Most NYSE Findings Upheld–Bar Sustained

Janet Gurley Katz, Exchange Act Rel. 61449, February 1, 2010

Time since appeal –1 year 3 months 8 days
Time since last brief – 10 months, 29 days

NYSE found that Katz (a former registered rep) engaged in host of violations. Among other things, NYSE found she: made unauthorized transfers of customer funds to accounts of other customers; made material misstatements to customers; made unsuitable transactions in customer accounts; engaged in unauthorized trades; exercised discretion in accounts without written authorization; and entered false information on customer new account forms. NYSE permanently barred her from association with any member.

On appeal the Commission sustained the findings relating to: unauthorized transfers between customer accounts; making material misstatements to a customer about transactions in his account statement; unsuitable recommendations; unauthorized trades; exercising discretionary authority without written authorization as to some, but not all customers found by NYSE; and entering false information on one customer's new account documents (but not all customers as found by NYSE). Needless to say, the Commission found the violations both extensive and egregious and sustained NYSE's bar.

The defense focused on the legitimacy of NYSE's fact finding. This of course rarely succeeds as the Commission defers to initial fact finders and their credibility based findings. The Commission noted that it is no defense to a charge of making unsuitable recommendations that the trades resulted in gains for the customer. Further, a client who is willing to take some risk may still have unsuitable trades recommended. As the Commission noted, "A client's ... desire for risk does not relieve a registered representative of the obligation to tailor recommendations to each customer's financial profile."

This case raises no difficult issues. There is no reason why it should have taken the Commission more than fifteen months to render a decision.

NYSE Sanctions For Disclosure of Confidential Client Information Upheld - No Scienter Required For Violation of Equitable Principles Rule

Thomas W. Heath, III, Exchange Act Rel. 59223, January 9, 2009

Time since appeal filed - 1 year, 1 month, 25 days
Time since last brief - 10 months, 18 days
Pages - 20
Footnotes - 68

Summary

Heath was a rep at J.P. Morgan. NYSE found he had disclosed non-public information about a Morgan client in violation of the NYSE rule prohibiting "conduct . . . inconsistent with just and equitable principles of trade." Heath was censured and fined $100,000. The Commission upheld the sanctions.

In early 2005 Heath was an investment banker and managing director at Morgan but was planning to move to Banc of America Securities. While he was negotiating employment with Banc America Heath was managing Morgan's role as Hibernia Bank's lead advisor in connection with its proposed acquisition of Capital One. Heath accepted the offer from Banc America before the deal was completed, but intended to see it through.

Five days before the public announcement of the Hibernia deal Heath told an executive at Banc America, one Corrigan who was a former rival for the position he had been offered about the details of the acquisition, cautioning that the information was confidential and non-public.

Corrigan then contacted another Banc America executive and suggested Banc America might try to participate in the deal. That executive contacted Hibernia with a view toward trying to participate in the deal. Later Corrigan approached Heath to ask if there was room for other advisors on the transaction. After the deal was publicly announced Morgan placed Heath on leave after learning he had been the source of the leak that lead Banc America to contact Hibernia. Banc America after an inquiry revoked Heath's employment offer and terminated the two Banc America executives who were involved.

NYSE's hearing officer found in a summary judgment order that Heath had violated his duty to maintain the confidentiality of material non-public information. NYSE found that Heath's motive was self-serving as he intended to gain the trust of, and smooth things over with a soon to be colleague.

Discussion

The Commission ruled that Heath violated "one of the most fundamental ethical standards of the securities industry" by disclosing confidential client information. This duty is grounded in fundamental fiduciary principles and is codified in NYSE's Code of Conduct. It specifically prohibits disclosure of confidential information to anyone outside the firm unless authorized to do so. Such duties continue after termination of employment according to the Code.

