Appendix — Texas Gulf Sulphur Co. v. Securities & Exchange Commission

Re POITIER ae EIS STH 6)

SUPRr IN THE

Suysene Gourt of the United

October Term, 1971

Texas Guir SutpHur Company, a Texas Corporation,

Cuartes F’. Focarty, Ricnarp D. Mo.iison, Ricnarp H.

Cuayton, Waiter Hotyk, Kenneto H. Darke, Davm M.

CrawForD, CLauDE QO. STEPHENS, Earn L. Huntineron and

Haroip B. Kinz,

Petitioners,

v.

SecurRITIEs anD ExcHance CoMMISSION,

Respondent.

APPENDICES

SEP 3 1971

COND el ge ILM LO ett a AE ELLEN ae BLOX CELA LEAL LLL LAE LNA EL rth es D>

PRR eet tee

SP ee

a

INDEX TO APPENDICES

PAGE

Appendix A

Opinion of the District Court (Dated August 16,1966) la

Judgment of the District Ceurt (Entered August 22,

ARRON it tubal niu ara EMO a eCT SERIE . SID th 64a

Opinion of the Court of Appeals (Decided August 13,

I ia esta ti oak ential eaesial aac eadiscocabsteoeeaomcagens 66a

Judgment of the Court of Appeals (Entered August

ate aR Rests NN apt RE ONO lee a Ir 172a

Second Opinion of the District Court ‘Dated Febru-

Os ere TaN PR ICI See Dea dete Poe Raden aa 175a

Second Judgment of the District Court (Entered

I I i auanitical etl decdiaincnctarisaavecenions 215a

Second Opinion of the Court of Appeals (Decided

TE, LAURER aR ener cee CMC SESS Po PORE ome 220a

Second Judgment of the Court of Appeals (Entered

SE iat cal satis asa easege tdvashonschikeimamanivctvidoion 234a

Appendix B

Constitutional Provisions, Statutes and Rules In-

EAR OR av aos Sen eae ie ducgadanidvisee sean 235a

APPENDIX A

Opinior of the District Court

UNITED STATES DISTRICT COURT

SouTHERN District or New York

65 Civ. 1182

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff,

against

Texas Gutr SucpHur Company, a Texas corporation, CHarirs F. Focarty,

Ricuarp D. Motrison, RicHarp H. Crayton, Warter Hoiyk, Kennetu H.

Darke, Davin M Crawrorp, THomas S. Lamont, Francis G. Coates,

Craupe O. Sternens, Tuomas P. O'Nemt, Jonn A. Murray, Eart L.

Huntincton and Harotp B. K LIne,

Defendants.

(5436) Bonsat, D. J.

Plaintiff, Securities and Exchange Commission (Com-

mission), has instituted this action charging each of the

defendants with violations of Section 10(b) of the Securi-

ties Exchange Act (15 U.S.C. 78j(b)) and Rule 10b-5 (17

C.F.R. 240; 10b-5) promulgated thereunder by the Com-

mission. All parties waived a jury and agreed that trial

should first be had on the issue of whether the defendants

or any of them had violated Section 10(b) and Rule 10b-5, .

reserving for later hearing the issue of the remedy to be

applied in the event such violations are found.

The Commission’s action arises out of the exploratory

activities of defendant Texas Gulf Suiphur Company

(TGS) on the Kidd 55 segment near Timmins, Ontario, be-

tween November 12, 196% and April 16, 1964. TGS is

(5437) alleged to have violated Section 10(b) and Rule

10b-5 by issuing a false press release regarding these ac-

tivities on April 12, 1964. Each of the individual defen-

dants was a director, officer or employee of TGS. Individ-

ual defendants who purchased stock or calls on stock of

TGS between November 12, 1963 and April 16, 1964, or

recommended such purchases to others, are charged with

violations of Section 10(b) and Rule 10b-5 on the ground

that they used to their own advantage material informa-

tion as to TGS’s exploratory activities on the Kidd 55 seg-

ment, which material information had not been disclosed

to or absorbed by the stockholders or the public. Five of

the individual defendants who accepted stock options

granted on February 20, 1964 are charged with violations

of Section 10(b) and Rule 10b-5 on the ground that they

2a

Appendix A —Opinion of the District Court

were in possession of such material information which they

used to their own advantage by failing to disclose it to the

Directors’ Committee which granted the stock options.’

Texas Gutr SutpHur Company (TGS)

In 1962 54 TGS (which was organized in 1909) was the

world’s largest supplier of sulphur. Its authorized capital

stock was 15,000,000 shares, without par value. (5438)

11,520,000 shares had been issued (including 1,504,101

shares held in the Company’s treasury). On December 31,

1963, there were issued and outstanding in the hands of

the public in excess of 10,000,000 shares held by some 65,000

shareholders. The stock of TGS was listed on the New

York Stock Exchange and was admitted to unlisted trading

privileges on the Midwest Stock Exchange. TGS’s total

assets, less current liabilities, had a book value of over

169,000,000 as of Dezember 31, 1963, and over $210,000,000

as of December 31, 1964. The stockholders’ equity was

stated to be in excess of $129,000,000 as of December 31,

1963, and in excess of $137,000,000 as of December 31, 1964.

Its annual sales were in excess of $62,000,000 for 1963 and

in excess of $70,000,000 for 1964. Its working capital was

approximately $47,000,000 as of December 31, 1963, and

approximately $87,000,000 as of December 31, 1964. Its

earnings per share for the period 1960-1964 were:

1960 1961 1962 1963 1964

$1.27 $1.26 $1.21 $0.93 $1.15

From i955 to 1963 TGS’s annual sales declined from

$93,000,000 in 1955 to $62,000,000 in 1963 and its (5439)

annual earnings from $32,000,000 in 1955 to $9,300,000 in

1963. This decline was attributed by TGS to the oversupply

of sulphur, resulting in depressed prices during the period.

3a

Appendix A —Opinion of the District Court

The market price of TGS stock on the New York Stock

Exchange declined from a high of $45 a share in 1955 to a

low of $11 a share in 1962. In 1963 the price rose from 13%

in March to 19%% in N ovember and to 21% at the end of the

year. In 1964 the price rose from a low of 211% in January

to a high of 3014 on April 15. On April 14, the day of TGS’s

public announcement of the Kidd mine, the price rose from

a low of 30% to a high of 37, closing at 363%. The price

continued to rise during the balance of April 1964 to a

high of 58% on April 30, on which day the stock closed at

5434.

Between 1956 and 1963, despite a growth in the demand

for sulphur, the price per ton of sulphur declined from

around $28 in 1956 to under $20 in 1963. However, by late

1963 the turn-around had been reached. Sulphur became in

short supply, and on April 1, 1964 TGS announced a $2

per ton increase in the price. TGS’s gross sales for (5440)

1963 were the highest in four years, up 5.56% from 1962.

TGS’s 1963 earnings were adversely affected by the mys-

terious loss of the S.S. Martne Sutpuur QUEEN early in

that year. In January 1964 TGS put into service a larger

liquid sulphur cargo vessel to replace the lost vessel and

announced the launching of the world’s largest. liquid sul-

phur tanker, which would make it possible to ship liquid

sulphur to Europe, and on February 8, 1964 it announced

plans to increase its Canadian production of sulphur by

900 tons per day.

Apart from its primary sulphur business, TGS was en-

aged in a diversification program in other fields, such as

phosphate, potash, trona, oil and gas. Its entry into the

phosphate and potash fields was important because phos-

phate, potash and sulphur are the three basic components

of fertilizers. On November 15, 1963, TGS announced the

creation of a new division for its phosphate project and

that its potash mine was near completion and was scheduled

AAR RAMS BT aer SKF

4a

Appendix A —Opinion of the District Court

to go into production in the spring of 1964. On December

16, 1963, TGS announced that it had acquired the Canadian

oil and gas properties of Delhi-Taylor Oil Company, and

on April 3, 1964 announced plans (5441) to proceed with a

3,000,000 ton-per-year phosphate program in North Caro-

lina at a cost of $45,000,000.

TGS had been engaged in exploration for sulphide de-

- posits on the Canadian Shield since 1957 and in 1963-64

undertook exploratory work on the Kidd 55 segment in Kidd

Township near Timmins, Ontario, which is more fully de- ©

scribed hereafter.

Tue InpivipvaL DEFENDANTS

The individual defendants are directors, officers and em-

ployees of TGS as follows:

Defendant Position —

Claude O. Stephens President and Director

Charles F. Fogarty Executive Vice President*

ard Director

Thomas S. Lamont Director

Francis G. Coates Director

Harold B. Kline Vice President and General

Counsel**

Richard D. Mollison Vice President

David M. Crawford Secretary***

Richard H. Clayton Engineer

Walter Holyk Chief Geologist

Kenneth H. Darke Geologist

Earl L. Huntington Attorney

John A. Murray Office Manager

* Prior to February 20, 1964 Mr. Fogarty was Senior Vice Presi-

dent.

** Prior to January 31, 1964 Mr. Kline was Vice President-

Administration and Secretary.

*** Mr. Crawford was employed by TGS in January 1964 and be-

came Secretary on February 20, 1964.

oa

Appendix A —Opinion of the District Court

(5442) Defendant Thomas P. O’Neill was an accountant

with TGS. He was served wih a summons and complaint,

but has failed to answer or appear. The Commission has

moved for a default judgment against O’Neill in a separate

Proceeding. Therefore he is not referred to hereafter.

Summary or TGS’s Expioratory Activities

ON THE Kopp 55 Secment

Exploration on the Canadian Shield:

In 1957 TGS initiated an exploration program for sul-

phides? on the Canadian Shield, a vast area comprising

most of eastern Canada. Much of the area is barren and

flat with few outcroppings of rock and is covered with a

Swampy material known as muskeg. The subsurface struc-

ture consists of Pre-Cambrian rocks, dating from an early

geologic time, and is complex and distorted.

(5443) Beginning in March, 1959, an exploration group—

headed by defendant Mollison, a mining engineer, and con-

sisting of defendant Holyk, the chief geologist; defendant

Clayton, an electrical engineer and seophysicist; and de-

fendant Darke, a geologist—conducted aerial geophysical

Surveys over more than 15,000 miles of the Canadian Shield

area. Sulphides conduct electricity better than most other

rock types and can be detected if they are in sufficient quan-

tity and concentration and are not too deeply buried be-

neath the earth’s surface.

