Legal hassles and regulatory probes against banks related to business malpractices continue unabated. As per the Wall Street Journal report, the U.S. Securities and Exchange Commission (SEC) is investigating whether large banks have been mismanaging the market for American Depositary Receipts (ADRs).
The SEC has issued subpoenas to four depositary banks – JPMorgan Chase & Co. (JPM - Free Report) , The Bank of New York Mellon Corporation (BK - Free Report) , Deutsche Bank AG (DB - Free Report) and Citigroup Inc. (C - Free Report) . The regulator is checking whether banks undermined the controls to avoid “market abuse and tax fraud.”
ADRs – created and launched by JPMorgan in 1927 – help investors to avoid complexities and expenses related to directly owning shares abroad. They also aid the foreign firms in expanding their investor base in the U.S. Notably, foreign firms transfer shares to depository banks, which are then used to back corresponding securities issued to the U.S. investors.
The SEC investigation is primarily related to the “pre-release” of ADRs, wherein banks issue depositary receipts without having the underlying shares in custody. This is basically done to flawlessly trade shares by bridging settlement times of different countries.
Nevertheless, the regulators are concerned that such practices could be used for “naked short sell”, an illegal trading method where investors bet against a company’s share without actually owning them. Further, the SEC is looking into allegations that such business practices are being used to illegally arbitrage between different tax systems.
To prevent such incidents, banks have systems in place. The brokers are required to certify that they are long on the shares and will treat shares for tax purpose as being owned by the banks. Moreover, brokers should give cash or collateral for at the least the value of the shares to banks.
The SEC is probing the effectiveness of such controls. Also, the investigation does not necessarily mean that enforcement action will be taken against banks.
Of the above-mentioned four banks, JPMorgan and BNY Mellon currently hold Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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