Heath argued that he could only be found to violate the rule if he acted in bad faith. He also claimed that if a good faith violation could be punished, he did not have fair notice of such an interpretation of the rule. The Commission rejected this argument noting that it has long held that violations are established by either bad faith or unethical conduct. Thus no scienter or bad motive is required to establish a violation.

Comment

This is a strong opinion that discusses in comprehensive detail the history and interpretation of the just and equitable practices rule of NYSE and FINRA. It reiterates an important point - no scienter is required for a violation of the rule when one engages in unethical conduct. Why did the Commission labored for so long on this case as it is neither factually nor legally complex given the Commission's prior interpretation of the rule. No new ground was broken here.

Commission Upholds NYSE Bar and Limits Scope Of Discovery In "State Actor" Defense Cases

Michael Sassano, Exchange Act Rel. 58632 (September 24, 2008)

Time since appeal filed - 9 months, 21 days

Time since last brief filed - 6 months, 13 days

Pages - 23

Summary

Sassano was formerly a registered rep at Oppenheimer. He stated an intention to assert the Fifth Amendment and refused to testify in a NYSE investigation.  He claimed the NYSE investigation was so entwined with SEC and another investigation to cause it to be a "state actor" for Fifth Amendment purposes.  NYSE barred him. The Commission upheld the sanction.

NYSE's investigation involved possible frequent mutual fund trading. At the same time the New York Attorney General was conducting a similar investigation and had subpoenaed Oppenheimer. The SEC's Division of Enforcement had also issued subpoenas to Sassano and Oppenheimer in connection with a parallel investigation it was conducting. NYSE delayed Sassano's testimony twice at the request of his counsel.  Before his testimony he left his employment and his counsel requested a third postponement.  Counsel also requested that NYSE staff discuss settlement in lieu of the scheduled testimony. Sassano failed to appear at testimony session. SEC and NYSE staff then attended a meeting where Sassano's attorney made an attorney proffer. Counsel did not provide specific information during the proffer. NYSE enforcement declined the proposed cooperation offer from Sassano's attorney at the proffer session and rescheduled Sassano's testimony.  Sassano notified NYSE staff he would not appear. Sassano was then charged with failure to cooperate with the NYSE investigation.

Sassano argued to the hearing officer that a hearing should be conducted to determine, based on the Commission's Frank Quattrone decision whether the NYSE investigation constituted 

"state action" thus permitting him to invoke his Fifth Amendment rights.  The hearing officer ordered limited discovery.  The hearing panel then ruled that NYSE attendance at the proffer decision was not initiated by either the SEC or NYSE and rejected Sassano's state action claim.

The Commission noted that failure to appear for testimony establishes a prima facie violation of the cooperation rule. 

In dealing with the state action argument the opinion notes that "The 'Fifth Amendment restricts only governmental conduct and will constrain a private entity only insofar as its actions are found to be 'fairly attributable' to the government.'"  The Supreme Court has used a test for state action that requires such a "close nexus between the State and the challenged action 'that the seemingly private behavior may be fairly treated as that of the state itself.'" Factors to be considered include whether: a challenged activity is a result of the State's "coercive power;" whether the State has provided overt or covert encouragement that the private party must be deemed that of the State; whether the private party is a willful participant in joint activity with the State.  

The Commission also noted that the burden of demonstrating joint activities sufficient to invoke the state actor doctrine is high and falls on the party asserting that defense.  The opinion stated that Sassano was thus required to "demonstrate a specific nexus between the government and the [NYSE] requests for testimony. . . . "  

Sassano argued that sharing of information between NYSE, the SEC, and the New York AG was sufficient to conclude the such a nexus existed.  The Commission rejected this argument noting that it has previously ruled that cooperation and information sharing will rarely render a self regulatory organization a state actor and that such cooperation standing alone is generally insufficient to establish the defense.

The Commission also rejected a claim that the chronology of similar simultaneous investigations was sufficient to establish that NYSE was a state actor.  It noted that multiple parties pursuing similar investigative steps is not unusual. An important factor in supporting this conclusion was that Sassano had produced no evidence that NYSE was acting as a result of government "persuasion or collusion."