In the course of this aerial exploration, TGS detected sev-

eral thousand anomalies—unusual variations in the conduc-

tivity of rocks. In the opinion of the exploration group

several hundred of these anomalies were (5444) worthy of

further investigation, and rights to land around them were

MAT PDA LT? TROL Tee Oa We pe

TRAC

Reh Ieee thy MP er, ae

CHOOT:

6a

Appendix A —Opinion of the District Court

acquired. One of these anomalies, detected as early as 1959,

was located near Timmins, Ontario, and was designated

as the Kidd 55 segment. On June 6, 1963, TGS acquired

an option to purchase the northeast quarter section (160

acres) of the Kidd 55 segment. Between November 8, 1963

and April 16, 1964 TGS drilled K-35-1, K-55-3, K-55-4,

IX-55-35, K-55-6, K-55-7 and K-55-10 at the locations shown

on the accompanying Plan Map of the Kidd 55 segment.

Drill Hole K-55-1

On October 29 and 30, 1963, defendant Clayton conducted

a ground geophysical survey on the northeast quarter sec-

tion which confirmed the existence of the anomaly previ-

ously detected by the aerial survey. Defendant Clayton in-

terpreted the survey as indicating three separate conductors

of electricity tending in a north-south direction with an

undetermined width and steep dip. Since the survey only

indicated the presence of conductive material and not

whether the material consisted of worthless or valuable

minerals and since there was little geological evidence as

to the makeup of the subsurface structure (the (5446) near-

est outcroppings of rock were located more than 1,000 feet

from the property), diamond core drilling was necessary for

(3445)

Plan Map

Kipp TowNsHip PROPERTY

PHOTOPRINT

(Mounted Opposite)

VR EY

FPO TELLS OST

7a

Appendix A —Opinion of the District Court

—

°

oo

o—————+. - ANOMALY LiMITs

2200S ee

\

K-55-3

2400S Rs Ad

2600S --——

K-55-

ef 95-10

2800 S

PLAN MAP

KIDD TOWNSHIP PROPERTY

t: -

2

1 Weta 1 t a

8a

Appendix A —Opinion of the District Court

further evaluation of the anomaly. TGS had previously

drilled 65 equally promising anomalies, but most of them

had revealed either barren pyrite or graphite, while a few

had shown marginal mineral deposits in insufficient quanti-

ties to be commercially mined.

On November 8, 1963, drilling of the initial hole (K-55-1)

was begun on section line 2400 S. The location, direction,

and angle of the hole were determined by defendants Holvyk,

Clayton and Darke, who considered the results of the geo-

physical survey and the location of property boundaries.

The collar of the hole was placed about 60 feet to the east

of the easternmost conductor, as interpreted by defendant

Clayton, and at the strongest part of the anomaly. The hole

was drilled westerly at an angle of 60 degrees in the hope

that it would cut through all three conductors.

On November 12, 1963, drilling of K-55-1 was terminated

at 655 feet. Defendant Holyk visually estimated that the

core of K-33d-1 indicated an average copper.content of 1.15%

and an average zine content of 8.64% over a length of 599

feet. The percentages of copper and zine (5447) mineraliza-

tion at any given point in the core fluctuated markedly, but

the copper mineralization appeared to be concentrated more

on the eastern edge of the anomaly.

Property Acquisition

As a result of the Visual examination of the core, TGS

determined to acquire the three other quarter sections mak-

ing up the Kidd 55 segment. Therefore, following the usual

practice in the mining industry, security measures were

put into effect. Further drilling on the anomaly was sus-

pended and members of the exploration group were in-

structed to keep the results of K-55-1 confidential. The

drill rig at the site of K-55-1 was moved away and cut sap-

9a

Appendix A —Opinion of the District Court

lings were stuck in the ground in the area of the hole to

conceal its location. A second drill hole (K-55-2) was

drilled off the anomaly in order to produce a barren core.

The core from K-55-1 was split longitudinally and shipped

to the Union Assay House, Salt Lake City, Utah, for chem-

ical assay. In mid-December, TGS received reports from

the assay which revealed an average metal content of ap-

proximately 1.18% copper and 8.26% zinc, as well as 3.94

ounces of silver per ton over a 602-foot length of the core.

These were the only chemical assay reports on any drill

hole which TGS received prior to April 16, 1964.

(5448) In the meantime, negotiations for the three other

quarter sections comprising the Kidd 55 segment had been

undertaken. TGS purchased one quarter-section outright

for $7,500 and acquired options for $7,000 to purchase the

other two for approximately $45,000. On March 27, TGS

decided that the land acquisition program had advanced

sufficiently to permit the company to resume drilling.

Drill Hole K-55-3

On March 31, the drilling of K-55-3 was commenced on

section line 2400 S approximately 75 feet west of the west-

ern limits of the anomaly and approximately 510 feet west

of K-55-1. It was drilled easterly at an angle of 45 degrees,

and therefore crossed K-55-1 in a vertical plane on section

2400 S. K-55-3 was completed by 7:00 p.m. on April 7 and

visual estimates of the core indicated an average copper

content of 1.12% and an average zine content of 7.93% over

641 feet of the hole’s 876-foot length. Like K-55-1, K-55-3

indicated substantial copper mineralization on the eastern

edge of the anomaly. Daily reports of the progzess of

K-05-3 and of the subsequent drill holes were made by de-

fendants Mollison and Holyk to defendants Stephens and

Fogarty.

a

10a

Appendix A —Opinion of the District Court

(5449) Drill Hole K-55-4

On April 7, drilling of K-55-4 was commenced slightly to

the east of the eastern edge of the anomaly on section line

2600 S, 200 feet to the south of K-d5-1, and was drilled

westerly on an angle of 45 degrees, parallel to K-53-1. By

7:00 p.m. on April 9, K-55-4 had encountered mineralization

over 366 feet of its 420-foot length, but had entered a stretch

of barren material at the 420-foot mark. The hole was com-

pleted to a length of 579 feet on April 10 at 7:00 p.m. with-

out encountering further mineralization. Visual estimates

of the 366 feet of mineralized core recovered from K-55-4

indicated an average copper content of 1.14% and an aver-

age zinc content of 8.24%. Like K-55-1 and K-55-3, K-55-4

encountered substantial copper mineralization on the east-

ern eage of the anomaly.

Drill Holes K-55-6 and K-55-5

On April 8, drilling of K-55-6 was commenced with a sec-

ond drill rig* on section 2400 S, 300 feet to the east of K-55-1.

It was drilled westerly at an angle of 60 degrees and was

intended to explore mineralization beneath hole K-55-1. Due

to the absence of geologists from the drill site on April 8

and 9,5 no immediate visual estimates of the core were

available. It was apparent, (5450) however, by the evening

of April 10 that the hole had encountered substantiai copper

mineralization over the last 127 feet of its 569-foot length.

On April 10, drilling of K-55-5 was commenced with a

third driil rig on section 2200 S, 200 feet north of K-55-1.

The hole was started on the eastern edge of the anomaly

and was drilled westerly at an angle of 45 degrees, parallel

to the holes previously drilled. By the evening of April 10,

K-55-5 had been drilled 97 feet and, although no immediate

visual estimates of the core were available, it was apparent

S00 IRE

OE ——— — ee ee ee a PrP errr SF wer

lla

Appendix A —Opinion of the District Court

that the hole had intersected substantial copper mineraliza-

tion over the last 42 feet of its length.

The results of drilling through the evening of April 10

were available to TGS when it issued its April 12 press

release.

Core Drilling between 7:00 p.m. April 10

and 7:00 a.m. April 13

Drilling of K-55-5 and K-55-6 continued, and by the morn-

ing of April 13, K-55-5 had encountered mineralization to

the 580-foot mark. It was subsequently drilled to a length

of 757 feet without encountering further mineralization.

Visual estimates of the core indicated that over a 525-foot

section the drill hole had intersected an average (5451) cop-

per mineralization of 0.82% and an average zinc mineraliza-

tion of 4.2%. By 7:00 a.m. on April 13, K-55-6 had en-

countered mineralization to the 946-foot mark. It was

subsequently drilled to a length of 1180 feet without inter-

secting any further mineralization. Visual estimates of a

504-foot section of the core indicated an average copper

content of 1.72% and an average zinc content of 6.60%.

On April 12 drilling of K-55-7 was commenced with a

fourth drill rig on section 2000 S at the eastern edge of the

anomaly. It was drilled westerly at an angle of 45 degrees

and by the morning of April 13 had encountered 50 feet of

mineralization over the 137 feet drilled. The drilling of a

mill test hole, K-55-8, was also commenced by April 11 and

completed by the evening of April 13. The core was 21,

inches in diameter as compared with the 11% inch diameters

of the other holes, and was intended to be used for metal-

lurgical testing to determine the amenability to milling of

the material that had been encountered. No geologist’s log

or visual estimates were made of K-55-8 and no metal-

lurgical tests of the core were reported prior to April 16,

LL

'

12a

alppendix 1 —Opinion of the District Court

(5452) Core Drilling between 7:00 a.m. April 13

and 7:00 p.m. April 15

On April 14 drilling of K-55-10 was commenced on section

2800 S on the eastern edge of the anomaly and was drilled

westerly at an angle of 45 degrees. By 7:00 p.m. on April

15, it had encountered mineralization over the last 231 feet

of the 249 feet of drilling. Drilling of K-55-7 was completed

to a iength of 707 feet, but encountered only 26 more feet

of mineralization between the 425-foot and the 451-foot

marks.

Purcuass or TGS Stock anp Catuts on TGS Stock

BY CERTAIN DEFENDANTS AND ‘‘TIPPEES’’ BETWEEN

NovEMBER 12, 1963 anp Apriz 16, 1964

The evidence established that all of the individual de-

fendants except Stephens and Kline purchased shares of

TGS and/or calls on TGS stock between November 12,

(5453) 1963, when the first drill hole on the Kidd property

was completed (K-55-1), and the close of business on April

16, 1964, the day on which TGS issued a press release

announcing the discovery of a copper mine on the Kidd 55

segment at a press conference called for the purpose. The

evidence also shows that certain persons who were referred

to by counsel at the trial as ‘‘tippees’’ purchased shares of

TGS and/or calls on TGS stock on the basis of advice re-

ceived directly or indirectly from defendants Darke, Coates

and Lamont. The following table lists these purchases (in-

cluding those of defendant Holyk’s wife), but does not

include the shares covered by stock options granted by TGS

to certain defendanis on February 20, 1964.

