Font Size: 
2nd Circuit Adopts Standard for Regulatory Sanction of Unethical Conduct
New York Law Journal
November 12, 2009
Image: Digital Vision
Regulators do not need to show bad faith when sanctioning someone for unethical conduct, the 2nd U.S. Circuit Court of Appeals has ruled.
The decision came in a case involving an investment banker who disclosed a client's confidential information, and required the circuit to interpret a New York Stock Exchange rule that subjects members to discipline for engaging in "conduct or proceeding inconsistent with just and equitable principles of trade."
The court upheld sanctions for J.P. Morgan investment banker Thomas W. Heath III in Heath v. Securities and Exchange Commission, 09-0825-ag, an appeal decided by circuit Judges Chester J. Straub and Richard C. Wesley and, sitting by designation, Southern District Judge Paul G. Gardephe.
Heath advised financial institutions in connection with mergers and acquisitions, rising to be a managing director at J.P. Morgan until 2005.
He covered J.P. Morgan's account with Hibernia Bank for nine years and Hibernia retained J.P. Morgan on Feb. 25, 2005, as its advisor for its merger with Capital One Corp.
Also in February 2005, Heath verbally accepted a job with Bank of America offered by Antonio Ursano, global head of Bank of America's financial institutions group, with the understanding that he would be allowed to finish pending business at J.P. Morgan.
Ursano instructed Heath to work with Eric Corrigan, then the head of Bank of America's depository institutions group.
Corrigan told Mr. Heath he knew that Heath was working "on a bank deal somewhere down in the south."
According to testimony before the hearing officer cited by the circuit, Heath responded: "If you really want to know, I will tell you exactly what it is, but you have to understand, you know, I have a week to go. This is obviously confidential information. The deal is done, the bankers have been hired, nothing is going to change."
Heath said he told Mr. Corrigan he could not act on the information in any manner and Corrigan replied, "I can understand that. I can keep a secret."
Heath then disclosed information about the merger.
Corrigan then told a colleague, who in turn placed a call to Capital One to try and get Bank of America a role as an advisor in the merger.
On March 6, 2005, after being confronted by a colleague on how a Bank of America representative could have had such explicit information on the pending deal, Heath was placed on leave. On March 15, even though it found that Heath had not acted with devious or malicious intent, Bank of America terminated its job offer.
The New York Stock Exchange Division of Enforcement charged the disclosure violated NYSE Rule 476(a)(6). A chief hearing officer granted summary judgment on liability in 2006 and a hearing panel imposed a penalty of censure and a $100,000 fine in 2007.
The Securities and Exchange Commission rejected Heath's appeal and he turned to the 2nd Circuit. In the court's 39-page opinion, Judge Straub said the rule, also known as the J&E Rule, is designed to help self-regulatory organizations "regulate the ethical standards of its members."
Judge Straub said there was "substantial authority" for the notion that bad faith need not be shown to support liability under the rule.
Here, he said, the chief hearing officer specifically found Heath "acted for self-serving reasons, i.e., to build a relationship with Corrigan," and dismissed his explanation "that he made the disclosures in order to preempt Corrigan from 'snooping' around the deal and acting on the information in the market place."
Judge Straub drew a distinction between this case and a case cited by Heath where the SEC was reversed by the 2nd Circuit, Buchman v. SEC, 553 F.2d 816 (1977). Buchman had applied a bad-faith standard in the context of a breach of contract.
Unlike Buchman, Judge Straub said, Heath had no "competing ethical and regulatory considerations; he owed a fiduciary duty to Hibernia to keep the information confidential and he disclosed that information in violation of his ethical obligation to his client."
The judge said, "This is a breach of confidence case, which implicates quintessential ethical considerations not necessarily implicated in a breach of contract case. Thus, the axiom that the J&E Rule prohibits mere unethical conduct and does not require scienter holds true in this case."
In the end, Judge Straub said, "It is clear from the Exchange Act and the relevant SEC and circuit precedent that the J&E Rule prohibits mere unethical conduct in a breach of confidence case."
The court rejected an argument by Heath that he had inadequate notice that his conduct in the case was prohibited.
Gary P. Naftalis of Kramer Levin Naftalis & Frankel represented Heath.
Dominick V. Freda, senior counsel for the SEC, represented the agency.
Mark Hamblett can be reached at mhamblett@alm.com.
