(standing) Hamer Budge and Francis M. Wheat; (seated) Byron D. Woodside, Manuel Cohen and Hugh F. Owens
The opportunity to extend that administrative rule to the common law would be mined in the financial transactions surrounding the discovery of copper and zinc ore in deposits owned by the Texas Gulf Sulphur Company near Timmins, Ontario. Speculation in Canadian mining businesses had been a concern of the SEC throughout the 1950s. In 1959, agents and geologists of Texas Gulf Sulphur ("TGS") discovered evidence of a major ore deposit reported to be worth $2 billion. Ordered by company officials to keep the find and analysis secret, TGS began to acquire the rights to the land over this immense ore deposit. On April 16, 1964, after previously denying rumors of the discovery, company officials announced the find in a major press conference.
In the months before the formal announcement, numerous TGS insiders bought stock or stock options in the company. Others tipped off outsiders who also bought stock in the company. Most of the stock was purchased when the price hovered around $20 a share, but within a month after the press conference, TGS stock was trading at over $58 per share. Upon discovering the scheme, the SEC sued TGS and thirteen of its officers, directors and employees under Rule 10b-5 to recover the profits from the insiders. Named in the suit was TGS director Thomas S. Lamont, a director and former vice chairman of Morgan Guaranty Trust, who was alleged to have tipped others to the knowledge, but not to have personally profited from the insider trades.(18) The SEC suit also named Herbert W. Klotz, an Assistant Secretary of Commerce in the Johnson Administration, as a defendant; he resigned a few days later.
The SEC argued that the company's press releases about the discovery were "materially false and misleading" and known to be so by TGS officer and employees. TGS contended that the SEC's position requiring disclosure before trading would "not have been in the best interest of the public, the company and its stockholders" because disclosing the find prematurely would have made it impossible to secure the mineral rights. During the trial, SEC Assistant General Counsel Frank E. Kennamer, Jr. told Federal District Judge Dudley B. Bonsal that it was "nearly impossible to define a rule fitting all situations" in which corporate insiders may or may not trade in their companies stock.(19) After a seventeen-day trial, Judge Bonsal cleared the company and all but two of the charged insiders, finding that the SEC failed to demonstrate the company press releases were "false and misleading." Observers claimed that the ruling stymied SEC attempts to develop a substantial body of federal law on the fiduciary responsibilities of insiders and corporations to investors.(20)
On appeal, in a landmark decision, the Second Circuit Court of Appeals adopted the "disclose or abstain" rule advocated by the SEC.(21) While finding that there was no affirmative duty of the company to prematurely disclose the ore find until after the mineral rights had been acquired, it nonetheless ruled that the Rule 10b-5 was intended to ensure that "all investors trading on impersonal exchanges had relatively equal access to material information" and that all members of the investing public "should be subject to identical market risks."(22) The SEC described the decision as "a long step forward" in the establishment of rules for corporations to follow, because the decision appeared to extend insider trading sanctions to anyone privy to confidential corporate data. Texas Gulf Sulphur would stand for the next decade as the pre-eminent insider trading rule.
(18) Eileen Shanahan, "S.E.C. Insider Suit Names Texas Gulf Sulphur Aides," The New York Times, April 20, 1965, 1.
(19) Richard Phalon, "S.E.C. Aide Says Insider Curb Is Varied from ‘Case to Case'", The New York Times, June 22, 1966, 63.
(20) Richard Phalon, "Texas Gulf Trial Clears All But 2," The New York Times, August 20, 1966, 1.
(21) Terry Robards, "Business Community Is Stirred By Texas Gulf Sulphur Decision," The New York Times, August 15, 1968, 54.
(22) SEC v Texas Gulf Sulphur, 401 F. 2d 833 (2nd Circuit, 1968), cert. denied, 394 U.S. 976 (1969).