Appendix 4 —Opinion of the District Court

Calls

Exercise

Number Price

200 21

300 22%

100 235%

400 23%

200 221%4-22%

200 233%

1000 2334-2354

200 24%

200 23%

300 2334-23%

200 2334

1000 2254-223%4

500 2214-2254

100 22%

300 23%

200 23%

1000 24%

; é Shares

Purchase

Date Purchaser Number Price

Hote K-55-1 Compretep Novemser 12, 1963

1963

Nov 12 Fogarty 300 1734-18

15 Clayton 200 17%

15 Fogarty 700 = 17%-17%

15 Mollison 100 17% ©

19 Fogarty 500 «18%

26 Fogarty 20). 17%

29 Holyk ( Mrs.) 50 18

CuHeEmicay Assays oF Dritt Core or K-55-1 RECEIVED DECEMBER 9-13, 1963

Dec 10 Holyk (Mrs. ) 100 20%

12 Holyk (or wife)

13 Mollison i100 21%

30 Caskey*

30 Fogarty 200 22

31 Fogarty 100 23%

1964

Jan 6 Holyk (or wife)

8 Murray

16 Westreich* 2000 2114-21%

24 Holyk (or wife)

Feb 10 Fogarty 300 221%-221%

17 Atkinson* 50 23%

17 Westreich* 50 23%

20 Darke 300 24%

24 Clayton 400 23%

24 Holyk (or wife)

24 Miller*

25 Miller*

26 Holyk (or wife)

26 Hunti: ston 50 23%

27 Darke (Moran as

nominee )

Mar 2 Holyk ( Mrs.) 200 22%

3 Clayton 100 22%

3 IX. W. Darke*

16 Huntington

16 Holyk (or wife)

17 Holyk (Mrs.) 100 23%

17 E. W. Darke* .

23 Darke

26 Clayton 200 25

14a

Appendix A —Opinion of the District Court

Shares Calls

Purchase Exercise

Date Purchaser Number Price Number Price

LAND Acquisition CoMPLETED Marcu 27, 1964

Mar 30 Atkinson* 400 2534-25%

30 Caskey* 100 25°. 1000 2534-25%

30 Darke 1000 25%

30 E. W. Darke* 200 25%

30 Holyk (Mrs.) 100 25%

30-31 Klotz* 2000 25'%-26%

30 Miller* 500 2514-25%

30 Westreich* 500 25%

Core Drittinc oF Kipp 55 SEGMENT RESUMED MarcH 31, 1964

Apr 1 Clayton 60 26%

1 Fogarty 400 26%

2 Clayion 100 26%

6 Fogarty 400 28%-28%

8 Mollison (Mrs.) 100 28%

421 Feet Kipp-55-4 CoMPLetep Apri 9, 1964, 7 P.M.

TGS Press RELEASE Issuep Aprit 12, 1964

Apr 15 Clayton 200 29%

16 Crawford (and wife) 600 30%-30%

TGS Press RELEASE AND Press CONFERENCE APRIL 16, 1964, 10 A.M.

Apr 16 Coates 2,000 31-315%

(for family trusts)

16 Haemisegger** 300 324

16 Robt. L. Armstrong** 200 31%4-34%

16 Charles Callery** 300 32%

16 James A. Baker III** 200 32%

16 Malcolm G. Baker Jr.** 500 3414-35

16 Morgan Guaranty

Trust Co.*** 10,000 3254-34

16 Lamont and family**** 3,000 34%

* Darke visited Mrs. Caskey and her daughter Miss Atkinson ‘n Washington between Dec.

25 and Dec. 30, 1963 and recommended TGS. They in turn recommended TGS directly

or indirectly to others marked with *, with the exception of E. W. Darke, Darke’s brother,

who purchased calls on Darke’s recommendation.

** Purchased Haemisegger, Coates’ son-in-law, for himself and customers (**) following

telephone call from Coates before 10 :20 a.m.

aad Purtees for its customers’ accounts following call from Lamont to Hinton at about

:40 am.

**¢* Purchased through Morgan Guaranty Trust Co. after 12:33 p.m.

lida

Appendix A —Opinion of the District Court

(5456) Tue Securities Excnance Act or 1934 (THE Act)

AND Ruts 10s-5

The Commission has instituted this action pursuant to

Section 27 of the Act (15 U.S.C. 78aa) which confers upon

the District Courts of the United States exclusive juris-

diction of violations of the Act or of the rules and regula-

tions promulgated thereunder and of ‘‘all suits in equity

and actions at law brought to enforce any liability or duty

created by’’ the Act or the rules and regulations there-

under. |

The preamble of the Act states that it is “to provide for

the regulation or securities exchanges and of over-the-

counter markets operating in interstate and foreign com-

merce and through the mails, to prevent inequitable and

unfair practices on such exchanges and markets, and for

other purposes.’’

Section 2 (15 U.S.C. 78b) provides that:

‘“*. . . transactions in securities as commonly con-

ducted upon securities exchanges and over-the-coun-

ter markets are affected with a national public in-

terest which makes it necessary to provide for

regulation and control of such transactions and of

practices and matters related thereto, including

transactions by officers, directors, and priucipal se-

curity holders, ... and to impose requirements neces-

sary to make such regulation and control reasonably

complete and effective, (5457) in order to protect

interstate commerce . . . and to insure the mainte-

nance of fair and honest markets in such trans-

actions. ...’’

16a

Appendix A —Opinion of the District Court

Section 2(2) (15 U.S.C. 78b(2)) provides:

‘‘The prices established and offered in such trans-

actions are generally disseminated and quoted

throughout the United States and foreign countries

and constitute a basis for determining and estab-

lishing the prices at which securities are bought and

oobd,...+.”

Section 2(3) (15 U.S.C. 18b (3)) states that:

‘‘Frequently the prices of securities on such ex-

changes and markets are susceptible to manipula-

tion and control... .”’

Section 4(a) (15 U.S.C. 78d(a)) provides for the establish-

ment of the Commission as the agency charged with the

administration of the Act.

Section 10 of the Act (15 U.S.C. 78}) provides:

‘‘Tt shall be unlawful for any person, directly or in-

directly, by the use of any means or instrumentality

of interstate commerce or of the mails, or of any

facility of any national securities exchange—

‘‘(b) To use or employ, in connection with the pur-

chase or sale of any security registered on a national

securities exchange or any security not so registered,

any manipulative or deceptive device or contrivance

in contravention of such rules and regulations as the

Commission may prescribe as necessary or appro-

priate in the public interest or for tue protection of

investors.’’

(5458) Pursuant to the authority conferred on the Com-

mission by Section 10(b), in May, 1942 the Commission

bk

17a

Appendix A —Opinion of the District Court

promulgated Rule 10b-5 (17 C.F.R. 240 3 10b-5), which pro-

vides :

‘‘It shall be unlawful for any person, directly or

indirectly, by the use of any means or instrumentality

of interstate commerce, or of the mails, or of any

facility of any national securities exchange,

(1) to employ any device, scheme, or artifice to

defraud, ,

(2) to make any untrue statement of a material

fact or to omit to state a material fact necessary in

order to make the statements made, in the light of

the circumstances under which they were made, not

misleading, or

(3) to engage in any act, practice, or course of

business which operates or would operate as a fraud

or deceit upon any person, in connection with the

purchase or sale of any security.’’

In Rule 10b-5 the Commission adapted the language of

Section 17(a) of the Securities Act of 1933 (15 U.S.C. 77q)

relating to fraudulent interstate transactions. Similar !an-

guage was also used in Section 206 of the Investment Ad-

visers Act of 1940 (15 U.S.C. 80b-6).°

The Commission has the responsibility of administering

the Act and of securing compliance therewith. To carry out

this responsibility, it has been given, among other powers,

authority under Sections 21( e) and 27 (15 U.S.C. 78u, 78aa)

to institute actions in the district courts to (5459) enjoin

existing or prospective violations of the Act and to enforce

any liability or duty created by the Act or the rules and

regulations promulgated pursuant thereto. The Commis-

sion contends that the defendants engaged in a ‘‘course of

18a

Appendix .1—Opinion of the District Court

business’’ which operated ‘‘as a fraud or deceit’’ on the

stockholders of TGS in violation of Section 10(b) and Rule

10b-5.’

The defendants assert that the Commission must establish

the elements of common law fraud—misrepresentation or

nondisclosure, materiality, scienter, intent to deceive, re-

liance, and causation—citing decisions in private actions

brought under Section 10(b) requiring proof of one or more

of these traditional elements as a condition precedent to

relief. Fischman v. Raytheon Mfg. Co., 188 F.2d 783, 786

(2d Cir. 1951) (‘‘proof of fraud is required in suits under

§10(b) of the 1934 Act... .’’); Weber v. C.M.P. Corpora-

tion, 242 F. Supp. 321, 324 (S.D.N.Y. 1965) (scienter) ; Bar-

nett v. Anaconda Company, 238 F.Supp. 766, 771 (S.D.N.Y.

1965) (causation). See, Comment, ‘‘Civil Liability Under

Section 10(b) and Rule 10b-5: A Suggestion for Replacing

the Doctrine of Privity,’’ 74 Yale L. J. 658 (1965).

(5460) However, recent decisions, even in private suits,

do not require proof of these elements in actions charging

violations of Rule 10b-5. Royal Air Properties, Inc. v.

Smith, 312 F. 2d 210 (9th Cir. 1962); Ellis v. Carter, 291

F. 2d 270 (9th Cir. 1961). In Stevens v. Voweill, 343 F. 2d

374, 379 (10th Cir. 1965), the court stated:

‘*Tt is not necessary to allege or prove common law

fraud to make out a case under the statute and rule.

It is only necessary to prove one of the prohibited

actions such as the material misstatement of fact

or the omission to state a material fact.’’

In a regulatory or enforcement proceeding under Sec-

tion 27 of the Act, the Commission is not required to prove

these common law elements. In S.E.C. v. Capital Gains

Bureau, 375 U.S. 180 (1963), the defendant was an invest-

RST Ae

SEER Ee

19a

Appendix A —Opinion of the District Court

ment advisor who published a monthly report, mailed to

approximately 5,000 customers, which recommended cer-

tain securities for long term investment. Before mailing

the report, the defendant would purchase the recommended

securities on the market and when the price rose after

customers received the report, defendant would sell at a

profit. The Commission sought an injunction under Sec-

tion 206 of the Investment Advisers Act of 1940 (15 U.S.C.

