Securities Regulation Daily Chinese bank affiliate to pay over $45M for ‘phantom’ ADRs, bid-rigging conspiracy
Friday, June 14, 2019

Chinese bank affiliate to pay over $45M for ‘phantom’ ADRs, bid-rigging conspiracy

By John M. Jascob, J.D., LL.M.

A broker-dealer subsidiary of Industrial and Commercial Bank of China agreed to settle SEC charges that the firm improperly handled "pre-released" American Depositary Receipts while also pleading guilty to antitrust violations.

In the largest recovery to date against a broker-dealer in the SEC’s ongoing investigation of potential ADR abuses, Industrial and Commercial Bank of China Financial Services LLC (ICBCFS) will disgorge nearly $24 million and pay another $18.7 million in penalties and interest to settle charges that it engaged in improper securities lending transactions involving pre-released American Depositary Receipts (ADRs). Separately, the broker-dealer agreed to pay a criminal fine of more than $3 million for its involvement in a bid-rigging conspiracy involving pre-released ADRs that violated federal antitrust laws (In the Matter of Industrial and Commercial Bank of China Financial Services LLCRelease No. 33-10647, June 14, 2019).

"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 in a news release. "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."

In a pre-release transaction, under certain circumstances a market participant may obtain newly issued ADRs from the depositary without simultaneously delivering the corresponding ordinary shares to the custodian. In these situations, deposit agreements, pre-release agreements, and the ADR itself, typically require a representation that the pre-release broker or its customer beneficially owns corresponding ordinary shares. The SEC alleged, however, that from at least September 2011 until approximately December 2015, associated persons on ICBCFS’s securities lending desk regularly loaned pre-release ADRs to customers or counterparties without taking reasonable steps to determine whether the requisite number of ordinary shares was owned and custodied by ICBCFS or its counterparties. As a result, in many instances ADRs were issued that were not backed by ordinary shares as required by the deposit agreements.

According to the SEC, this inflated the total number of tradeable securities and resulted in inappropriate short selling and dividend arbitrage. For example, pre-released ADRs that were improperly obtained by ICBCFS were used to permit certain tax-advantaged borrowers to collect dividends without any corresponding tax withholding.

Antitrust violations. In the criminal action, ICBCFS pleaded guilty to conspiring to borrow pre-release ADRs from U.S. depository banks at artificially suppressed rates. During the conspiracy, ICBC and its co-conspirators coordinated efforts to artificially increase their profits under the auction-style process used to solicit competitive bids for rates to borrow ADRs. On at least 24 occasions, the government alleged, ICBCFS agreed with one or more co-conspirators as to the bids they would submit to U.S. depository banks. On many occasions, the conspirators agreed to submit the same bid.

"In today’s proceeding, the Department of Justice and its law enforcement partners held to account another broker-dealer for its role in suppressing competition and rigging bids in the financial services industry," said Assistant Attorney General Makan Delrahim of the Justice Department’s Antitrust Division. "The competitive integrity of financial markets is essential to their efficient operation, and the Antitrust Division will continue to aggressively prosecute collusion that corrupts our financial markets."

The release is No. 33-10647.

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