SEC, MSRB, FINRA to Hold Compliance Outreach Program for Municipal Advisors

The Securities and Exchange Commission, Municipal Securities Rulemaking Board (MSRB), and Financial Industry Regulatory Authority (FINRA) today announced the opening of registration for the Compliance Outreach Program for Municipal Advisors. 

There is no cost to attend the program, which provides an open forum for municipal advisory industry professionals to discuss compliance practices with regulators and promote a more effective compliance structure for regulatory obligations of municipal advisors.  The event will be held at the SEC’s Atlanta Regional Office on November 8, from 9:00 a.m. to 4:00 p.m. ET, and webcast live on the SEC’s website. Additional information, including the agenda, is available on the SEC, MSRB, and FINRA websites.

The SEC’s Office of Compliance Inspections and Examinations (OCIE) and Office of Municipal Securities are partnering with the MSRB and FINRA to sponsor the program.  Topics of discussion include the duties and standards of conduct for non-solicitor municipal advisors under MSRB Rule G-42 and the Securities and Exchange Act of 1934, and municipal advisor compliance with supervision, registration, and books and records rules. The program also will include a roundtable discussion among the regulators and a question and answer session with participants.

“This program is designed to promote compliance with municipal advisor regulations and affords the industry the opportunity to hear from all three regulators on the regulatory obligations of municipal advisors,” said Rebecca Olsen, Deputy Director of the SEC’s Office of Municipal Securities.  Suzanne McGovern, Assistant Director of the SEC’s broker-dealer and municipal advisor examination programs, added, “This municipal advisor outreach will take a deeper dive into regulatory requirements and their practical implementation, helping municipal advisor professionals ensure proper regulatory compliance.”

MSRB Executive Director Lynnette Kelly said, “This program is consistent with the MSRB’s goal of assisting municipal advisors in understanding and complying with their regulatory obligations, and municipal advisors will benefit from getting first-hand feedback from our staff.”

Mike Rufino, FINRA’s Head of Member Regulation-Sales Practice, said, “Any firm that wants to enhance its understanding of the regulatory expectations in the important areas of fiduciary duty and supervision will benefit from participating in the outreach program.”

Registration is being administered by the MSRB and is open to all municipal advisor industry professionals, with a maximum of two in-person attendees per firm. In-person attendance is limited to a first-come, first-served basis.  For those who cannot attend in person, the program will be webcast live on the SEC’s website. 

Register to attend the program here.  Information on accessing the webcast and the links to program materials will be posted on the SEC, MSRB, and the FINRA websites on the day of the program.

Former Amazon Employee and College Friend Charged With Insider Trading

The Securities and Exchange Commission today announced insider trading charges against a former Amazon financial analyst who allegedly leaked confidential information to his former fraternity brother in advance of a company earnings announcement so they could turn an illegal profit.  The college friend and his trading partner also are charged in the SEC’s complaint.

The SEC alleges that Brett Kennedy accessed nonpublic 2015 first quarter earnings information without authorization while working at Amazon and shared it with Maziar Rezakhani, who illegally traded on the financial results before their public release to make more than $116,000 in illicit profits.  According to the SEC’s complaint, Rezakhani paid Kennedy $10,000 in cash for the tip and also shared the trading profits with Sam Sadeghi, who was advising him on his brokerage account trades and joined Rezakhani at a meeting with Kennedy to discuss the nonpublic information.  The SEC’s complaint alleges that Rezakhani and Sadeghi aimed to establish a successful track record with the trading in Rezakhani’s brokerage account and together open a hedge fund in New York that would accept investments from others.

According to the SEC’s complaint, Rezakhani boasted on at least two trading-related internet communication platforms in the days leading up to Amazon’s earnings announcement that he was predicting first quarter revenue of $22.7 billion and earnings per share of -$0.12, writing that the “numbers are so obvious” that a “5 year old can guess what they will do.”

Jina L. Choi, Director of the SEC’s San Francisco Regional Office, said, “As alleged in our complaint, Rezakhani boasted on social media that he could accurately predict Amazon’s financial performance.  But he failed to predict that we would catch him and his accomplices in their illegal scheme.”

Sadeghi and Kennedy agreed to settlements that are subject to court approval.  Without admitting or denying the allegations, Sadeghi agreed to pay disgorgement of $11,599.74 plus $1,035.39 in interest and an $11,599.74 penalty for a total of $24,214.87.  Kennedy agreed to pay disgorgement of $10,000 plus interest of $875.36.  In a parallel action, the U.S. Attorney’s Office for the Western District of Washington today announced criminal charges against Kennedy.

