23 Aug securities and exchange commission v. Texas Gulf Sulphur Co
securities and exchange commission v. Texas Gulf Sulphur Co.
United States Court of Appeals 401 F.2d 833 (2nd Cir. 1968)
The SEC (plaintiff) brought an action against the Texas Gulf Sulphur Company (TGS) and 13 of its directors, officers, and employees (defendants) for violation of Section 10(b) of the Exchange Act and SEC Rule 10(b)-5, seeking an injunction against further misleading press releases and requesting rescission of the defendants’ purchases and stock options. On June 6, 1963, TGS had acquired an option to buy 160 acres of land in Timmons, Ontario. On November 11, 1963, preliminary drilling indicated that there would be major copper and zinc finds. TGS acquired the land and resumed drilling on March 31, 1964, and by April 8, it was evident that there were substantial copper and zinc deposits. On April 9, Toronto and New York newspapers reported that TGS had discovered “one of the largest copper deposits in America.” On April 12, TGS’s management said that the rumors of a major find were without factual basis. At 10 a.m. on April 14, the board of directors authorized the issuance of a statement confirming the copper and zinc finds and announcing the discovery of silver deposits as well. On April 20, the NYSE announced that it “was barring stop orders [orders to brokers to buy a stock if its price rises to a certain level to lock in profits in case of a sharp rally in that stock] in Texas Gulf Sulphur” because of the extreme volatility in the trading of the stock.
Approximately one month later, rumors circulated about insider trading. It was later found that when drilling began on November 12, 1963, TGS’s directors, officers, and employees owned only 1,135 shares of stock in the company and had no calls (options to purchase shares at a fixed price). By March 31, 1964, when drilling resumed, insiders (tippers) and their tippees had acquired an additional 7,100 shares and 12,300 calls. On February 20, 1964, TGS had issued stock options to three officers and two other employees as part of a compensation package.
From April 9, 1964 to April 14, 1964, when the confirmatory press release was issued, 10 insiders and their tippees made estimated profits of $273,892 on the purchase of their shares or calls of TGS stock. The federal district court dismissed charges against all but two defendants. Those defendants, Clayton and Crawford, appealed, and the SEC appealed from the part of the district court decision that had dismissed the complaint against TGS and the nine other individual defendants.
Judge Waterman
Rule 10(b)-5 was promulgated pursuant to the grant of authority given the SEC by Congress in Section 10(b) of the Securities Exchange Act of 1934. By that Act Congress proposed to prevent inequitable and unfair practices and to ensure fairness in securities transactions generally, whether conducted face-to-face, over the counter, or on exchanges. The Act and the Rule apply to the transactions here, all of which were consummated on exchanges.
The essence of the Rule is that anyone who, trading for his own account in the securities of a corporation, has “access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone” may not take “advantage of such information knowing it is unavailable to those with whom he is dealing,” i.e., the investing public. Insiders, as directors or management officers, are, of course, by this Rule, precluded from so unfairly dealing, but the Rule is also applicable to one possessing the information who may not be strictly termed an “insider” within the means of Sec. 10(b) of the Act. Thus, anyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such insider information remains undisclosed. So, it is here no justification for insider activity that disclosure was forbidden by the legitimate corporate objective of acquiring options to purchase the land surrounding the exploration site; if the information was, as the SEC contends, material, its possessors should have kept out of the market until disclosure was accomplished.
As we stated in List v. Fashion Park, Inc., “The basic test of materiality is whether a reasonable man would attach importance in determining his choice of action in the transaction in question.” This, of course, encompasses any fact “which in reasonable and objective contemplation might affect the value of the corporation’s stock or securities.” Such a fact is a material fact and must be effectively disclosed to the investing public prior to the commencement of insider trading in the corporation’s securities. The speculators and chartists of Wall and Bay Streets are also “reasonable” investors entitled to the same legal protection afforded conservative traders. Thus, material facts include not only information disclosing the earnings and distributions of a company but also those facts which affect the probable future of the company and those which may affect the desire of investors to buy, sell, or hold the company’s securities.
The core of Rule 10(b)-5 is the implementation of the Congressional purpose that all investors should have equal access to the rewards of participation in securities transactions. It was the intent of Congress that all members of the investing public should be subject to identical market risks—which market risks include, of course, the risk that one’s evaluative capacity or one’s capital available to put at risk may exceed another’s capacity or capital. The insiders here were not trading on an equal footing with the outside investors. They alone were in a position to evaluate the probability and magnitude of what seemed from the outset to be a major ore strike; they alone could invest safely, secure in the expectation that the price of TGS stock would rise substantially in the event such a major strike should materialize, but would decline little, if at all, in the event of failure, for the public, ignorant at the outset of the favorable probabilities, would likewise be unaware of the unproductive exploration, and the additional exploration costs would not significantly affect TGS market prices. Such inequities based upon unequal access to knowledge should not be shrugged off as inevitable in our way of life, or, in view of the congressional concern in the area, remain uncorrected.
We hold, therefore, that all transactions in TGS stock or call
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