ICBC to pay more than $42M for improper handling of ADRs

The settlement “marks the largest recovery against a broker in the SEC’s ongoing investigation of ADR practices, which thus far has resulted in settlements with 10 financial institutions exceeding $414 million,” the SEC said. In a separate action, Industrial and Commercial Bank of China Financial Services (ICBCFS) pleaded guilty to an antitrust charge and was sentenced to pay a criminal fine of more than $3 million, the Department of Justice announced.

ADRs, U.S. securities that represent foreign shares of a foreign company, require a corresponding number of foreign shares to be held in custody at a depositary bank. The practice of “pre-release” allows ADRs to be issued without the deposit of foreign shares, provided 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 ADRs represent.

The SEC’s order finds that ICBCFS improperly obtained pre-released ADRs from depositary banks when ICBCFS should have known that neither the firm nor its customers owned the foreign shares needed to support those ADRs. This inflated the total number of a foreign issuer’s tradeable securities and resulted in abusive practices such as inappropriate short selling and dividend arbitrage.

In certain countries, demand for ADR borrowing increased around dividend record dates so that certain tax-advantaged borrowers could, through a series of transactions, collect dividends without any corresponding tax withholding. Pre-released ADRs that were improperly obtained by ICBC were used to satisfy that demand.

“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. “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.”

The SEC’s order finds that ICBC violated the antifraud provisions of Section 17(a)(3) of the Securities Act of 1933 and failed reasonably to supervise its securities lending desk personnel. Without admitting or denying the SEC’s findings, ICBCFS agreed to be censured, return nearly $24 million in ill-gotten gains, and pay $4.4 million in prejudgment interest and a $14.3 million penalty.

In the Justice Department’s action, ICBCFS admitted, as part of its guilty plea, that from May 2012 until at least August 2014, it conspired with other institutions and individuals to submit rigged bids to borrow pre-release ADRs. According to the Justice Department, ICBC’s plea is the second in the ongoing criminal antitrust investigation. Banca IMI Securities previously pleaded guilty for its role in the conspiracy and was sentenced to pay a fine of more than $2 million on May 10, 2019.

ICBC pleaded guilty to conspiring to borrow pre-release ADRs from U.S. depository banks at artificially suppressed rates. During the conspiracy, a U.S. depository bank began using an auction-style process and invited ICBC and other broker-dealers to submit competitive bids for rates to borrow ADRs. In response, ICBC and its co-conspirators intensified their coordination in an effort to artificially increase their profits under the auction-style process. On at least 24 occasions, ICBC reached an agreement with one or more co-conspirators as to the bids they would submit to U.S. depository banks. On many occasions, the conspirators agreed they would all submit the same bid.