The SEC announced that BNY Mellon has agreed to pay over $54 million to settle charges related to the improper handling of American Depositary Receipts (ADRs) to brokers in thousands of pre-release transactions. BNY Mellon’s negligent practices allegedly inflated the total number of a foreign issuer’s tradeable securities, which resulted in inappropriate short selling and dividend arbitrage of more than $29 million (In the Matter of The Bank of New York Mellon, Release No. 33-10586, December 17, 2018).
Pre-released ADRs. A depositary bank issues ADRs to a market participant that has delivered the corresponding number of foreign securities to the depositary’s foreign custodian. Depositary agreements may provide for "pre-release" transactions in which a market participant can obtain newly issued ADRs from the depositary before delivering ordinary shares to the custodian as long as the broker or its customer owns the number of foreign shares that corresponds to the number of shares the ADR represents.
BNY Mellon. According to the SEC, BNY Mellon was negligent with respect to whether the pre-release brokers (or the parties on whose behalf the pre-released ADRs were being obtained) actually beneficially owned the corresponding number of ordinary shares as they represented to BNY Mellon in their pre-release agreements. BNY Mellon did not take reasonable steps to determine that the pre-release brokers or their counterparties complied with the pre-release obligations, and thus at times negligently facilitated short selling and enabled the settlement of trades with some ADRs that were not actually backed by ordinary shares held for the benefit of the depositary in accordance with the requirements of the ADR facility, the SEC alleged. As a result, BNY Mellon’s net revenues from the negligently conducted pre-release transactions totaled approximately $29 million.
Charges. The SEC’s order instituting administrative proceedings charges BNY Mellon with violating Securities Act Section 17(a)(3). To settle the SEC’s charges, BNY Mellon agreed to pay disgorgement and prejudgment interest of $33.6 million and a civil monetary penalty of $20.6 million. It also agreed to cease and desist from further violations of Section 17(a)(3).
The SEC’s ongoing investigation into abusive ADR pre-release practices has resulted in six other enforcement actions against a bank or broker. The proceedings against BNY Mellon are also the third against a depositary bank. Previous monetary sanctions for similar conduct have been obtained against Citibank ($38.7 million), Banca IMI Securities ($35 million), SG Americas Securities ($800,000), and ITG Inc. ($24 million).
Cooperation and remediation. The SEC’s order acknowledges the voluntary remediation and cooperation with the SEC’s investigation in accepting BNY Mellon’s offer of settlement. After the staff opened its investigation, BNY Mellon voluntarily ended its pre-release activity over dividend record date in November 2015, and by 2016 had ended the remainder of its pre-release activity. BNY Mellon also met with SEC staff on multiple occasions, assisted in identifying individuals who provided relevant testimony, and provided detailed factual summaries at the staff’s request as well as on its own initiative.
BNY Mellon did not admit or deny the SEC’s findings in settling the charges.
No-action relief. BNY Mellon requested, and was granted, a waiver of ineligible issuer status under Securities Act Rule 405. Absent the waiver, the SEC’s order would render BNY Mellon ineligible to avail itself of the benefits of being a well-known seasoned issuer (WSKI) such as making communications by way of free-writing prospectuses, automatically effective shelf registration statements, and pay-as-you-go filing fees. The SEC determined that BNY Mellon had shown good cause why it should not be considered an ineligible issuer under Rule 405.
The release is No. 33-10586.
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