80b-6) (8) (5461) to compel defendant to disclose this

practice to customers. The district court denied a pre-

liminary injunction on the ground that ‘‘fraud’’ was used

in the Investment Advisers Act of 1940 in its technical

common law sense and that the Commission had failed to

establish an intent to injure clients or an actual loss to

clients. (191 F. Supp. 897, 898.) The Second Circuit Court

of Appeals, sitting en banc, affirmed the district court by

a 5-to-4 vote. (306 F. 2d 606.)

In reversing, the Supreme Court held that:

‘*It would defeat the manifest purpose of the In-

vestment Advisers Act of 1940 for us to hold, there-

fore, that Congress, in empowering the courts to

enjoin any practice which operates ‘as a fraud or de-

ceit,’ intended to require proof of intent to injure

and actual injury to clients. (375 U ‘S., at 192.)

‘‘Congress intended the Investment Advisers Act of

1940 to be construed like other securities legislation

‘enacted for the purpose of avoiding frauds,’ not

technically and restrictively, but flexibly to effectu-

ate its remedial purposes. (375 US., at 195.) (Em-

phasis supplied)

SSS

20a

Appendix —Opinion of the District Court

Since there is a direct parallel between the language

of Rule 10b-5(3) and Section 206 of the Investment Advis-

ers Act of 1940, both in wording and in intent, the use of

‘‘fraud’’ in Rule 10b-5(3) cannot be interpreted in its

narrow common (5462) law sense. Cf.. Berko v. Securities

and Exchange Commission, 316 F. 2d 137 (2d Cir. 1963).

The suggestion made by the defendants that Section 16

of the Act (15 U.S.C. 78p), relating to directors, officers,

and principal stockholders, defines ‘‘insiders’’ and limits

the liabilities of insiders to the sanctions provided in Section

16, is equally without merit. A Section 16 action can be

brought only by the corporation itself or derivatively by

an existing security holder against officers, directors or

beneficial owners of ten per cent or more of the corpora-

tion’s listed equity securities. It covers only short-swing

profits realized within a six-month period, and any recov-

ery inures to the corporation. Profits are recoverable re-

gardless of any intent to defraud and without proof that

they were realized by reason of inside information. In

short, Section 16 was enacted as a ‘‘crude rule of thumb’’

to make unprofitable all short-swing speculation by a spe-

cifically defined group of insiders. See, Blau v. Lamb,

F.2d (2d Cir., June 27, 1966).

A Section 10(b) action, on the other hand, may be

brought pursuant to Section 27 by the Commission or by

any party claiming to have been defrauded. The section

(5463) applies to ‘‘any person,’’ not merely to the persons

encompassed by Section 16. H. L. Green Co. v. Childree,

185 F. Supp. 95 (S.D.N.Y. 1960) (accountants) ; Cady, Rob-

erts & Co., 40 S.E.C. 907 (1961) (broker). Section 16 re-

quires both a purchase and a sale of a listed security, while

Section 10(b) applies to a purchase or sale of any security.

The numerous differences between Section 16 and Section

21a

Appendix A —Opinion of the District Court

10(b) clearly indicate that the provisions of the former

impose no limitation en the enforcement of the latter. See,

3 Loss, Securities Regulation, 1473, 1474 (2d ed. 1961) ;

Comment, ‘‘The Prospects for Rule X-10B-3- An Emerg-

ing Remedy for Defrauded Investors,’’ 59 Yale L. J. 1120,

1140-42 (1950).

To establish violations of Section 10(b) and Rule 10b-

9(3), the Commission must prove that the defendants en-

gaged in a ‘‘course of business’’ which operated as a

“fraud or deceit . . . in connection with the purchase or

sale of any security.’’ Questions arise therefore as to

whether insider purchases based on material, undisclosed

information constitute violations of Section 10(b) and Rule

10b-5(3) ; if so, who are insiders; whether the statute and

rule are limited to ‘*face-to-face’’ transactions; and, fi-

nally, what constitutes materia] information.

(5464) The statute and rule go at least as far as the

federal common law rule. Iist v. Fashion Park, Inc., 340

F.2d 457, 461-2 (2d Cir. 1965). As long ago as 1909, the

Supreme Court held in Strong v. Rapide, 213 U.S. 419

(1909), that the failure of the director and general manager

of a corporation to disclose “*special facts’’ in purchasing

its securities operated as a fraud on the seller. The Court

Stated that:

“‘Tf it were conceded, for the purpose of the argu-

ment, that the ordinary relations between directors

and shareholders in a business corporation are not of

such a fiduciary nature as to make it the duty of a

director to disclose to a shareholder the general

knowledge which he may possess regarding the value

of the shares of the company before he purchases

any from a shareholder, yet there are cases where,

by reason of the special facts, such duty exists.”? 213

US., at 431.

22a

Appendix A —Opinion of the District Court

Applying this ‘‘special facts’’ doctrine to Section 10(b) and

Rule 10b-5, trading by an insider on the basis of material

undisclosed information constitutes a deceptive practice in

violation of the statute and rule. See, Loss, supra, at

1445-73.

In Strong v. Rapide, the defendant was a director and

general manager of the corporation, and owned three-

fourths of its outstanding shares. He was, therefore, an

(5465) insider under any standard. Section 10(b) has been

construed as imposing a similar liability on officers, direc-

tors, and major stockholders. Cochran v. Channing Corpo-

ration, 211 F. Supp. 239 (S.D.N.Y. 1962). Further, since

Section 10(b) applies to ‘‘any person’’ it can include ‘‘in-

siders’’ who are not officers, directors or major stockholders.

Cady, Roberts € Co., supra, at 912.

In Brophy v. Cittes Service Co., 70 A. 2d 5, 7 (Del. Ch.

1949), the court pointed out ‘‘if an employee in the course

of his employment acquires secret information relating to

his employer’s business, he occupies a position of trust and

confidence toward it, analogous in most respects to that of

a fiduciary, and must govern his actions accordingly.’’

Citing Brophy, the Commission in Cay, Roberts € Co.,

supra, found that the obligation to disclose material infor-

mation rests on two grounds:

‘*. .. first, the existence of a relationship giving

access, directly or indirectly, to information intended

to be available only for a corporate purpose and not

for the personal benefit of anyone, and second, the

inherent unfairness involved where a party takes ad-

vantage of such information knowing that it is un-

available to those with whom he is dealing.’’ 40

S.E.C., at 912.

23a

Appendix A —Opinion of the District Court

(5466) Therefore, insiders subject to the disclosure require-

ments of Section 10(b) and Rule 10b-5 may include em-

ployees as well as officers, directors, and controlling

stockholders who are in possession of material undisclosed

information obtained in the course of their employment.

An insider’s liability for failure to disclose material in-

formation which he uses to his own advantage in the pur-

chase of securities extends to purchases made on national

securities exchanges as well as to purchases in ‘‘face-to-

face’’ transactions. List v. Fashion Park, Inc., supra, at

461-62. In Cochran v. Channing Corporation, supra, at 243,

the court stated:

‘‘The Securities Exchange Act was enacted in part

to afford protection to the ordinary purchaser or

seller of securities. Fraud may be accomplished by

false statements, a failure to correct a misleading im-

pression left by statements already made or, as in

the instant case, by not stating anything at all when

there is a duty to come forward and speak. It is the

use of inside information that gives rise to a violation

of Rule 10b-5. [Citations omitted. |] Lack of com-

munication between defendant and plaintiff does not

eliminate the possibility that Rule 10b-5 has been

violated.”’

And, as noted in Cady, Roberts, ‘‘it would be anomalous

indeed if the protection afforded by the anti-fraud provi-

sious were withdrawn from transactions effected on ex-

changes, (5467) primary markets for Securities transac-

tions.’’ 40 S.E.C., at 914.

In response to the defendants’ contention that it would

be impossible for an insider trading on a national exchange

24a

Appendix A —Opinion of the District Court

to seek out the other party .o the transaction and disclose

material information to him (Goodwin v. Agassiz, 186 N.E.

659 (Mass. 1933)), it is clear that there are other ways of

disclosing significant corporate developments. The New

York Stock Exchange provides in its Company Manual that

‘‘important developments which might affect security

values or influence investment decisions should be promptly

disclosed.’’ (Listing Agreement at A-20.) If legitimate

business reasons require a period of non-disclosure, the

insider should forego transactions in his company’s securi-

ties during that period. Cady, Roberts, supra, at 911. As

stated by the court in Oliver v. Oliver, 45 S.E. 232, 234 (Ga.

1903) :

‘‘It might be that the director was in possession

of information which his duty to the company re-

quired him to keep secret; and, if so, he must not

disclose the fact even to the shareholder, for his ob-

ligation to the company overrides that to an indi-

vidual holder of the stock. But if the fact so known

to the director cannot be published, it does not follow

that he may use it to his (5468) own advantage, and

to the disadvantage of one whom he also represents.

The very fact that he cannot disclose prevents him

from dealing with one who does not know, and to

whom material information cannot be made known.”’

However, to establish a violation of Section 10(b) and

Rule 10b-5, the undisclosed information must. be material.

List v. Fashion Park, Inc., supra. There is nothing in the

Act which precludes insiders from purchasing stock of their

company or from being beneficiaries of the company’s in-

centive stock option plan. On the contrary, it is important,

25a

Appendix A —Opinion of the District Court

\

under our free enterprise system that insiders, including

directors, officers, and employees, be encouraged to own se-

curities of their company. The incentive that comes with

stock ownership benefits both the company and its stc:k-

holders.

Moreover, it is obvious that any director, officer, or em-

ployee will know more about his company or have more

specialized knowledge as to at least some phase of its busi-

ness than an outside stockholder can have or expect to

have. Often this specialized knowledge may whet the specu-

lative interest of the insider, particularly if he believes in

the future of his company, and may lead him to purchase

stock. Purchases under such circumstances are not encom-

passed by Section 10(b) and Rule 10b-5. As Stated (5469)

in Loss, supra, at 1463:

‘*. .. an insider is under no obligation to give the

ordinary investor the benefit of his superior financial

analysis. It has been aptly said that, ‘Even though a

shrewd guess by an insider is often worth fifty ac-

counting statements, it would be highly unfair to

make him publicize his guess and then to hold him

responsible if it turns out to be wrong.’ ’’ (Quoting,

Comment, ‘‘The Prospects for Rule X-10b-5,’’ 59

Yale L. J., at 1148.)

