SEC-registered broker-dealer ITG Inc. ("ITG") agreed to pay $24.4 million to settle SEC charges alleging that it had prompted the issuance of American Depository Receipts ("ADRs") without obtaining the underlying foreign shares for "pre-release ADRs." A "pre-release ADR" is a transaction in which a broker may obtain newly issued ADRs from a depositary bank when the underlying foreign securities have been purchased prior to their delivery to the depositary bank's custodian, as long as the broker commits to owning the underlying securities.
In its Order against ITG, the SEC determined that associated persons on ITG's securities lending desk obtained and lent "pre-released" ADRs from depositary banks without taking reasonable steps to determine whether the requisite number of ordinary shares were "owned and custodied by the person on whose behalf the pre-released ADRs were being obtained." The SEC found that as a result of that conduct, ITG obtained ADRs that often were not backed by ordinary shares that were supposed to be underlying the ADRs, as required by agreements entered into between ITG and the relevant depositary bank. The SEC also determined that ITG failed to establish effective supervisory policies and procedures to prevent its associated persons from engaging in such misconduct.
Lofchie Comment: The issue of improper pre-release procedures is one that seems to arise every few years. Improper pre-release is generally in violation of the agreement that firms have with the securities depositories. It is sometimes done to obtain a tax benefit. Firms that engage in pre-release should review their transactions to confirm that they are being done properly.
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