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Heath v. Securities and Exchange Commission

November 4, 2009

THOMAS W. HEATH III, PETITIONER,
v.
SECURITIES AND EXCHANGE COMMISSION, RESPONDENT.



SYLLABUS BY THE COURT

Petitioner Thomas W. Heath III appeals from the Opinion and Order of the Securities and Exchange Commission ("SEC"), affirming the New York Stock Exchange LLC's ("NYSE") finding that Petitioner violated NYSE Rule 476(a)(6) by disclosing a client's confidential information to a third party. Rule 476(a)(6) -- the so-called "J&E Rule" -- subjects registered members to disciplinary sanctions for engaging in "conduct or proceeding inconsistent with just and equitable principles of trade." The NYSE found that, although Petitioner did not act in bad faith, he engaged in unethical conduct in violation of the J&E Rule. Petitioner now appeals the SEC's Opinion and Order, arguing that: (1) bad faith, and not mere unethical conduct, was required to sustain the J&E Rule violation; (2) alternatively, if the J&E Rule does in fact prohibit mere unethical conduct in this case, it failed to provide adequate notice that his conduct was sanctionable; and (3) the NYSE improvidently granted summary judgment against him by failing to resolve questions of fact and draw reasonable inferences in his favor. Because we conclude that Petitioner's arguments lack merit, we deny the Petition.

The opinion of the court was delivered by: Straub, Circuit Judge

Argued: September 16, 2009

Before STRAUB AND WESLEY, Circuit Judges AND GARDEPHE, District Judge.*fn1

Petitioner Thomas W. Heath III appeals from the Opinion and Order of the Securities and Exchange Commission ("SEC"), affirming the New York Stock Exchange LLC's*fn2 ("NYSE") finding that Petitioner violated NYSE Rule 476(a)(6) by disclosing a client's confidential information to a third party.*fn3 Rule 476(a)(6) -- the so-called "J&E Rule" -- subjects registered members to disciplinary sanctions for engaging in "conduct or proceeding inconsistent with just and equitable principles of trade." The NYSE found that, although Petitioner did not act in bad faith, he engaged in unethical conduct in violation of the J&E Rule.On appeal to the SEC, Petitioner argued that bad faith is required to sustain a J&E Rule violation. The SEC held that a finding of mere unethical conduct was sufficient to sustain a J&E Rule violation for a breach of confidence and affirmed the NYSE's finding that he violated the Rule by making the disclosure. Petitioner now appeals the SEC's Opinion and Order, principally arguing that bad faith, and not mere unethical conduct, was required to sustain the J&E Rule violation. He argues alternatively that, if the J&E Rule does in fact prohibit mere unethical conduct in this case, it failed to provide adequate notice that his conduct was sanctionable. Finally, he argues that the NYSE improvidently granted summary judgment against him by failing to resolve questions of fact and draw reasonable inferences in his favor. Because we conclude that Petitioner's arguments lack merit, we deny the Petition.

BACKGROUND

I. Factual Background

Petitioner joined J.P. Morgan Securities as an investment banker in its Financial Institutions Group in 1992, where he advised financial institutions in connection with mergers and acquisitions. He ultimately became a Managing Director and remained with J.P. Morgan until 2005.

Hibernia Bank was a client of J.P. Morgan. Petitioner covered the account for nine years. Petitioner testified that he was close to the CEO of Hibernia, both professionally and personally. Through this relationship, he secured J.P. Morgan's engagement as Hibernia's financial advisor in connection with its merger with Capital One Corp. Hibernia "formally engaged" J.P. Morgan in this capacity on February 25, 2005.

In mid-January of that year, Antonio Ursano, Global Head of Bank of America's Financial Institutions Group, contacted Petitioner, unsolicited, and proposed that Petitioner join Bank of America as the sole head of its bank group. Petitioner met with him and initially indicated he was not interested. They met again, at Ursano's insistence, and Ursano offered Petitioner a job for two years at $3 million per year, with the understanding that he would be promoted within the year to succeed Ursano as head of Bank of America's Financial Institutions Group. Petitioner said that he would consider it, and, on February 13, 2005, he gave Ursano a verbal commitment to join Bank of America (pending a written agreement).

