The SEC alleges the operations of two U.S.-based Deutsche Bank subsidiaries improperly handled pre-released ADRs.
Two U.S.-based subsidiaries of Deutsche Bank A.G. will pay nearly $75 million to settle charges of “improper handling” of pre-released American Depositary Receipts (ADRs), the SEC reports.
The Deutsche Bank subsidiaries are Deutsche Bank Trust Co. Americas (DBTCA), a depositary bank, and Deutsche Bank Securities Inc. (DBSI), a registered broker-dealer.
The case stems from a continuing SEC investigation into abuses involving pre-released ADRs.
In proceedings against DBTCA and DBSI, the SEC found that their misconduct allowed pre-released ADRs to be used for abusive practices, including inappropriate short selling and inappropriate profiting around dividend payouts.
ADRs, the SEC explains, are U.S. securities that represent foreign shares of a foreign company, and they “require a corresponding number of foreign shares to be held in custody at a depositary bank.” The pre-release practice permits 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 ADR represents.”
In its order against DBTCA, depositary bank, the SEC found that it “improperly provided thousands of pre-released ADRs over a more than five-year period when neither the broker nor its customers had the requisite shares.”
In its order against DBSI, the broker-dealer, the SEC found that “its policies, procedures, and supervision failed to prevent and detect securities laws violations concerning borrowing and lending pre-released ADRs, involving approximately 850 transactions over more than three years.”
According to the SEC’s order, from at least April 2012 until approximately June 2015, DBSI “received from Pre-Release Brokers pre-released ADRs that had been issued by Depositaries where neither the Pre-Release Brokers nor DBSI had taken reasonable steps to satisfy the Pre-Release Brokers’ obligations under the Pre-Release Agreements.”
Indeed, according to the SEC, “DBSI understood that the ADRs that DBSI borrowed from Pre-Release Brokers may have been sourced from Depositaries pursuant to Pre- Release Agreements. And as a party to a Pre-Release Agreement with [DBTCA] its affiliated Depositary … DBSI understood the beneficial ownership and other representations that Pre-Release Brokers would have been required to make to Depositaries in order to obtain pre-released ADRs. DBSI also understood the conduit nature of Pre-Release Brokers’ securities lending businesses, which under the circumstances should have indicated that the Pre-Release Brokers did not own underlying ordinary shares.”
According to the SEC’s order, from at least June 2011 through September 2016, DBTCA, the depositary, “pre-released ADRs to Pre-Release Brokers in thousands of transactions,” and “several of the largest (by share volume) Pre-Release Brokers that routinely obtained pre-released ADRs from DBTCA during that period failed in many instances to take reasonable steps to ensure that they or their counterparties complied with the Pre-Release Obligations.
“Indeed, those Pre-Release Brokers falsely certified to DBTCA that they were complying with the Pre-Release Agreements,” according to the order. “Instead, these Pre-Release Brokers loaned the ADRs they received in the pre-release transactions to other parties pursuant to loan agreements that did not require compliance with the Pre-Release Obligations. As a result of these transactions, many of the ADRs that DBTCA provided to the Pre-Release Brokers were not actually backed by ordinary shares held for the benefit of DBTCA in accordance with the terms of the Deposit and Pre-Release Agreements.”
The commission maintains that DBTCA “should have known that if a Pre-Release Broker’s counterparty could not have obtained pre-released ADRs from DBTCA directly because it had ‘difficulty executing the pre-release agreement,’ then it should not have been permitted to obtain them indirectly through a Pre-Release Broker.”
Furthermore, the SEC finds that “certain personnel in the DR Group were negligent in continuing to pre-release ADRs to Pre-Release Brokers without taking reasonable steps to determine whether the Pre-Release Brokers, in violation of their Pre-Release Agreements, were on-lending the ADRs to counterparties who were not complying with the Pre-Release Obligations.”
Additionally, the commission notes that “DBTCA’s own policies and statements to issuers reflected that DBTCA understood that the traditional reason for a pre-release — a reason that would appear consistent with the Pre-Release Obligations — was to address settlement timing disparities that prevented a party from delivering the ordinary shares to the custodian in time to obtain the ADRs.”
However, it was DBTCA’s practice that pre-release transactions were “often outstanding for lengths of time that could not be caused by such inter-jurisdictional settlement disparities. From June 2011 through September 2016, over 11,300 pre-release transactions, out of a total of more than 44,700, were outstanding for 10 days or more; over 3,100 were outstanding for 30 days or more; and approximately 230 were outstanding for 100 days or more.
“In addition, virtually all of the pre-release transactions — all but a few dozens — were closed by the Pre-Release Broker delivering ADRs to the Depositary rather than delivering ordinary shares to the Custodian,” according to the SEC. “Based on the durations of its pre-release transactions and the manner in which the transactions were closed, DBTCA should have recognized that pre-release was being used in connection with trading strategies that had nothing to do with settlement timing disparities, and therefore in circumstances indicating potential non-compliance with the Pre-Release Obligations.”
In the standard formulation, DBTCA and DBSI neither admit nor deny the SEC’s findings.
However, DBTCA has agreed to “return more than $44.4 million of allegedly ill-gotten gains plus $6.6 million in prejudgment interest and a more than $22.2 million penalty, nearly $73.3 million in total.” And DBSI has agreed to “pay nearly $1.6 million, representing $1.1 million in disgorgement and prejudgment interest and a nearly $500,000 penalty.”
Additionally, the commission has acknowledged each of the two entities’ “cooperation in the investigation and remedial acts.”
These actions against the two Deutsche Bank entities follow last year’s settled charges against ITG Inc. and Banca IMI Securities Corp., two brokers which, the SEC says, “at times obtained pre-released ADRs from DBTCA and other depositaries and lent them to other brokers, including DBSI. The SEC also charged a former managing director and head of operations at broker-dealer ITG for failing to supervise personnel on ITG’s securities lending desk who improperly handled pre-released ADRs.”
“Our charges against DBTCA and DBSI show that entities can’t just rely on representations from other professionals when they have doubts about their validity,” Sanjay Wadhwa, senior associate director of the SEC’s New York regional office, says in a statement. “The charges also highlight the importance of supervising employees who use counterparties to engage in suspect transactions.”
FTF News contacted a Deutsche Bank spokesperson for comment.
“The bank provided substantial cooperation to the SEC in its inquiry and voluntarily stopped engaging in pre-release ADR transactions entirely by late 2016,” the spokesperson replied, declining to comment further.
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