However, where an insider comes into possession of ma-

terial information which he uses to his own advantage by

purchasing stock or calls on the stock of his company prior

to public disclosure, he violates Section 10(b) and Rule

10b-5. Information is not material merely because it would

be of interest to the speculator on Bay Street or Wall

Street. Material information has been defined as informa-

tion ‘‘which in reasonable and objective contemplation

26a

Appendix A —Opinion of the District Court

might affect the value of the corporation’s stock or securi-

ties....’’ List v. Fashion Park, Inc., supra, at 462, citing,

Kohler v. Kohler Co., 319 F. 2d 624, 642 (7th Cir. 1963).

It is information which, if known, would clearly affect ‘‘in-

vestment judgment,’’ Cady, Roberts, supra, at 911, or which

directly bears on the intrinsic value of a company’s stock.

See, Kardon v. National Gypsum Co., 73 F. Supp. 798 (E.D.

Pa. 1947); Speed v. Transamerica Corp., 99 F. Supp. 808

(5470) (D. Del. 1951); Ward Larrance Truck Corp., 13

S.E.C. 373 (1943).

Material informaticn need not be limited to information

which is translatable into earnings, as suggested by defend-

ants. But the test of materiality must necessarily be a con-

servative one, particularly since many actions under Section

10(b) are brought on the basis of hindsight. As stated by

a former member of the steff of the Commission:

‘“‘It is appropriate that management’s duty of dis-

closure under rule 10b-5 be limited to those situations

which are essentially extraordinary in nature and

which are reasonably certain to have a substantial

effect on the market price of the security if disclosed.

A more rigorous standard would impose an unrea-

sonable burden on management in its securities trad-

ing. Moreover, such a standard could involve the

courts to an unrealistic degree in the determination of

whether certain types of information might have an

impact on the market. A finer web might well pre-

vent some management trading that represents an

abuse, but only at the cost of possibly exposing man-

agement to meritless litigation in many other casvs.”’

(Fleischer, ‘Securities Trading and Corporate Infor-

mation Practices: The Implications of the Texas

Gulf Sulphur Proceeding,’ 51 Va. L. Rev. 1271, 1289

(1965).)

27a

Appendix A —Opinion of the District Court

(5471)

AppLication or Section 10(b) or tHe Act axp Rute 10b-5

To PurcHAsES BY INDIVIDUAL DereNDANTS

All of the individual defendants were direetors, officers

or cuiployees of TGS. With the exceptions of Stephens and

Kline, each purchased stock of TGS using the facilities of

a national securities exchange. Accordingly, the jurisdic-

tional requirements of the Act and Rule 10b-5 have been

satisfied with respect to these purchases. The issue remains

as to whether any of the defendants in purchasing TGS

stock or calls on TGS stock were using for their own ad-

vantage material information as to the drilling on the Kidd

o0 segment not disclosed to the public. Defendants Hunt-

ington and Murray had no detailed knowledge as to the

work and hence were net in possession of material informa-

tion. Huntington knew only that TGS was acquiring prop-

erty rights in Kidd Township. Murray had no knowledge

of the situation on the Kidd 55 segment at the time he made

his purchases. In considering whether the remaining in-

dividual defendants were in possession of material informa-

tion when they made their purchases, the period from No-

vember 12, 1963 to April 16, 1964 may be conveniently

subdivided as follows:

(1) November 12, 1963 to 7:00 p.m. April 9, 1964

(2) 7:00 p.m. April 9 to 10:00 a.m. April 16, 1964

(8) April 16, 1964 from 10:00 a.m. to the close ef business

on that day.

(5472)

(1) November 12, 1963 to 7:00 p.m. April 9, 1964

K-55-1 was completed on November 12, 1963. Visual esti-

mates at the drill site, which were subsequently confirmed

8a

Appendix A —Opinion of the District Court

by chemical assays received in mid-December, indicated

substantial zine and copp°r mineralization over approxi-

mately 600 feet of the core’s 657 foot length. On the basis

of the visal estimates, TGS took customary security meas-

ures to maintain the secrecy of the drilling results while it

undertook to acquire the remaining quarter sections of the

Kidd 55 segment. On March 31, 1964 drilling was resumed.

K-55-3 was drilled and established that mineralization

existed in a vertical plane over 350 feet wide and 500 feet

deep. On April 7 drilling of K-55-4 was begun 200 feet

south of K-55-1 and by 7:00 p.m. on April 9 it had been

drilled to 421 feet and had encountered 366 feet of minerali-

zation. K-55-1, K-55-3, ard K-55-4 intersected substantial

copper mineralization on the eastern edge of the anomaly.

According to the Commission’s experts, Adelstein® (the

Commission’s chief mining engineer) and Pennebaker (con-

sulting geologist to the Commission), K-55-4 established a

third dimension to the mineralized zone, so that the (5473)

drilling through 7:00 p.m. on April 9 established a mine.”

The geologists called by tie defendants disputed the con-

clusions reached by Adelstein and Pennebaker, unanimously

agreeing that the drilling of the three holes to 7:00 p.m. on

April 9 did noc establish that TGS had a mine. The Com-

mission has taken the position with respect to registration

statements filed under the Securities Act of 1933 that ‘‘three

diamond drill holes‘are insufficient to determine whether

a commercial ore body is present, even though they should

encounter a gold bearing structure.’’ Pan-American Gold

Ltd., 31 S.E.C. 141, 147-8 (1950).

It is unnecessary to determine whether TGS had a mine

since the drilling of K-55-4 to 7:00 p.m. on April 9 was a

strong indication that the mineralization encountered on

the vertical plane between K-55-1 and K-55-3 extended

southward 200 feet. There was real evidence that a body

—

29a

Appendix A —Opinion of the District Court

of commercially mineable ore might exist. At 7:00 p.m.

on April 9, those with knowledge of the drilling results had

material information which it was reasonably certain, if

disclosed, would have had a substantial impact on the mar-

ket price of TGS stock. Therefore, they were under a duty

not to use such material information to their personal ad-

vantage without first diselosing it to the public.

(0474) However, the drilling results up to 7:00 p.m. on

April 9 did not provide such material information. When

considered in relation to the far-flung business of TGS at

the time, it cannot be said that the drilling results of

K-55-1 and K-55-3 constituted material information, the

disclosure of which would have had a substantial impact

on the market price of TGS’s 10,000,000 outstanding shares.

K-55-1

There is no doubt that the drill core of K-55-1 was unusu-

ally good and that it excited the interest and speculation of

those who knew about it. However, all the experts agreed

that one drill core does not establish an ore body, much

less a mine. Defendants’ experts unanimously concluded

that there is no way even to estimate the probabilities that

one drill core will lead to the discovery of an ore body. Con-

cededly, the geophysical survey conducted prior to the drill-

ing of K-55-1 indicated a ‘first class”’ anomaly over a length

of more than 1,000 feet, but the conductive materials evi-

denced by the survey outside the first drill hole could have

consisted of worthless pyrite or graphite, both of which

materials were found in the core of K-55-1. As stated by

Boniwell, a mining geophysicist, (5475) geophysics is of

little help in predicting continuity.

Moreover, the core of K-55-1 was not solid ore. The

percentages of copper and zine mineralization fluctuated

30a

Appendia A —Opinion of the District Court

markedly. Although it appears this is not unusual due to

the complex nature of the Pre-Cambrian subsurface rock

structure, it supports the testimony of defendants’ experts

that no predictions could be made as to how far rineral

values encountered by K-55-1 extended beyond the 11% inch

drill core. As was brought out by Walkey, a mining engi-

neer employed by Kamkotia Mines 12 miles from the Kidd

03 segment, mineral deposits on the Canadian Shield tend

to be highly irregular in structure, with wide variaticns in

grade. Walkey, Boniwell and Wiles (a mining engineer

with forty years’ experience) testified as to instances where

one drill hole had produced a promising core but subsequent

drilling had shown that the mineral values did not extend

any appreciable distance beyond that core. Therefore, the

first promising core may turn out to be a liability by induc-

ing further drilling with negative results."

Bellemore and Pearson, security analysts called by de-

fendants, testified that from an investment point of (5476)

view no significance could be attached to the results of a

single drill hole, however rich.

The most that can be said of the individual defendants’

knowledge after the drilling of K-55-1 is that they had

‘*hopes, perhaps with some reason,’’ that it would lead to a

mine. James Blackstone Mem. Lib. Ass’n v. Gulf, M. € O. R.

Co., 264 F. 2d 445, 450 (7th Cir. 1959). The results of

K-55-1 were too ‘‘remote’’ when considered in light of the

size of TGS, the scope of its activities, and the number of

its outstanding shares, to have had any significant impact

on the market, t.e., to be deemed material. List v. Fashion

Park, Inc., supra.

The Commission contends, however, that the results of

K-55-1 were material because of the significance attached to

sla

AWpoudiv | —Opinion of the District Court

those results by certain defendants. Between the comple-

tion of K-55-1 on November 12, 1963 and the completion of

K-55-3 on April 4, 1964, defendants Fogarty, Mollison,

Holyk, Clayton and Darke Spent more than $100,000 in pur-

chasing stock and ealls on the stock of TGS. These defend-

ants could bring considerable expertise to bear in evaluating

the results of K-55-1 and their purchases may have been

prompted by an educated guess that K-55-1 would (5477)

lead to the discovery of a mine. Therefore, a question is

presented as to whether information which may have special

significance to an insider because of his professional back-

ground, is material.

¢ A similar question would be presented where an engineer

in the research department of a publicly-held corporation

believes that he may have invented a process which will

substantially increase the corporation’s earnings or where

a chemist in a large pharmaceutical firm thinks that he may

have devised a chemical formula which can cure cancer.

In these instances it ean be assumed that the insider, because

of his educated Suess, will be enthusiastic and his enthu-

siasm may lead him to purchase stock in his company and

to recommend the stock to his associates and friends even

though his educated guess may turn out to be wrong. It

may be argued that such purchases are ‘‘unfair’’ to the

outside stockholders and come within the ambit of Section

10(b) and Rule 10b-5. Purchases on the basis of educated

guesses may be viewed as an attempt to secure additional

corporate compensation. Cary, ‘“‘Corporate Standards and

Legal Rules,’’ 50 Calif. L. Rev. 408 (1962).