Ursano asked Petitioner to begin in one week, but Petitioner said "that he was working on a large transaction which he felt he needed to complete both in the interest of his client and of his current employer." He did not disclose any further details regarding the "transaction" at that time. While he did not say so explicitly to Ursano, Petitioner was referring to the Hibernia and Capital One merger. Petitioner believed that leaving J.P. Morgan without closing the Hibernia and Capital One deal would be disruptive to the transaction, and to Hibernia particularly.

On February 18, Petitioner informed Tim Main, his supervisor at J.P. Morgan, that he intended to join Bank of America, but that he would stay at J.P. Morgan to secure the Hibernia engagement and "get the deal across the finish line." Main agreed that it was the "honorable" thing to do. Petitioner emphasizes that he had no monetary interest in completing the acquisition at J.P. Morgan and he intended to forfeit any deal-based bonus by resigning prior to fiscal year end.

Ursano asked Petitioner to meet Eric Corrigan, the then-head of Bank of America's Depository Institutions Group, who would have reported to Petitioner upon his arrival. They met on February 23. The purpose of their meeting was to get acquainted with each other and to begin developing a working relationship. They did not discuss Hibernia at this meeting. Petitioner testified that Corrigan seemed to think that they were going to be co-heads of the bank group and not that Petitioner was coming on as the sole head.

Two days later, on February 25, Petitioner received an offer letter from Bank of America, which stated that he would join as a Managing Director and head of banks for the Financial Institutions Group (reporting to Ursano, who was the head of the Financial Institutions Group) with compensation of approximately $6 million over two years.

On March 1, Ursano asked Petitioner to discuss with Corrigan how they were going to work out coverage on their joint accounts, and to assure Corrigan that he was a "decent guy" and a "good partner" who was "not going to stomp all over him" on those accounts. Petitioner and Corrigan had a phone conversation that day during which Petitioner made suggestions about how Corrigan could get involved in Petitioner's accounts and invited Corrigan to meet with a number of his clients. Petitioner testified that his objective was to "build [Corrigan] up" and to let him know that he had heard "nice things" about him from clients, and that he would be "there to help out" if Corrigan needed it.

Near the end of this conversation, Corrigan asked about Petitioner's pending transaction, stating that "there are a lot of rumors out in the marketplace. And [we] . . . know you have a bank deal somewhere down in the south." Petitioner testified that he initially refused to divulge any information regarding the Hibernia acquisition, but eventually responded: "if you really want to know, I will tell you exactly what it is, but you have to understand, you know, I've got a week to go. This is obviously confidential information. The deal is done, bankers have been hired, nothing is going to change. And you just have to understand and respect that." Corrigan replied, "well, are you comfortable telling me?" Petitioner responded, "the real question is, are you comfortable with me telling you because you're the one that can't act on this in any way." Corrigan replied, "I can understand that, I can keep a secret." At that point, Petitioner disclosed that Capital One was acquiring Hibernia; J.P. Morgan was representing Hibernia in the deal; forty-five percent of the deal was being funded with cash; the deal had been in motion before January; and Hibernia believed that Capital One's price-to-earnings ratio was sufficiently low that it gave Hibernia a "degree of comfort with the stock."

Petitioner testified that he disclosed this information to Corrigan for "a couple of reasons":

I think that you have to understand that I was talking to someone who, as the gray area merged, was increasingly more of a colleague. And I realize that that is technically not what was going on, but the whole gist of the conversation was business going forward. The -- the -- you know, the conversation itself, I had mentioned that, you know -- I said, well, there's a good marketing piece that we'll talk about going forward. . . . I'm dealing with someone who's going to be a colleague. I'm dealing with someone who the whole purpose of this thing is to build trust and -- and build a collegiality with. I'm -- the conversation has gone more towards marketing and this deal had direct relevance. The final thing that I will tell you is when he says they are hearing rumors and they know I've got something in the south, I mean, my forehead just beaded up with sweat, I'm terrified. And my view was -- that I basically put a firewall around the problem and I sincerely believe that. And I know in hindsight that is incredibly stupid particularly given what happened. But understand, I knew with 100 percent certainty there was zero role for -- for B of A in that deal, zero.