Of note is the Commission's comment that the joint proffer session was sufficient evidence for allowing Sassano to develop through discovery evidence of possible NYSE and SEC collusion as was done in this case.  Here, the critical fact is that the joint proffer session was proposed not by the SEC or NYSE, but was instigated by Sassano's lawyer.

The Commission also declined to order additional discovery as it has previously done in other cases of recent vintage such as Quattrone.  It explained those remands as involving cases where the SRO had not made its staff available for testimony or provided affidavits as it did here.

Comment

This case does not use the weak language about discovery remands in some of the Commission's previous state action cases.  The Commission here signals a distinct shift compared to some of those earlier cases as it makes clear that while discovery may be appropriate that process "may not [be] use[d] . . . to go on a fishing expedition . . . ."  Further, an appeal based on a state action defense "is subject to dismissal if the applicant 'fail[s] to introduce sufficient evidence' to justify his state action claim."  It also noted that discovery is not mandated whenever there is a state action claim and should be ordered only when there is a "reasonable and credible basis" to conclude the SRO was acting as a state agent.  Further, the opinion indicates that discovery should be limited.  On appeal, attempts to obtain a remand to engage in additional discovery must be extremely specific, including an explanation of specific information to be sought and an explanation of the significance of that information.

The Commission also used strong language in justifying a permanent bar for an associated person who refused to testify noting, "a complete failure to respond to a request for information . . . renders the violator presumptively unfit for employment in the securities industry."

NYSE Sanctions Against Firm For Submitting Inaccurate Trading Data Upheld

Schone-Ex, LLC, Exchange Act Rel. 57857 (May 23, 2008)

Time since appeal filed - 10 months, 7 days

Times since last brief - 7 months, 5 days

Pages - 15

Footnotes - 33

Summary

This case is interesting because the Commission adopted a "destruction of the business" test for evaluating whether fines are excessive or oppressive (the statutory test) with virtually no discussion and citation to only one case which does not rule that to be the exclusive definition of the statutory terms. 

NYSE requested that Shone-Ex (a member firm) submit data to it concerning short sale transactions through a so-called "blue sheet."  The firm made an inaccurate response and was also sanctioned for failing to supervise its blue-sheet supervisory procedures.  Blue sheets are a mechanism whereby the SEC, and other regulators request that firms supply trading data on selected trades, usually as part of a regulatory investigation.  These requests and responses are now done electronically but in the distant past (for example when I first went to work for the SEC) they were done by a paper form on blue paper sent to the firm by the regulators (and hence the name "blue sheet").  Regulators traditionally use these forms to determine the names and account numbers of traders.

NYSE censured the firm and fined it $300,000.  The Commission upheld the sanctions.

NYSE's blue sheet requests were in 2002 and 2004.  Shon-Ex executes trades for an affiliated clearing firm, Schonfeld Securities.  Both firms have the same CEO and compliance officer.  Schone-Ex contracted with an independent data processing firm to file blue sheets with regulators.  During the period in question, no one at the firm verified the accuracy of submissions made by the data processing firm even though copies were sent to the firm.  In June  2004 NYSE discovered that blue sheet responses concerning 146 trades wrongly showed 100 short trades as long.  Schone-Ex's CEO contacted the data firm, but it was slow to correct the reporting errors.  In November 2004 the firm notified NYSE that it had submitted inaccurate blue sheet responses from June through October.  Thus, the exchange did not obtain accurate data until November.  The firm did not put into place procedures to ensure the accuracy of blue sheet responses until May 2005.

At trial, even Schon-Ex's expert agreed that the blue sheet system is a vital regulatory surveillance system.  

Schone-Ex admitted that it submitted erroneous data to NYSE and did not maintain adequate procedures to verify the accuracy of data submitted on its behalf by the data processing firm. It noted that the trades were accurately recorded on its own books and that the errors were solely those of the data processing firm.