(5478) However, most insiders necessarily have educated

guesses about the prospects of particular company pro-

grams. If it is held that purchases made on the basis of

educated guesses are proscribed by Section 10(b) and Rule

32a

Appoudix A —Opinion of the District Court

10b-5, insiders who purchase stock in their company will

do so at their peril. If they announce their educated guesses

before purchasing and their guesses turn out to be wrong,

they would be subject to suit; and if they purchase and

keep their educated guesses to themselves and they turn

out to be right, they would again be subject to suit. The

creation of such a dilemma would result in insiders not

buying at all although insiders should be encouraged to

have a stake in the coiapanies for which they work.

The outside stockholder can never match the knowledge

of an insider who necessarily knows more about the com-

pany and is in a better position to evaluate its prospects.

It may be that the ‘‘fairness’’ overtones of Cady, Roberts

indicate a trend toward the elimination of all insider pur-

chasing. But even were the Court prepared to accept the

proposition that all insider trading is unfair, a proposition

of doubtful validity at best, it would be deterred by the

admonition of Judge Learned Hand that it is not ‘‘desirable

for a lower (5479) court to embrace the exhilarating oppor-

tunity of anticipating a doctrine which may be in the womb

of time, but whose birth is distant. . . .’’ Spector Motor

Service Inc. v. Walsh, 139 F. 2d 809, 823 (2d Cir. 1944)

(dissenting opinion) (reprinted in Bar Bulletin, N. Y. Co.

Lawyers Assn, Vol. 23, No. 4, at 156, 1965-66). Therefore

the purchases pricr to 7:00 p.m. on April 9 were not based

on material undisclosed information even if the purchasers

had educated guesses based on the results of the first drill

hole.

K-55-3

K-55-3 established that K-55-1 had not gone down dip,

and indicated a vertical plane on section 2400 S containing

mineralization. However there was no indication that the

33a

Appendix A —Optnion of the District Court

mineralization extended beyond the plane. Defendant Mol-

lison testified that at Kamkotia a drill hole could produce

substantial mineralization while another 50 feet away pro-

duced a barren core. The results of K-55-3 added to the

information previously known but did not constitute ma-

terial information. If disclosed, it would not have had a

substantial impact on the market price of the Company’s

stock.

Accordingly, the purchases made by certain defendants

prior to 7:00 p.m. on April 9, 1964 were not based (5480)

on material information. The fact that subsequent drill-

ing established a major ore body is immaterial. As stated

recently in Value Line Fund, Inc. v. Marcus, CCH Fep.

Sec. L. Rep. 191,523,, at 94,956 (S.D.N.Y. 1965), ‘‘the court

must be guided not by hindsight, but by the facts as they

existed at the time of the. . . challenged transaction.’’

Similarly, purchases by Darke’s “‘tippees’’ prior to

7:00 p.m. on April 9 were not made on the basis of material

undisclosed information. Toward the end of December,

1963, Darke visited Caskey and Atkinson in Washington.

The evidence shows no more than that Darke indicated to

them that he thought TGS was a good buy. There is no

direct evidence that Darke again communicated with any

of his ‘‘tippees,’’ but the record shows that on March 30,

1964 Darke and his ‘‘tippees,’’ Atkinson, Caskey, E. W.

Darke, Klotz, Miller and Westreich, purchased substan-

tial amounts of TGS stock and calls on TGS stock. As the

Commission po‘nts out, this is strong circumstantial evi-

lence that Darke must have passed the word to one or

more of his ‘'1:j»pees’’ that drilling on the Kidd 55 segment

was about te .. resumed. But, for the reasons hereinbefore

stated, this 11 >rmation was not material.

0 EE

34a

Appoudis A —Opinion of the District Court

(5481) For the foregoing reasons, the Court finds no

violations of Section 10(b) or Rule 10b-5 on the part of any

of the individual defendants who purchased shares of TGS

or calls on TGS stock or recommended such purchases

to others prior to 7:00 p.m. on April 9, 1964.

(2) 7:00 p.m. April 9, 1964 to 10:00 a.m. April 16, 1964

Defendant Clayton purchased 200 shares of TGS stock

on April 15; defendant Crawford purchased 600 shares on

April 16. These defendants (and defendants Coates and

Lamont) raise the defense that even if they were in posses-

sion of material information when they made their pur-

chases, the material information had already become a

matter of public knowledge.

The trial developed that rumors of an ore discovery by

TGS were flying around Canada during the early part of

April and were being given wide circulation in the Cana-

dian press. These rumors reached the New York press

by April 11, on which day they were played up in both the

New York Times and the New York Herald Tribune. At

this point defendants Stephens and Fogarty agreed that a

press release was necessary and this decision led to the

issuance of the April 12 press release hereafter discussed.

Fogarty (5482) also gave instructions that a reporter from

The Northern Miner (an important Canadian publication

on the mining industry in Canada), who had previously

been invited to visit the Kidd 55 segment on April 21, be

asked to come on April 13 instead.

The Northern Miner reporter, Ackerley, visited the prop-

erty on April 13, interviewed defendants Mollison, Holyk

and Darke, looked at the records of the drilling to that

time, and prepared an article for publication. The article

stated in part that ‘‘The Northern Miner can say that u

35a

Appendia 1 —Opinion of the District Court

major new zine-copper-silver mine is definitely in the mak-

ing, one that has all the earmarks of shaping into a substan-

tial open pit operation . . . something in excess of 10,-

000,000 tons of ore is indicated.’? Ackerley delivered a

copy of his proposed article to defendant Mollison in Tim-

mins and it was agreed that it would not be published un-

til cleared by Mollison. Defendants Mollison and Holyk

read the article and though they felt that some of its con-

clusions were too optimistic, they considered it Ackerley’s

article and would not quibble with it. Defendant Mollison

returned the article to The Northern Miner on the evening

of April 15, and it was published in The Northern Miner’s

April 16 edition.

(5483) The Northern Miner had a small circulation—e—

the United States—7,400 subscribers—including distribu-

tion in the New York area to 1,412 subscribers, who pre-

sumably received the paper on the morning of April 16.

Lhe Northern Miner also had a small newsstand circulation

in New York, but the evidence fails to establish when the

April 16 edition reached the newsstands. Reports of The

Northern Miner article were telephoned and telexed from

Toronto to some brokers in New York early on the morn-

ing of April 16 prior to the opening of the New York Stock

Iixchange.

The annual convention of the Canadian Institute of Min-

ing and Metallurgy was held at the Queen Elizabeth Hotel

in Montreal on April 13-15, attended by 500 to 600 repre-

sentatives of the mining industry and of the business world,

including some representatives from the United States. The

rumors with respect to a copper discovery by TGS near

Timmins were a leading subject of gossip in the corridors

and bars of the hotel. The convention was attended by the

Ontario Minister of Mines and his Deputy.

Nel Rk Ae Si Rie Na RY I a Rh TE ROE IR EE INN SR ROY Rad OM Lt

36a

Appendix A —Opinion of the District Court

On the morning of April 15, defendants Mollison and

Holyk met the Minister of Mines and his Deputy at the

(5484) Montreal airport and flew them to Toronto, in-

forming them during the course of the flight of the current

developments on the Kidd 55 segment. The Minister indi-

cated a desire to make a public statement and Mollison as-

sisted him by drafting that statement. Mollison’s draft con-

cluded by saying that ‘‘the information now in hand. . .

gives the company confidence to allow me (the Minister) to

announce that TGS has a minable body of Zn, Cu, Ag ore

of substantia! dimensions that will be developed and brought

to production as rapidly as possible.’’ Mollison and Holyk

were under the impression that the Minister would issue

the statement in Toronto over radio and television at 11:00

p-m. on the evening of April 15 and Mollison so informed

defendants Stephens and Fogarty in New York.

The Minister made no announcement on the evening of

the 15th, but on the morning of the 16th, at about 9:40 a.m.,

he delivered the statement drafted by Mollison to the press

gallery at the Ontario Parliament in Toronto. Members of

the press gallery included representatives of both the Cana-

dian and American news media, but there was no evidence

as to who was in the press gallery at the time.

The effect of the foregoing was that before the market

opened on April 16, some brokers and some speculators

(5485) had picked up information that TGS had made an

ore discovery. However, no announcement had yet been

made by TGS. Only the day vefore, defendants Stephens,

Fogarty and Crawford were preparing the announcement

which was to be made at 10:00 a.m. on April 16. They took

steps to assure the attendance of appropriate representa-

tives of the news media at the press conference where the

announcement would be made. The officers of TGS knew

37a

Appendix A —Opinion of the District Court

about the rumors in Canada, the Northern Miner article

and the pending announcement of the Ontario Minister of

Mines. Had they thought that their effect was to make the

material information public there would have been little

purpose in making the arrangements for a press conference,

and issuing a detailed announcement on April 16. The ma-

terial information did not become public knowledge prior

to TGS’s official announcement. Therefore, insiders who

purchased stock prior to TGS’s announcement may not

assert as a defense that the material information ha

already become a matter of public knowledge. |

Turning now to the two defendants who purchased shares

of TGS after 7:00 p.m. on April 9, 1964 and before 10:00

a.m. on April 16:

Ricnarp H. Ciayton

Clayton was a geophysicist in the employ of TGS. His

job was to conduct geophysical surveys, and he conducted

such surveys on the Kidd anomaly. While he did not par-

ticipate (5486) in the drilling, he spent a great deal of his

time at Timmins and at the Kidd 55 segment, and the evi-

dence establishes that he kept himself fully informed. He

was in Timmins on April 12 and 13 and, according to Adel-

stein, he told Adelstein (on June 3, 1964) that he thought

TGS had a mine when he learned the results of K-55-4.

While Clayton denied making this statement, he testified at

a pre-trial examination that he thought that, with the results

of K-55-6, TGS had a potential ore body. By 7:00 p.m. on

April 13, K-55-6 had been drilled to 949 feet, encountering

substantial mineralization. Indeed, no further mineraliza-

tion was encountered by K-55-6 <fter that time. On Apri

14 Clayton left for New York u a was in TGS’s New Yo *-

38a

Appendix i —Opinion of the District Court

office on April 15. He picked up the telephone at TGS’s

office in New York, called his broker in Toronto and ordered

200 shares of TGS stock. The broker executed the order on

April 15 on the Midwest Stock Exchange in Chicago at

2934.