Throughout his testimony, Petitioner emphasized that he was attempting to prevent Corrigan and others at Bank of America from "snooping" around the deal. As he put it, he was attempting to "put a firewall around the problem."

Corrigan confirmed to Petitioner that he understood that he could not act on the information in any way, and Petitioner believed that Corrigan, an experienced industry professional and future colleague, would keep the information confidential as he had promised. That same day, however, Corrigan disclosed the information to Thomas Chen, the head of Bank of America's Diversified Financial Services Group. Chen in turn left a voicemail message for the head of Capital One's mergers and acquisitions group, inquiring whether there was a role for Bank of America on the deal.

On March 3, while Petitioner was in a meeting at Bank of America, Corrigan invited Petitioner to stop by his office. During their conversation, Corrigan asked Petitioner how the Hibernia deal was going and whether there was room for another advisor on the merger. Petitioner testified that he was emphatic in saying that there was no way that could happen and that he thought he had made that "abundantly clear" in their prior conversation and he was shocked that Corrigan even asked. He made clear that "it's Morgan and Bear Sterns [at Hibernia] and at Capital One it's Credit Suisse First Boston and nothing is going to change." Corrigan made no mention of the call to Capital One or the fact that he disclosed the information to Chen.

On March 6, the merger agreement between Hibernia and Capital One was signed and announced by The Wall Street Journal. The total transaction was valued at approximately $5.3 billion, representing a 24% premium or approximately $1 billion over the closing price of Hibernia shares on Friday, March 4. As Petitioner had disclosed to Corrigan, Credit Suisse First Boston acted as financial advisor to Capital One, and J.P. Morgan and Bear Stearns acted as financial advisors to Hibernia (with J.P. Morgan as the lead advisor). Neither the terms of the deal nor the parties' financial advisors had changed since Petitioner's March 1 conversation with Corrigan.

That same day, Alex Lynch, a colleague of Petitioner's from J.P. Morgan, informed Petitioner that there was "a problem." He said that Capital One received a call from Bank of America in an attempt to get itself retained, armed with "very explicit information" about the merger with Hibernia. Lynch said that "they had everything. . . . it was as if you had handed them a term sheet and they used it. . . . [W]hen we connected the dots and add it all up, it points directly at you." Petitioner was immediately put on leave.

Petitioner spoke to Corrigan that day and told him that a colleague from J.P. Morgan had told Petitioner that Bank of America approached Capital One in an attempt to get itself retained with specific details of the merger. Corrigan denied disclosing the information. Petitioner did not tell Corrigan at this point that he was put on leave. The next day he asked Corrigan again. This time Corrigan said that he "kind of did" disclose the information. Corrigan denied revealing Hibernia's role in the merger to Chen, but admitted that he suggested to Chen that the rumors that Capital One was involved in a merger were true. Petitioner then spoke to Chen, and Chen said that when he called Capital One, he mentioned only that he was aware that Capital One was involved in a bank deal.

Petitioner disclosed the entire situation to Ursano at Bank of America and recommended that he "elevate this internally to the top of the house immediately." Over the next two days, a Bank of America investigative team interviewed Corrigan, Chen and Petitioner, and, on March 1, Bank of America's counsel informed Petitioner's counsel that Bank of America believed that Petitioner did not act with any devious or malicious intent, but had made an error in judgment. On March 15, 2005, Bank of America "revoked" its offer of employment to Petitioner and fired Corrigan and Chen. J.P. Morgan had fired Petitioner the day before.

II. NYSE Proceedings

On January 25, 2006, the NYSE Division of Enforcement ("Enforcement") charged that Petitioner's disclosure violated NYSE Rule 476(a)(6), which prohibits conduct inconsistent with just and equitable principles of trade. Enforcement filed a motion for summary judgment on October 18, 2006, and Petitioner filed a competing motion on October 26, 2006. On November 24, 2006, the NYSE Hearing Board ("Hearing Board") granted summary judgment on liability against Petitioner, finding that he violated the J&E Rule by making the disclosure to Corrigan.*fn4

First, the Chief Hearing Officer cited NYSE Rule 476(c), which grants a hearing officer the authority to "resolve any and all procedural and evidentiary matters and substantive legal motions." In the Matter of NYSE Disciplinary Proceedings Against Thomas W. Heath, III, NYSE Hearing Bd. (Nov. 24, 2006), SPA at 23.*fn5 She concluded that "[t]his includes the authority to consider and, if warranted, grant a motion for summary judgment." Id. She held that "[a] Hearing Officer's power to decide a summary judgment motion under NYSE Rule 476(c) is analogous to that of a federal court deciding a summary judgment motion under Rule 56." Id. at 24.