The primary challenge on appeal was Schone-Ex's claim that the penalty was excessive.  Exchange Act Section 19(e) requires that the SEC sustain NYSE sanctions unless it finds that the sanction is excessive, oppressive or imposes an unnecessary or inappropriate burden on competition.  In evaluating sanctions the SEC addresses "the nature of the violation and the mitigating factors."  The SEC also evaluates the seriousness of the offense, the harm to the investing public, the potential gain to the broker, the potential for repetition, and the deterrent value on the offending broker and others.  Further, the courts have directed that the SEC determine that sanctions are "remedial and not excessive or oppressive."

The Commission found that the record was unclear as to whether the NYSE investigation was hindered by the inaccurate submissions (indeed NYSE found that the harm to the investigation "should not weigh heavily" in assessing a penalty).  It nevertheless concluded that the misconduct was "significant."  In doing so the Commission noted the critical regulatory role of blue sheet responses.  It further noted that the inaccurate data submitted covered trades over a several year period.  The Commission found that Schone-Ex did not promptly and forcefully move to correct the problems or to put surveillance procedures into place.  

Schone-Ex also complained that in supporting the sanctions, NYSE relied on sanctions in settled disciplinary actions against other firms.  The Commission noted that NYSE rules specifically allow reference to prior disciplinary actions without exempting settlements.  

Practitioners should note that the SEC also relies on settled SEC matters as precedent for substantive law.  See, Carl L. Shipley, Release 34-10870, fn. 6 (June 21, 1974), 1974 SEC LEXIS 3113 ("A long series of such non-adjudicative orders issued in many cases may be significant for certain purposes as pointing to a settled administrative construction or practice. But an isolated order or two of [that type] is of no general import. Such cases are not to be confused with those in which we accept an offer of settlement, issue an order that makes findings, and imposes the sanction assented to by the settling respondent or respondents, and either together with the order or at a later time issue an opinion stating our views on the issues raised."). The Supreme Court has long recognized that "the interpretation of an agency charged with the administration of a statute is entitled to substantial deference."  Blum v. Bacon, 457 U.S. 132, 141 (1982).  

Another significant factor considered by the Commission was that Schone-Ex had three prior disciplinary actions, including one involving failure to supervise.  The Commission noted that NYSE had also considered the disciplinary history of a subsidiary of the firm, but noted that it did not consider that matter.

Last, the Commission rejected Schone-Ex's claim that the fine was excessive.  It noted that the firm had not established that the fine "threatens its business."  Needless to say, this is a very high bar for a firm challenging a sanction to meet.

Comment

This case indicates that the Commission takes the failure of firms to submit accurate trading data to regulators very seriously.  It will reverse a fine as excessive only if the firm can show that the penalty is so large as to "threaten [the] business" of the firm.  Needless to say, this construction of the statutory words "excessive or oppressive" are ready made for appeal.  The Commission justified its conclusion only by quoting from McCarthy v. SEC, 406 F.3d 179, 190 (2d Cir. 2005) ("a compelling argument can be made that suspending McCarthy now will not serve remedial interests and will work an excessive and punitive result - namely, the destruction of the brokerage practice McCarthy has built during several years of rule-abiding trading.").  The fact that in McCarthy the Court found destruction of the business to be "excessive or oppressive" of course does not mean that only destruction of the business can be deemed "excessive or oppressive."  Its willingness to adopt the destruction of the business test with no further discussion and analysis seems to run a significant risk of appellate reversal.  So, once again we see an ipse dixit pronouncement from the Commission, this time in connection with a significant regulatory standard, namely when industry fines will be upheld.