It is clear that at the time of this purchase Clayton was

in possession of material inside information which had not

yet been made available to the public and that he used this

information to his own advantage. In this proceeding by

the Commission it is immaterial whether (5487) Clayton

intended to deceive or to defraud anyone or whether he

knew at the time that his purchase would violate Section

10(v) and Rule 10b-5. The Commission has established that

Clayton violated these provisions in making his April 15

purchase.

Clayton contends that he is not subject to the jurisdic-

tion of this court. He was employed by TGS, a United States

corporation, and, according to his testimony, shuttled back

and forth between Canada and New York on TGS business

during the period from November 1963 to April 1964. His

April 15 purchase was initiated by him while ke was in New

York in TGS’s office. He placed his order with his Toronto

broker by telephone from New York to Canada, employing

a channel of interstate and foreign commerce. The transac-

tion was consummated on the Midwest Stock Exchange in

Chicago. He had previously purchased TGS stock, and on

two occasions his orders were executed on the New York

Stock Exchange. Though he placed his orders with a

Toronto broker, all his purchases were effected on an

American stock exchange. Clayton’s telephone call from

New York on April 15 brought about the purchase. There-

fore, the court has subject matter jurisdiction. (Section 27

of the Act, (5488) 15 U.S.C. 78aa; Ferraiola v. Cantor, CCII

FED. SEC. L. REP. 191,704 (S.D.N.Y. 1966)). Under Sec-

39a

Appendia A —Opinion of the District Court

tion 27 Clayton could be served wherever he was found and

service outside of the United States has been sustained.

Ferraiola v. Cantor, supra; S.E.C.v. VTR Inc., CCH FED.

SEC. L. REP. 791,618 (S.D.N.Y. 1966) ; S.E.C. v. Briggs,

234 F’. Supp. 618 (N.D. Ohio 1964) ; see Advisory Commit-

tee’s Note to the 1963 revision of Rule 4 of Fed. R. Civ. P.

reprinted at 31 F.R.D. 627, 630 (1962). Service upon Clay-

ton by leaving the summons and complaint with his wife at

his home in Timmins was valid. (Rule 4(d)(1), (e), (f),

€ Fed. R. Civ. P.)

Davip M. CrawFrorp

Crawford is a lawyer who came with TGS on February

20, 1964, on which date he was appointed secretary of the

Company and manager of its public and Government rela-

tions. He had not been informed as to. the developments on

the Kidd 55 segment. He read the rumor article in the New

York Herald Tribune on April 11 while on his way to Hous-

ton to prepare for TGS’s annual stockholders’ meeting. He

returned to New York either late on the 14th or early on

the 15th of April, and on that day participated with Fogarty

(3489) and a representative of Doremus & Co. in the prepa-

ration of the April 16 press release. The evidence estab-

lishes that by the evening of April 15 he was fully familiar

with the contents of the announcement which was to be made

the following morning. He spent the night in a room main-

tained by TGS at the Drake Hotel in New York City. About

midnight he telephoned his broker in Ciivago and ordered

300 shares of TGS for himself and his wife to be purchased

as soon as the market opened the following day. During

the night he decided to increase his order, and he telephoned

his broker again at about 8:30 a.m. on April 16 to increase

the order from 300 shares to 606 ahares. The purchase was

40a

Appendix .1—Opinion of the District Court

executed on the Midwest Stock Exchange on April 16 at

30% to 3014.

Here again, while there is no evidence that Crawford in-

tended to deceive or to defraud anyone, it is clear that he

sought to, and did, ‘‘beat the news.’’ There is no doubt that

he believed that he could get the stock more cheaply if he

bought before TGS’s announcement was made. In so doing,

he was utilizing material undisclosed information to his own

advantage and violated Section 10(b) and Rule 10b-5.

(5490)

(3) 10:00 a.m. April 16 to Close of Business on that Day

Between the announcement and the close of business on

April 16 defendants Coates and Lamont either purchased

shares of TGS or recommended their purchase to others.

A regular meeting of the Board of Directors was held at

TGS’s offices at 9:00 a.m. on April 16. During the meeting

defendant Stephens distributed copies of the announcement

to be made to the press at the press conference called for

10:00 a.m. Stephens also told the Board that a statement

regarding TGS’s discovery had been issued in Toronto at

11:00 p.m. the previous evening by the Ontario Minister of

Mines. At the conclusion of the Directors’ meeting, repre-

sentatives of the news media, over 22 in all, came into the

Board Room. The announcement was made by Stephens,

and they were given copies of the press release which

Stephens, Fogarty and Crawford had prepared. The press

release stated in part:

‘‘Texas Gulf Sulphur Company has made a major

strike of zine, copper and silver in the Timmins area

of Ontario, Canada.

4la

Appendix A—Opinion of the District Court

‘Seven driil holes are now essentially complete

and indicate an ore body of at least 800 feet in

length, 300 feet in width and (549!) having a vertical

depth of more than 800 feet.

‘‘This is a major discovery. The preliminary data

indicate a reserve of more than 25 million tons of

ore. The only hole assayed so far represents over

606 feet of ore, indicating a true ore thickness of

nearly 400 feet.

‘‘Visual examination of cores from the other holes

indicate comparable grade and continuity of ore.

‘The ore body is shallow, having only some 20

feet of overburden. This means that it can easily be

mined initially by the open pit method.”

Summaries of the announcement were carried over the

internal news wire of Merrill Lynch, Pierce, Fenner &

Smith at 10:29 a.m., and over the Dow Jones broad tape

between 10:54 a.m. and 11:02 a.m.

Francis G. Coates

Coates was a Houston lawyer and a member of the Board

f Directors of TGS. After reading the Herald Tribune

-rticle of April 11 he telephoned defendant Stephens from

{ouston and was told by Stephens that TGS did not have

5492) enough information to know what it had. Coates

42a

Appendix A —Opinion of the District Court

came to New York on April 15 and saw a draft of the pro-

posed April 16 announcement that afternoon. On the 16th

he attended the Directors’ meeting and remained for the

press conference at which the announcement was made.

The press conference started at 10:00 a.m. and lasted ten

or fifteen minutes. Shortly before 10:20 a.m. Coates left

the meeting room and telephoned his son-in-law, Haemi-

segger, a broker in Houston. He told Haemisegger of

TGS’s discovery and ordered 2,000 shares of TGS stock

for the accounts of four family trusts of which he was a

trustee but not a beneficiary. Haemisegger executed the

order at prices from 31 to 31% on the New York and Mid-

west Exchanges. Haemisegger immediately imparted the

information he had received from Coates to four of his

customers, and they, as well as Haemisegger himself, pur-

chased a total of 1500 shares of TGS stock at prices ranging

from 31% to 35.

Coates iost no time in telephoning his son-in-law j in order

to purchase TGS stock for his family trusts. Coates could

not, as could Lamont when he telephoned Hinton at the

Morgan Guaranty Trust Company just before 10:40 a.m.

assume ‘‘ without thinking about it, that the [ore discovery]

(5493) was already a matter of public information. . . .”’

Cady, Roberts, supra, at 917. The announcement had been

made, however, and it has been the generally accepted rule

that it is the makirtg of the announcement that controls.

For example, the Commission in Cady Roberts found viola-

tions of Section 10(b) and Rule 10h-5 for purchases made

‘‘during the time when respondents should have known

that the board of directors .. . was taking steps to make

the information publicly available but before it was actually

announced.’’ Cady, Roberts. supra, at 915. (Emphasis

supplied.) Coates, an experienced corporate lawyer, testi-

EEE eee

43a

Appendix A —Opinion of the District Court

fied that he believed that the standard in the marketplace

was that once the announcement is made, insiders were

free to purchase stock or to recommend it to others.

It may be, as the Commission contends, that a more effec-

tive rule should be established to preclude insiders from

acting on information after it has been announced but before

it has been absorbed by the public. Perhaps such a rule

should extend not only to corporate insiders but to others

who may be in a position to take unfair advantage of the

stockholders. What of a representative of the news media

who, upon hearing the announcement, calls his broker before

he calls (5494) his office? What of a wire house which has

an inside track in getting the information to its registered

representatives and to its customers? (The April 16 an-

nouncement went out over Merrill Lynch’s news wire to its

145 offices half an hour before it went out over the Dew

Jones ticker.) Should the representatives of the news

media and the wire houses be subjected to such a rule since

they are in possession of material information which the

average stockholder has not had an opportunity te absorb?

These examples are offered merely to illustrate the prob-

lems that arise it the present practice is to be changed.

The Commission took the position, on summation, that

it is for the courts to fix a reasonable waiting period after

‘in announcement is made, during which insiders cannot pur-

chase stock, so that the announcement can first be absorbed

by the public. In other words, it seems to be the Commis-

“lon’s position that a fairer practice than now exists should

he evolved through court decisions. This could only lead

fo uncertainty. A decision in one case would not control

another case with different facts. No insider would know

whether he had waited long enough after an announcement

had been made. He would be subject to suit by the Com-

44a

Appendix A —Opinion of the District Court

mission (and to private (5495) suits brought by others rid-

ing on the Commiss:on’s coattails).

The Commission has not supplied, nor has the Court

found, decisions specifying a waiting period after a corpo-

rate announcement is made. After this action was insti-

tuted, Cary, the former chairman of the Commission, and

Fleischer, his former executive assistant, discussed a waiting

period in policy terms.’* If a waiting period is to be fixed,

this could be most appropriately done by the Commission,

which was established by Congress with broad rule-making

powers. Should the Commission determine that it lacks

authority to fix a waiting period, authority should come

from Congress rather than from the courts.

Since TGS’s announcement had been made when Coates

telephoned Haemisegger, he did not violate Section 10(b)

or Rule 10b-5.

Tuomas S. Lamont

Lamont was a director of TGS. He was also a director

of Morgan Guaranty Trust Compaay and a member of its

Executive Committee and its Trust and. Investment Com-

mittee. (5496) Lamont testified that he first heard of the

exploration on the Kidd 55 segment on April 10 when de-

fendant Stephens telephoi.ed him about the rumors in Can-

ada, end Lamont advised Stephens to ignore them unless

they reached the New York press. Stephens informed La-

mont that the exploration was ‘‘at the prospect stage.”’