The Chief Hearing Officer explained that Petitioner's main argument is that "to prevail on its charge . . . , Enforcement must show that [he] acted in bad faith." Id. at 25. She disagreed, holding that "[a] violation of the just and equitable principles of trade codified by NYSE Rule 476(a)(6) may occur either through bad faith or unethical conduct." Id. She cited several SEC decisions for this proposition and concluded that "the concept of unethical conduct is different from--namely, that it is broader than--bad faith." Id.

The Chief Hearing Officer then found that by disclosing confidential information, Petitioner had acted unethically. She reasoned: "There is no dispute that the information that [Petitioner] disclosed to Corrigan included sensitive, nonpublic details of a transaction that had not yet been consummated. . . . It is commonly accepted that when a financial advisor takes on work that requires the communication of such sensitive, nonpublic information from the client to the advisor, the client has an expectation that the advisor will keep that information confidential." Id. at 27. She noted that "[i]t is undisputed that [Petitioner's] employer had a Code of Conduct that spelled out the duties of an employee to keep confidential certain sensitive information learned on the job." Id. at 27. She concluded:

But the duty of confidentiality at issue here stems not only from the explicit Code of Conduct, but also from the ethical obligation to which every financial advisor becomes subject upon learning of sensitive, nonpublic information about a client in the normal course of business. It is a duty that should be self-evident to any experienced financial professional. By disclosing confidential information about the pending transaction to someone who, at the time of the disclosure, was an employee of a competitor firm, [Petitioner] breached the duty that he owed to his client and thereby violated the just and equitable principles of trade.

Id. (footnote omitted).

In support of his summary judgment motion, Petitioner submitted a letter, dated February 10, 2006, from Randall Howard, Hibernia's President of Commercial Banking and a member of its board of directors at the time of the merger with Capital One. The letter stated:

I am comfortable and confident in [Petitioner's] judgment that his disclosure to a B of A subordinate was made in strict confidence with no intention that the individual would breach that confidence in any way. Moreover, at the point of the disclosure all terms of the transaction and hiring of bankers had been finalized, and the deal was in effect completed. Given the circumstances, I do not view Tom's discussion as a breach of our confidence. Had we known about this at the time, there is no remedial or regulatory action we would have sought.

I have known Tom for many years. He has always been an honest, straightforward banker, and our thoughts of him are evidenced by the fact that we looked to him as our advisor for our most important transaction. I absolutely would work with Tom again should the opportunity present itself and entrust him with the most guarded of confidences. His year-long absence from the industry leaves a large gap which has not been filled.

The Chief Hearing Officer noted that the "letter was prepared and submitted long after the breach occurred and apparently in the executive's personal capacity, rather than on behalf of the client." Id. at 27-28 n.3. She concluded, "In the absence of any contemporaneous waiver by his client, [Petitioner]'s obligation to maintain the confidentiality of his client's information is unaffected." Id. She also found that there was no competing obligation or equitable excuse to justify Petitioner's action. She explained:

Nothing in the record would indicate that [Petitioner], in the instant matter, was under any competing obligation to make the disclosures that he did or that any "equitable excuse" relieved him of his ethical obligation to keep the information confidential. Rather, his reasons for making the disclosures--while certainly lacking any malevolent or deceitful quality--were, in the final analysis, self-serving in that they were intended to gain the trust of, and thereby smooth things over with, a soon-to-be colleague. [Petitioner] admits that he made the disclosures, at least in part, to make Corrigan "understand that he was going to be a good partner and that he was not going to 'stomp all over him.'" On the record before me, I cannot find anything that excuses the unethical conduct in which [Petitioner] engaged.

Id. at 29 (citation and footnote omitted).

In a footnote, the Chief Hearing Officer also dismissed Petitioner's explanation that he made the disclosures in order to preempt Corrigan from "snooping" around the deal and acting on ...


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