The Securities and Exchange Commission hit Merrill Lynch with an $8 million fine for improperly borrowing pre-released American Depository Receipts—U.S. stocks that represent shares in a foreign company. This is the agency’s ninth enforcement action against firms for similar violations, which have brought in over $370 million in settlements.
If a broker has an agreement with the depository bank, they can “pre-release” ADRs, allowing shares to be issued without the deposit of foreign shares. Merrill allegedly borrowed pre-released ADRs from brokers who had pre-release agreements but did not own the foreign shares needed to support those ADRs, the SEC claims.
“Such practices resulted in inflating the total number of a foreign issuer’s tradeable securities, which resulted in abusive practices like inappropriate short selling and dividend arbitrage that should not have been occurring,” the SEC said in a statement. “The order against Merrill Lynch found that its policies, procedures and supervision failed to prevent and detect securities laws violations concerning borrowing pre-released ADRs from these middlemen.”
Merrill agreed to pay $4.4 million in disgorgement, a $2.89 million penalty and $724,000 in prejudgment interest.
“Our action conveys the message that an entity like Merrill may not avoid liability by using another broker to obtain fraudulently issued ADRs on its behalf,” said Sanjay Wadhwa, senior associate director of the SEC’s New York regional office.
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