Shearman & Sterling LLP | Government Regulatory Enforcement Blog | A Second Broker-Dealer Settles SEC Allegations Over Improper Handling Of Pre-Released ADRs<br >  
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  • A Second Broker-Dealer Settles SEC Allegations Over Improper Handling Of Pre-Released ADRs
    On August 18, 2017, the Securities and Exchange Commission (“SEC”) announced that broker-dealer Banca IMI Securities Corp. (“BISC”), an indirect, wholly-owned U.S. subsidiary of Italian bank Intesa Sanpaolo SpA, agreed to pay more than $35 million to settle claims that it violated federal securities laws when it requested the issuance of, and received, pre-released American Depositary Receipts (“ADRs”) from various banks without possessing a corresponding number of underlying foreign shares or taking reasonable steps to ensure that such shares were held by the customers on whose behalf it was obtaining the pre-released ADRs, as required by its contracts with issuing banks.  In the Matter of Banca IMI Securities Corp., Admin. Proc. File No. 3-18118 (Aug. 18, 2017).  The SEC alleged that this conduct violated Section 17(a)(3) of the Securities Act of 1933 and reflected a failure by BISC to supervise reasonably its securities lending desk personnel, as required under Section 15(b)(4)(E) of the Securities Exchange Act of 1934.  This is the second such settlement the SEC has announced this year.  See In the Matter of ITG Inc., Admin Proc. File No. 3-17770 (Jan. 12, 2017).

    ADRs are securities that represent an ownership interest in a specified number of foreign securities, and are issued by depositary banks in exchange for foreign shares that the depositary banks hold on deposit.  Pre-released ADRs are ADRs that are issued by depositary banks prior to the receipt of the underlying ordinary shares.  Pre-released ADRs are typically issued by depositary banks to broker-dealers pursuant to contracts (known as pre-release agreements) that require such broker-dealers to represent that, even though they have not yet delivered to the depositary bank the ordinary shares represented by the ADRs, they (or their customer) hold a long position in such ordinary shares.  Once issued by a depositary bank, pre-released ADRs are indistinguishable from ADRs. 

    According to the SEC order, between at least January 2011 and August 2015, BISC had pre-release agreements with four different depository banks.  The SEC claimed, however, that BISC’s securities lending desk had an ongoing practice of obtaining pre-released ADRs pursuant to such pre-release agreements, and then lending them to its customers, without owning the underlying ordinary shares or taking reasonable steps to determine whether the requisite number of ordinary shares were owned and custodied by the person on whose behalf the pre-released ADRs were being obtained.  In short, the SEC alleged that BISC consistently breached the representations in its pre-release agreements with depositary banks.  According to the SEC, this resulted in the issuance of ADRs that in many instances were not backed by ordinary shares.  

    Without admitting or denying the SEC’s findings, BISC agreed to pay over $20 million in disgorgement and interest and a $15 million civil penalty.  The SEC’s substantive allegations were, in essence, precisely the same as those brought previously against ITG in January 2017.