NYSE Sanction Decision Remanded

James Gerard O'Callaghan, Exchange Act Rel. 57840 (May 20, 2008)

Time since appeal - 10 months, 25 days

Time since last brief - 7 months, 17 days

Pages - 18

Footnotes - 42 

Summary

O'Callaghan, an independent NYSE floor broker appealed a NYSE disciplinary action.  NYSE found that he violated Exchange Act Section 11(a) and Rule 11a-1 and NYSE rules by initiating and executing trades for an account of his father-in-law over which he had investment discretion.  That Exchange Act section specifically prohibits floor brokers from trading for an account over which the broker exercises investment discretion.  NYSE fined him $30,000 and suspended him for three months.  The Commission upheld the findings of violations, but remanded the sanctions to NYSE for further explanation.

O'Callaghan admitted that he had trading discretion over the account and that he was trying to save his father-in-law commissions by charging him floor broker rates.  He also loaned money to the account but did not receive interest  payments for the loans.  NYSE found that O'Callaghan's investigative and hearing testimony were contradictory.  

Under NYSE rules, a floor broker is prohibited from generating an order on the floor, determining the stock, size of the order, or whether it is a buy or sell.  Under NYSE rules, a floor broker with trading discretion would be required to place the order initially with an "upstairs" trading desk which would transmit it to an unaffiliated floor broker for execution, thereby precluding the "initiating" floor broker from exploiting his "time and place advantages" by executing the order himself.  O'Callaghan's own expert agreed that a floor broker could not create an order and execute it himself on the floor.

O'Callaghan testified in his own defense, but did not call any witnesses to corroborate his claims.  He did not call his father-in-law to testify, claiming he was ill.  The hearing panel specifically found that O'Callaghan was not credible as he gave contradictory explanations for his conduct.  

The main claims on appeal involved allegations that NYSE had denied O'Callaghan due process and failed to give him a fair hearing.  The Commission rejected these claims, finding the hearing process to be fair.  It noted that constitutional due process requirements to not apply to self-regulatory organizations.  O'Callaghan's primary claim was that NYSE had not obtained tapes of his telephone calls even though he had the ability to obtain them from the third-party vendor that kept them but did himself do so.

The fact that the violations occurred in 2000 and 2001, but the hearing did not begin until early 2005 did not constitute an unreasonable delay and O'Callaghan produced no evidence of prejudice resulting from this delay.

The Commission found that NYSE had not sufficiently articulated a remedial purpose for the three month suspension imposed on O'Callaghan.  It noted that the the purpose of an expulsion or suspension is to protect investors, not punishment.  NYSE in its decision noted that a three month suspension had the potential to be "catastrophic and terminal" on O'Callaghan's business.  Yet it also found mitigating factors.  The Commission found that NYSE had not explained how a three month suspension would protect the public.  It also noted that a detailed explanation of mitigating factors was required.  

Comment

The Commission itself has been reversed in recent years by various courts of appeals for failure to carefully articulate the basis for its sanctioning decisions.   

Gregg Heinze, Exchange Act Rel. 56100 (July 19, 2007)

NYSE Appeal, failure to provide testimony to NYSE.

Time between appeal and decision - 8 months, 27 days.
Time between last brief and decision - 5 months, 20 days.
Pages - 10.

Comment

This is a rehash of the Turk decision of June 22, 2007 (see below). Respondent was a NYSE specialist.  Heinze asserted the 5th Amendment in response to an SEC subpoena and refused to appear before the NYSE in connection with a related investigation.  The Department of Justice was also conducting an investigation. The NYSE barred Heinze because of his failure to testify in its investigation.  Heinze claimed that the SEC, NYSE and DOJ were conducting a joint investigation and that hence the NYSE was a "state actor" subject to the 5th Amendment.

Just as in the Turk case, the Commission remanded to the NYSE to allow Heinze to develop his defense that the NYSE investigation, SEC investigation, and DOJ inquiry were so intertwined that he should be permitted to assert the 5th Amendment.

No surprise here, just a rehash of the Turk decision.