The SEC’s investigation was conducted by Sallie Kim and supervised by Steven Buchholz of the San Francisco office.  The litigation against Rezakhani will be led by Ms. Kim and Mr. Buchholz.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Western District of Washington and the Federal Bureau of Investigation.

State Street Paying Penalties to Settle Fraud Charges and Disclosure Failures

The Securities and Exchange Commission today announced that State Street has agreed to pay more than $35 million to settle charges that it fraudulently charged secret markups for transition management services and separately omitted material information about the operation of its platform for trading U.S. Treasury securities.

An SEC order finds that State Street’s scheme to overcharge transition management customers generated approximately $20 million in improper revenue for the firm.  State Street used false trading statements, pre-trade estimates, and post-trade reports to misrepresent its compensation on various transactions, especially purchases and sales of bonds and other securities that trade outside large transparent markets.  When one customer detected some hidden markups and confronted State Street employees, they falsely called it a “fat finger error” and “inadvertent commissions” in order to conceal the scheme.   

“Agreeing to a fee arrangement and then secretly tucking in hidden, unauthorized markups is fraudulent mistreatment of customers,” said Paul G. Levenson, Director of the SEC’s Boston Regional Office that investigated the overcharges.

In a separate SEC order, the agency finds that State Street failed to inform subscribers to its government securities trading platform called GovEx that despite marketing the system as “fair and transparent” it provided one subscriber with a “Last Look” trading functionality that allowed a short period of time for the subscriber to reject a match to a submitted quote.  The subscriber used Last Look to reject 57 matches that each had a $1 million face value.  State Street did not inform the counterparties that their orders had been rejected with Last Look.  While developing Last Look, State Street even told one subscriber that the platform did not have Last Look functionality at all.

“Firms that run trading platforms cannot mislead subscribers about their order handling operations,” said Kathryn A. Pyszka, Associate Director of the SEC’s Chicago Regional Office that investigated the GovEx-related disclosure failures. 

State Street Bank and Trust Company agreed to pay a $3 million penalty without admitting or denying the findings that its GovEx-related disclosure failures violated Section 17(a)(2) of the Securities Act of 1933.  The SEC’s investigation was conducted by Jonathan I. Katz of the Chicago office and Marcus D. Fruchter of the Market Abuse Unit, and the case was supervised by Ms. Pyszka, Joseph G. Sansone, and Robert A. Cohen.

State Street Global Markets LLC, State Street Global Advisors Funds Distributors LLC, and State Street Bank and Trust Company agreed to pay a $32.3 million penalty to settle the fraud charges for the hidden transition services markups, which violated Sections 17(a)(1) and (3) of the Securities Act of 1933 as well as Section 15(c)(1) and Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5(a) and (c).  State Street Corporation and certain foreign subsidiaries previously agreed to pay separate penalties to U.S. criminal authorities and the United Kingdom’s Financial Conduct Authority.  The SEC’s investigation was conducted by Eric Heining, Rory Alex, Rua Kelly, and Paul Block of the Boston office with assistance from examiner Mark Gera.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the District of Massachusetts, Fraud Section of the U.S. Department of Justice, Federal Bureau of Investigation, United Kingdom’s Financial Conduct Authority, and City of London Police.

SEC Announces Agenda for September 13 Meeting of the Advisory Committee on Small and Emerging Companies

The Securities and Exchange Commission today announced the agenda for the next meeting of its Advisory Committee on Small and Emerging Companies.  The committee will discuss the Sarbanes-Oxley Act auditor attestation requirement and explore whether updates are needed to Securities Act Rule 701, which many companies use to provide stock and option awards.  The committee also will vote on a final report that would be issued before the committee’s charter expires on September 24.

The September 13 meeting will begin at 9:30 a.m. in the multipurpose room at the SEC’s headquarters at 100 F Street, N.E., Washington, D.C., and is open to the public.  It will be webcast live on the SEC’s website and archived on the website for later viewing. 

The committee provides a formal mechanism for the SEC to receive advice and recommendations on privately held small businesses and publicly traded companies with a market capitalization less than $250 million.

Members of the public who wish to provide their views on the matters to be considered by the committee may submit comments electronically or on paper.  Please submit comments using one method only.  Information that is submitted will become part of the public record of the meeting.

