US-based depositary bank, broker-dealer arms of German banking giant Deutsche Bank on Friday agreed to pay $75 million to settle claims that they issued American Depository Receipts (ADRs) without possessing the underlying foreign shares.
The Securities and Exchange Commission said Deutsche Bank Trust Co. Americas (DBTCA) and Deutsche Bank Securities Inc. (DBSI) provided ADRs, which are certificates representing ownership of a foreign stock, to clients without ensuring they would be backed by the actual shares. The SEC said that the pre-released ADRs were used for abusive practices, including “inappropriate short selling and inappropriate profiting around dividend payouts.”
DBTCA and DBSI, which didn’t admit or deny the claims, agreed to pay $30 million in penalties and interest and forfeit $45 million in profits, the commission added.
The SEC’s New York regional office said Deutsche Bank failure to supervise its securities lending desk caused ADRs to be issued while not backed by actual shares, leaving them ripe for potential market abuse.
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The probe of DB’s subsidiaries, which covered activity in late 2016, was related to the prerelease of ADRs, where banks issue depositary receipts without first having the underlying shares in their custody. The practice, while intended to smooth trading, could be abused for betting against a company’s stock by selling shares they don’t own, without borrowing or locating the shares needed to cover the sale. The regulator also says such receipts are being used to illegally arbitrage between different tax regimes.
Brokers who sell or transfer ADRs are typically responsible for ensuring that a matching number of foreign shares has been deposited with a custodian.
Stephanie Avakian, Co-Director of the SEC Enforcement Division, commented: “The SEC’s actions involving pre-released ADRs have revealed industry-wide abuses. Failures at each institutional link in the chain of these transactions, from depositary bank to broker-dealer, left the markets for those ADRs ripe for potential abuse at the expense of ADR holders.”
Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office, added: “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. The charges also highlight the importance of supervising employees who use counterparties to engage in suspect transactions.”