognized that pre-release was being used in connection with trading strategies that had nothing to do with settlement timing disparities,” said the order.

The settlement is the eighth action against a bank or broker, and fourth action against a depositary bank, levied by the SEC in its ongoing investigation into abusive ADR pre-release practices.

“With these charges against JPMorgan, the SEC has now held all four depositary banks accountable for their fraudulent issuances of ADRs into an unsuspecting market,” Sanjay Wadhwa, senior associate director of the SEC’s New York Regional Office, said in a release.  “Our investigation continues into brokerage firms that profited by making use of these improperly issued ADRs.”

Although JPMorgan neither admitted nor denied the SEC’s findings, the bank agreed to pay disgorgement of more than $71 million in ill-gotten gains, plus $14.4 million in prejudgment interest, as well as a $49.7 million penalty.

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