Electronic submissions:

Use the SEC’s Internet submission form or send an e-mail to rule-comments@sec.gov.

Paper submissions:

Send paper submissions to Brent Fields, Secretary, Securities and Exchange Commission, 100 F Street, N.E., Washington, D.C. 20549-1090.

All submissions should refer to File Number 265-27, and the file number should be included on the subject line if e-mail is used.

Agenda

Radio Host Charged With Concert Ticket Investment Scam

The Securities and Exchange Commission today charged a sports radio personality and another New York City man with stealing millions of dollars from investors who were allegedly promised their funds would be used for the purchase and resale of concert tickets.

In a complaint filed in federal district court in Manhattan, the SEC alleges that Craig Carton and Joseph Meli falsely claimed they had access to large blocks of face value tickets to popular concert performances.  According to the SEC’s complaint, investors were falsely promised high returns from the price markups in ticket resales.  But instead of purchasing tickets for resale, Carton and Meli allegedly misappropriated at least $3.6 million to repay earlier investors and cover such other expenses as Carton’s gambling debts.  Carton allegedly stole an additional $2 million by tricking a concert venue into forwarding an investor’s money into a bank account belonging to one of Carton’s companies. 

According to the SEC’s complaint, one investor was provided documents falsely representing that large blocks of Adele tickets were being purchased at face value directly from Adele’s management company when in fact no such agreement was in place.  Meli was separately charged earlier this year with operating a Ponzi scheme involving purported resales of tickets to the Broadway musical Hamilton and other events.

“As alleged in our complaint, investors were lured with promises of big profits from resales of A-list concert tickets, but little did they know their money was being used to cover Carton’s gambling debts among other things,” said Paul Levenson, Director of the SEC’s Boston Regional Office.

The SEC’s complaint seeks disgorgement of ill-gotten gains plus interest and penalties against Carton and Meli along with six businesses they control: Advance Entertainment LLC, AdvanceM Ltd., Misoluki Inc., Misoluki LLC, Ticket Jones LLC, and Tier One Tickets LLC.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Carton.

The SEC’s case is being handled by Dahlia Rin, John McCann, Martin Healey, and Celia Moore of the Boston office.  The SEC appreciates the assistance of the FBI and the U.S. Attorney’s Office for the Southern District of New York.

Radio Host Charged With Concert Ticket Investment Scam

The Securities and Exchange Commission today charged a sports radio personality and another New York City man with stealing millions of dollars from investors who were allegedly promised their funds would be used for the purchase and resale of concert tickets.

In a complaint filed in federal district court in Manhattan, the SEC alleges that Craig Carton and Joseph Meli falsely claimed they had access to large blocks of face value tickets to popular concert performances.  According to the SEC’s complaint, investors were falsely promised high returns from the price markups in ticket resales.  But instead of purchasing tickets for resale, Carton and Meli allegedly misappropriated at least $3.6 million to repay earlier investors and cover such other expenses as Carton’s gambling debts.  Carton allegedly stole an additional $2 million by tricking a concert venue into forwarding an investor’s money into a bank account belonging to one of Carton’s companies. 

According to the SEC’s complaint, one investor was provided documents falsely representing that large blocks of Adele tickets were being purchased at face value directly from Adele’s management company when in fact no such agreement was in place.  Meli was separately charged earlier this year with operating a Ponzi scheme involving purported resales of tickets to the Broadway musical Hamilton and other events.

“As alleged in our complaint, investors were lured with promises of big profits from resales of A-list concert tickets, but little did they know their money was being used to cover Carton’s gambling debts among other things,” said Paul Levenson, Director of the SEC’s Boston Regional Office.

The SEC’s complaint seeks disgorgement of ill-gotten gains plus interest and penalties against Carton and Meli along with six businesses they control: Advance Entertainment LLC, AdvanceM Ltd., Misoluki Inc., Misoluki LLC, Ticket Jones LLC, and Tier One Tickets LLC.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Carton.

The SEC’s case is being handled by Dahlia Rin, John McCann, Martin Healey, and Celia Moore of the Boston office.  The SEC appreciates the assistance of the FBI and the U.S. Attorney’s Office for the Southern District of New York.

Fee Rate Advisory #1 for Fiscal Year 2018

The Securities and Exchange Commission today announced that in fiscal year 2018 the fees that public companies and other issuers pay to register their securities with the Commission will be set at $124.50 per million dollars.