Here, the respondent alleged that NASD staff made comments indicating SEC control over its investigation.  Further, the Commission found that these allegations, if credible "would suggest the possibility that the Division exercised significant control and influence over the NYSE's investigation of Heinze, which would be relevant to a state action inquiry."  The remand was based on these circumstances and the fact that the NYSE decision came before recent Commission decisions such as Turk and similar cases.

Warren E. Turk, Exchange Act Rel. 55942 (June 22, 2007)

NYSE Appeal

Time between appeal and decision - 1 year, 8 days.
Time between last brief and decision - 6 months, 26 days.
Pages - 10

Summary

The NYSE found that Turk, a former specialist had failed to provide testimony in connection with a NYSE investigation.  He was censured and barred.   The Commission remanded the matter to the NYSE.  Turk claims that he could not be charged for failing to testify in the NYSE investigation because he could invoke his 5th Amendment rights at such testimony as the NYSE is a "state actor", or because in this case, it was acting as one.  The Commission rejected the claim that the NYSE is generally a "state actor", relying on previous SEC and court decisions.  The Commission remanded because the 5th Amendment does apply to a non-state actor whose actions are "fairly attributable" to the government.  

The Commission has recently remanded similar matters to self regulatory organizations.  See, Frank P. Quattrone, Exchange Act Rel. 53547 (March 24, 2006),  Justin F. Ficken, Exchange Act Rel. 54699 (November 3, 2006).  The hearing here was before the Quatrone decision and the record concerning Turk's claims was sparse.  

On remand Turk must have an opportunity to develop a full evidentiary record and must have "a full opportunity to conduct discovery."  However, such discovery is not grounds for a "fishing expedition" and "a respondent must provide a reasonable and credible basis to conclude hat the SRO's relationship with the government in the case suggests such a 'close nexus between the State and  the challenged action' that the seemingly private behavior 'may be fairly treated as that of the State itself.'" (footnote omitted).

This decision is interesting due to the Commission's contradictory discussion of the scope of discovery that Turk will be entitled to on remand.  On the one hand, it held that mere cooperation and coordination between the government and the NYSE was unremarkable and insufficient to establish the defense.  One the other hand, it ordered that Turk be given a "full  opportunity" to conduct discovery.  Yet, it qualified that pronouncement with the seemingly contradictory caveat that Turk could not use discovery as a fishing expedition and would be required to specifically justify his discovery requests.  This rather unhelpful formulation will not assist the NYSE much on remand.  For example, will Turk be permitted to depose Commission, NYSE, and DOJ staff to determine the extent and nature of their cooperation and coordination?  Will Turk be permitted to review staff notes of meetings?  Unfortunately, the opinion is silent on these issues.

Key Points

• Self regulatory organizations such as the NYSE and NASD are private actors.  D.L. Cromwell Invs., Inc. v. NASD Regulation, Inc., 279 F.3d 155, 162 (2d Cir. 1999), cert. denied, 531 U.S. 1069 (2001).
• Cases dealing with firing of government employees for asserting their 5th Amendment rights are inapplicable and do not apply to self regulatory organizations.
• Private parties' actions "may constitute state action if there is such a 'close nexus between the State and the challenged action' that the seemingly private behavior 'may be fairly treated as that of the State itself.'"
• The burden of establishing joint activities sufficient to render a SRO a state actor is high.
• Mere cooperation and coordination of a SRO with the SEC or the DOJ will rarely render the SRO a state actor.
• On remand respondent must justify discovery with specificity pursuant to the standard used for permitting discovery in response to a motion for summary judgment.  He must show that the specific proposed discovery would lead to information that would support his claims.

Further Discussion

Turk testified before the SEC staff and was scheduled to testify before the NYSE staff.  Before that testimony staff of his firm advised him that he was being placed on leave at the request of the U.S. Attorney's Office.  He then notified the NYSE that he would not testify.  Turk was then charged in an administrative proceeding by the SEC and a separate NYSE proceeding. Approximately 7 months later, Turk advised the NYSE that he was prepared to testify because he no longer felt it likely that he would be criminally charged.