The securities laws require the Commission to make annual adjustments to the rates for fees paid under Section 6(b) of the Securities Act of 1933 and Sections 13(e) and 14(g) of the Securities Exchange Act of 1934.  The Commission must set rates for the fees paid under Section 6(b) to levels that the Commission projects will generate collections equal to annual statutory target amounts.  The Commission’s projections are calculated using a methodology developed in consultation with the Congressional Budget Office and the Office of Management and Budget.  The statutory target amount for fiscal year 2018 is $620 million.  The annual adjustment to the fee rate under Section 6(b) also sets the annual adjustment to the fee rates under Sections 13(e) and 14(g).

By law, the annual rate changes for fees paid under Section 6(b) of the Securities Act of 1933 and Sections 13(e) and 14(g) of the Securities Exchange Act of 1934 must take effect on the first day of each fiscal year.  Therefore, effective Oct. 1, 2017, the Section 6(b) fee rate applicable to the registration of securities, the Section 13(e) fee rate applicable to the repurchase of securities, and the Section 14(g) fee rates applicable to proxy solicitations and statements in corporate control transactions will increase from $115.90 per million dollars to $124.50 per million dollars.  The Section 6(b) rate is also the rate used to calculate the fees payable with the Annual Notice of Securities Sold Pursuant to Rule 24f-2 under the Investment Company Act of 1940.

The Commission will issue further notices as appropriate to keep the public informed of developments relating to fees under Section 6(b), Section 13(e) and Section 14(g).  These notices will be posted on the Commission’s Internet Web site at www.sec.gov.

Muni Bond Issuer and Underwriter Charged With Disclosure Failures

The Securities and Exchange Commission today announced that a municipal financing authority in Beaumont, California, and its then-executive director have agreed to settle charges that they made false statements about prior compliance with continuing disclosure obligations in five bond offerings.

Also settling charges are the underwriting firm behind those offerings and its co-founder for failing to conduct reasonable due diligence on the continuing disclosure representations.

The SEC’s Enforcement Division uncovered the violations as part of a review of municipal issuers and underwriters that did not voluntarily self-report under the agency’s Municipalities Continuing Disclosure Cooperation (MCDC) Initiative.  The Beaumont Financing Authority and the underwriter, O’Connor & Company Securities Inc., would have been eligible for more lenient remedies had they self-reported during the MCDC Initiative.

According to the SEC’s order, the Beaumont Financing Authority had issued approximately $260 million in municipal bonds in 24 separate offerings from 2003 to 2013 for the development of public infrastructure.  For each of those offerings, a community facilities district established by Beaumont agreed to provide investors with annual continuing disclosures, including important financial information and operating data.  From at least 2004 to April 2013, the district regularly failed to provide investors with the promised information.  The Beaumont Financing Authority failed to disclose this poor record of compliance when it conducted the 2012 and 2013 offerings totaling more than $32 million.  As a result, the bonds appeared more attractive and investors were misled about the likelihood that the district would comply with its continuing disclosure obligations in the future.

“Investors in municipal bonds depend on timely and complete continuing disclosure from municipal issuers,” said LeeAnn Ghazil Gaunt, Chief of the SEC Enforcement Division’s Public Finance Abuse Unit.  “Issuers and underwriters will continue to be held accountable when they fail to provide investors with an accurate picture of past compliance with continuing disclosure obligations.”

In a complaint filed in the Eastern Division of the U.S. District Court for the Central District of California, the SEC charged Beaumont’s then-city manager Alan Kapanicas, who also served as the Beaumont Financing Authority’s executive director.  According to the complaint, he approved and signed the misleading offering documents.  Kapanicas agreed to settle the charges without admitting or denying the allegations, and pay a $37,500 penalty.  He also agreed to be barred from participating in any future municipal bond offerings. 

In consenting to an SEC order without admitting or denying the findings, the Beaumont Financing Authority agreed to retain an independent consultant to review its policies and procedures.  It also is required to establish appropriate and comprehensive policies, procedures, and training for employees as well as designate a compliance officer in order to ensure compliance with continuing disclosure agreements. 

O’Connor & Company Securities Inc. and its co-founder and former primary investment banker Anthony Wetherbee agreed to settle the charges against them without admitting or denying the SEC’s findings.  O’Connor & Company Securities Inc. will pay a $150,000 penalty and retain an independent compliance consultant to review its policies and procedures.  Wetherbee will pay a $15,000 penalty and serve a suspension from the securities industry for six months.

The SEC’s investigation was conducted by Steven Varholik and Jason H. Lee of the Public Finance Abuse Unit with assistance from Deputy Chief Mark R. Zehner, Jonathan Wilcox, and Creighton L. Papier.  The investigation was supervised by Monique C. Winkler.   

SEC Charges Investment Adviser With Defrauding Professional Athlete and His Wife

The Securities and Exchange Commission today charged investment adviser Jeremy Drake with defrauding two clients, a high profile professional athlete and the athlete’s wife, by deceiving them about the investment advisory fees they were paying.  The SEC alleges that Drake went to elaborate lengths to conceal his fraud, including creating and sending false documents and masquerading as another person to corroborate his lies. 

The SEC alleges that Drake, then with Los Angeles-based HCR Wealth Advisors, deceived the clients for more than three years, telling them that they paid a special “VIP” annual rate of 0.15 to 0.20 percent of their assets under management when in fact they paid 1 percent.  Drake’s deception led the clients to pay $1.2 million more in management fees than Drake represented.  Drake personally received approximately $900,000 of incentive-based compensation based on the fees paid by the clients during the course of his deception.

According to the SEC’s complaint filed in the U.S. District Court for the Central District of California, Drake repeatedly lied to the clients and their representatives and sent false and misleading emails, deceptive fee reports, and other fabricated documents.  The complaint alleges that in June 2016, as one of the clients demanded an explanation about the fees, Drake created the persona of “Ron Stenson,” who purportedly corroborated Drake’s story.  Upon discovery, the complaint alleges that Drake admitted to one of the clients that he had been lying and warned her that reporting his misconduct could result in bad publicity for her husband.

“As alleged in our complaint, these two clients trusted Drake to manage their investments, but all the while Drake was lying to them and then tried to conceal his lies by fabricating documents and even acting as an imposter to back up his claims,” said Michele Wein Layne, Director of the SEC’s Los Angeles Regional Office.

The SEC charged Drake with violating and aiding and abetting violations of the anti-fraud provisions of the Investment Advisers Act of 1940.  The SEC is seeking a permanent injunction, return of Drake’s allegedly ill-gotten gains plus interest, and penalties.

The SEC’s investigation, which is continuing, has been conducted by M. Lance Jasper and Spencer E. Bendell, and the litigation will be led by Kristin Escalante.  

Hedge Fund Adviser Charged for Inadequate Controls to Prevent Insider Trading

The Securities and Exchange Commission today announced that hedge fund advisory firm Deerfield Management Company L.P. has agreed to pay more than $4.6 million to settle charges that it failed to establish, maintain, and enforce policies and procedures reasonably designed to prevent the misuse of inside information, including information about confidential government decisions.

The case relates to insider trading charges that the SEC recently filed against current and former Deerfield analysts, a political intelligence analyst who passed them information, and an employee at the Centers for Medicare and Medicaid Services (CMS). 

According to the SEC’s order, Deerfield conducted extensive research in the health care sector to help inform its investment decisions, and engaged research firms specializing in political intelligence about upcoming regulatory and legislative decisions.  But Deerfield’s policies and procedures required only an initial review of the research firms’ own policies and procedures, and Deerfield otherwise placed the burden on its own employees to police themselves by identifying issues and informing supervisors.

The SEC’s order finds that Deerfield was on notice that the political intelligence analyst might be conveying material, nonpublic information.  An email from the analyst said that he “heard from a reliable cms source” that CMS was about to issue a regulation, and an internal Deerfield email noted that the analyst “has a guy” at a “closed-door” government meeting.  From at least May 2012 to November 2013, Deerfield generated more than $3.9 million in trading profits based on material, nonpublic information from the political intelligence analyst.  Through its management agreements with the hedge funds, including performance-based compensation, Deerfield received approximately $714,110 due to these trades. 

“An investment adviser’s policies and procedures must be tailored to address the specific risks presented by its business.  Deerfield relied on political intelligence firms, creating a risk that it would receive and trade on illegal inside information.  As it turns out, that is exactly what happened,” said Robert A. Cohen, Co-Chief of the SEC Enforcement Division’s Market Abuse Unit. 

Without admitting or denying the findings, Deerfield consented to the SEC’s order finding that it violated Section 204A of the Investment Advisers Act of 1940 by failing to establish, maintain, and enforce policies and procedures reasonably designed to prevent the misuse of material, nonpublic information.  Deerfield is censured and required to pay disgorgement of $714,110 plus interest of $97,585 and pay a penalty of $3,946,267. 

The SEC’s investigation was conducted by Ann Rosenfield, Patrick McCluskey, and Carolyn Welshhans in the Market Abuse Unit.  The SEC’s ongoing litigation in the insider trading matter is being led by Gregory Bockin and Cheryl Crumpton.  The case has been supervised by Mr. Cohen.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Southern District of New York, the Federal Bureau of Investigation, and the Department of Health and Human Services Office of Inspector General.  

Commission and Commission Staff Issue Updates to Interpretive Guidance on Revenue Recognition

The Securities and Exchange Commission today issued two releases and the SEC staff released a Staff Accounting Bulletin to update interpretive guidance regarding revenue recognition.

Consistent with developments in private-sector accounting standard setting, the SEC issued a release to update its guidance for bill-and-hold arrangements by stating that registrants should no longer refer to the criteria in Accounting and Auditing Enforcement Release No. 108, In the Matter of Stewart Parness (AAER 108), to recognize revenue for such arrangements upon the registrants’ adoption of Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers. The release states that until a registrant adopts ASC Topic 606, it should continue referring to the guidance included in AAER 108.

In addition, the SEC issued a release to update its 2005 Commission Guidance Regarding Accounting for Sales of Vaccines and Bioterror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile. The release states that consistent with ASC Topic 606, manufacturers should recognize revenue for vaccines that are placed into the Vaccines for Children Program and the Strategic National Stockpile.  The release states that until a registrant adopts ASC Topic 606, it should continue referring to the guidance included in the 2005 Release.

Separately, the SEC’s Office of the Chief Accountant and Division of Corporation Finance released Staff Accounting Bulletin (SAB) No. 116 that brings existing SEC staff guidance into conformity with the Financial Accounting Standard Board’s adoption of and amendments to ASC Topic 606. The SAB modifies SAB Topic 13, Revenue Recognition, SAB Topic 8, Retail Companies, and Section A, Operating-Differential Subsidies of SAB Topic 11, Miscellaneous Disclosure. The guidance in SAB 116 applies upon a registrant’s adoption of ASC Topic 606. Until such time, the SAB states that registrants should continue referring to prior staff guidance on revenue recognition.

The statements in Staff Accounting Bulletins are not Commission rules or interpretations nor are they published as bearing the Commission’s official approval.  They represent interpretations and practices followed by the SEC’s Office of the Chief Accountant and the Division of Corporation Finance in administering the federal securities laws.

Banca IMI Securities to Pay $35 Million for Improper Handling of ADRs in Continuing SEC Crackdown

The Securities and Exchange Commission today announced that broker Banca IMI Securities Corp. (BISC), an indirect, wholly-owned U.S. subsidiary of Italian bank Intesa Sanpaolo SpA, has agreed to pay more than $35 million to settle charges that it violated federal securities laws when it requested the issuance of and received American Depositary Receipts (ADRs) without possessing the underlying foreign shares.

ADRs are U.S. securities that represent shares of a foreign company, and for all issued ADRs there must be a corresponding number of foreign shares held in custody at a depositary bank.  Under “pre-release agreements,” brokers such as BISC may obtain ADRs without depositing corresponding foreign shares provided the broker owns or takes reasonable steps to determine that the customer owns the number of foreign shares that corresponds to the number of shares the ADR represents.

The SEC’s order finds that BISC obtained pre-released ADRs and lent them to counterparties without satisfying the proper requirements.  BISC’s improper handling of ADRs, which lasted from at least January 2011 to August 2015, made it possible for such ADRs to be used for inappropriate short selling or inappropriate profiting around dividend record dates.  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 tax withholding.  Pre-released ADRs that were improperly issued were used to satisfy that demand. 

Earlier this year, broker ITG settled charges for similar misconduct.

“U.S. investors who invest in foreign companies through ADRs have a right to expect market professionals to create new ADRs only when they are backed by foreign shares so that the new ADRs are not used to game the system,” said Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office.  “As our order finds, BISC’s actions left the ADR markets ripe for potential abuse.”

The SEC’s order finds that BISC violated 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, BISC agreed to be censured and pay more than $18 million in disgorgement plus more than $2.3 million in interest and a $15 million penalty.  The SEC’s order acknowledges BISC’s cooperation in the investigation and its remedial actions.

The SEC’s continuing investigation is being conducted by William Martin, Andrew Dean, Elzbieta Wraga, and Adam Grace of the New York office and supervised by Mr. Wadhwa.