Thereafter, Lamont heard rumors from friends and read

the article which appeared in the Herald Tribune on April

11, and TGS’s April 12 press release as reported in the

press. On April 13 or 14 he had a conversation about the

rumors with Hinton, the Executive Vice President of Mor-

4

|

:

y

45a

Appendix A —Opinion of the District Court

gan Guaranty Trust Company. Lamont told Hinton that

he knew nothing more than had appeared in the press. On

April 15 Lamont was informed by Stephens that a press

conference would follow the regular Directors’ meeting

scheduled for the morning of the 16th. Lamont attended

the Directors’ meeting and read the press release, and

attended the press conference at which the announcement

was made. "

Following the announcement, and while he was still at the

TGS office, Lamont telephoned Hinton about 10:40 a.m.

and told Hinton that good news about TGS had come out

or would be shortly coming out on ‘‘the tape.’’ Immediately

(5497) following Lamont’s telephone call, Hinton tele-

phoned his trading department and was informed that TGS

stock was active and up three points. Hinton thereupon

placed an order for 2,000 shares of TGS for the account

of the Bank’s customer, the Nassau Hospital, which order

was executed at about 10:41 a.m. Thereafter, Hinton placed

further orders for purchases of TGS stock for customers

of the Bank, including pension trusts, purchasing a total of

10,000 shares at prices ranging from 325% to 34. At about

12:30 p.m. on April 16 Lamont ordered the purchase of

some 3,000 shares of TGS for himself and members of his

family, which orders were executed at a price of 3414.

Lamont’s telephone call to Hinton was made some 20

minutes after Coates telephoned his son-in-law, both calls

heing made after the announcement. His own purchases

were ordered more than two hours after the announcement.

For the reasons previously stated with respect to defend-

ant Coates, Lamont did not violate Section 10(b) or Rule

10b-5, since the announcement had been made."*

46a |

Appendix A —Opinion of the District Court

(5498) Stock Options issued by TGS to certain defendants

on February 20, 1964.

Five of the defendants—Stephens, Fogarty, Kline, Molli-

son and Holyk—are charged with violating Section 10(b)

and Rule 10b-5 by accepting stock options voted to them

on February 20, 1964 by the Directors’ Committee to Ad-

minister the Restricted Stock Option Incentive Plan (the

Committee).'‘* The Commission contends that these de-

fendants violated the statute and the rule because they had

knowledge as to the drilling results of the first hole, K-55-1,

which knowledge they failed to disclose to the Committee

or to the Board of Directors prior to accepting their options.

TGS’s restricted Stock Option Incentive Pian (the Plan)

was inaugurated in 1961 with the approval of its stock-

holders.’®> Three non-management directors, John H. Hill,

Leslie M. Cassidy and defendant Coates, were the members

of the Committee appointed by the Board. At the meet-

ing of the Committee held on February 20, 1964, two mem-

bers, Hilt and defendant Coates, were present. The min-

utes disclose that the Board of Directors at its meeting

on March 16, 1961 had directed that no shares should be

(5499) optioned to any employee earning less than $24,000

annually. The Committee granted stock options to 21 offi-

cers and employees earning $24,000 or more per annum

(including defendants Stephens, Fogarty, Mollison and

Kline) and recommended to the Board the granting of

stock options to five employees (including defendant Holyk)

whose annual salaries were in the $15,000 to $21,000 range,

which recommendation was approved by the Board at its

meeting later on the same day.

The use of stock option plans is a commonly accepted

device to provide incentive to officers and employees. Re-

stricted stock options of the type authorized by the stock-

47a

Appendix A —Opinion of the District Court

holders of TGS are not uncommon in publicly-owned com-

panies. As pointed out by Judge Weinfeld in Kornfeld v.

Eaton, 217 F. Supp. 671, 677 (S.D.N.Y. 1963), aff’d 327

F. 2d 263 (2d Cir. 1964) :

‘* . . . Restricted stock options of the type here

under consideration have their genesis in express

approval by the stockholders of the corporation and

are intended to enable its employees to benefit from

an increase in the market value of the security. The

corporate purpose is satisfied through the optionee’s

services and his efforts to further its interests. In-

deed it is in the corporate economic interest that

its employees have an investment stake in it. Con-

gress itself has recognized the salutary purpose of

such plans by extending them favorable tax treat-

ment.’’

(5500) The Committee necessarily relied on information

furnished it by the higher echelon of TGS’s manage-

ment (which would include defendants Stephens and Fo-

garty, but not Mollison, Kline or Holyk). The Commit-

tee did not inquire of the recipients what special knowledge

they might have as to various phases of TGS’s business as

it was entitled to rely on the information furnished by the

maragement.

The record shows that at the time they accepted their

stock options, each of the five defendants (except Kline)

knew of the situation on the Kidd 55 segment as it existed

at the time. ‘Since the land acquisition program had not

heen complciv t they had been instructed not to divulge this

information. inueed, on February 20, 1964, neither the

Board of Dir .« vs nor the Committee had been informed.'®

Defenda ‘s:.ne was informed by defendants Stephens

and Fogar:, i: }anch in November 1963 that TGS was ec -

RN Rd PIES. ven OLS Oe Th a 7

48a

Appendix A --Opinion of the District Court

ducting explorations in the Timmins area and that the

completion of tae first drill hole was a favorable develop-

ment; that it was on the boundary of the TGS property

and that TGS was interested in acquiring additional prop-

erty. He knew no detai!s and his only information came

from his (5501) superiors. Defendants Mollison and Holyk

knew the results of K-55-1 and had reported these results

to their superior, defendant Fogarty. Kline, Mollison and

Holyk had no duty to iniorm the Committee of information

already known to their superiors since they could assume

that such information would be reported to the Committee

by the management.

Defendants Stephens and Fogarty as President and Ex-

ecutive Vice President were management. Both were also

Directors and potential recipients of stock options. They

were under a duty to inform the Committee of material in-

formation affecting the issuance of the stock. options. The

Plan required that the option price be at least 95% of the

fair market value of the stock on the date on which the

options are to be granted. The Committee fixed the option

price as ‘‘the average of the highest and lowest prices of

the Company’s stock on the New York Stock Exchange

during February 20, 1964.’’ Therefore, included in Steph-

ens’ and Fogarty’s duty of disclosure was any material

information bearing on the market value of TGS stock on

that date. :

A corporate officer may be guilty of fraud if he with-

holds material information from his company to his own

advantage. New Park Mining Co. v. Cranmer, 225 F. Supp.

261 (S.D.N.Y. 1963). Therefore, if the information known

(5502) to defendants Stephens and Fogarty would have

substantially affected the price of the TGS stock on the

New York Stock Exchange, their receipt of stock options

49a

Appendix A —Opinion of the District Court

without disclosure to the Committee could have constituted

a fraud on TGS. A stock option is a security (the Act, See-

tion 3(a) (10); 15 U.S.C. 78c(a)(10)), so that such a fraud

would have come within the ambit of Section 10(b) and

Rule 10b-5. See Ruckle v. Roto American Corp., 339 F. 2d

. 24 (2d Cir. 1964).

On February 20, 1964, defendants Stephens and Fogarty

knew (1) that K-55-1 had been completed; (2) that the

drill core had been assayed and that the assay certificates

showed substantial mineralization; and (3) that the land

acquisition program was in progress and that further drill-

ing would await its completion. However, the Court has

already determined that the information as to developments

on the Kidd 55 segment were not material until 7:00 p.m.

on April 9, some seven weeks later. The same definition of

materiality applies. Since the information was not matcrial,

defendants Stephens and Fogarty were not required to

disclose it to the Committee. Hence, defendants Stephens

und Fogarty were not guilty of fraud or deception in fail-

ing to furnish the information. In (5503) view of the land

acquisition program, the security measures which they es-

tablished were for the benefit of the Company and its stock-

holders.'”

In accepting the stock options granted to them on Feb-

ruary 20, 1964, defendants Stephens, Fogarty, Kline, Molli-

son and Holyk did not violate Section 10(b) or Rule 10b-5.

THe Aprit 12, 1964 Press RELEASE

On Sunday, April 12, 1964, at about 3:00 p.m., TGS issued

a press release, the substance of which appeared in the

Monday morning newspapers. The text of the release

stated in part:

50a

Appendix A —Opinion of the District Court

‘‘New York, April 12—The following statement was

made today by Dr. Charles F. Fogarty, executive vice

president of Texas Gulf Sulphur Company, in regard

to the company’s drilling operations near Timmins,

Ontario, Canada. Dr. Fegarty said:

‘**During the past few days, the exploration ac-

tivities of Texas Gulf Sulphur in the area of Tim-

mins, Ontario, have been widely reported in the press,

coupled with rumors of a substantial copper dis-

covery there. These reports exaggerate the scale of

operations, and mention plans and statistics of size

and grade of ore that are without factual basis and

have evidently originated by speculation of people

not connected with TGS.

‘¢ «The facts are as follows. TGS has been explor-

ing in the Timmins area for six (5504) years as part

‘of its overall search in Canada and elsewhere for

various minerals—lead, copper, zinc, etc. During the

course of this work, in Timmins as well as in Eastern

Canada, TGS has conducted exploration entirely on .

its own, without the participation by others. Nu-

merous prospects have been investigated by geo-

physical means and a large number of selected ones

have been core-drilled. These cores are sent to the

United States for assay and detailed examination as

a matter of routine and on advice of expert Canadian

legal counsel. No inferences as to grade can be drawn

from this procedure.

‘«*Most of the areas drilled in Eastern Canada

have revealed either barren pyrite or graphite with-

out value; a few have resulted in discoveries of small

or marginal sulphide ore bodies.

$e O08 M8 ot te RNC

SSS SSS

dla

Appendix A —Opinion of the District Court

‘* ‘Recent drilling on one property near Timmins

has led to preliminary indications that more drilling

would be required for proper evaluation of this pros-

pect. The drilling done to date has not been conclu-

sive, but the statements made by many outside quar-

ters are unreliable and include information and

figures that are not available to TGS.

“**The work done to date has not been sufficient

to reach definite conclusions and any statement as

to size and grade of ore would be premature and

possibly misleading. When we have progressed to

the point where reasonable and logical conclusions

can be made, TGS will issue a definite statement to

its stockholders and to the public in orde> to clarify

the Timmins project.’ »

(5506) The Commission argues that at the time the press

release was issued, TGS knew that it had discovered a

copper mine on the Kidd 55 Segment and that the press

release was materially misleading in characterizing this

discovery as a “‘prospect’’ and in Stating that ‘‘any state-

taent as to size and grade of ore wouid be premature,” For

these reasons the Commission contends that the press re-

lease violated Section 10( b) and Rule 10b-5.

52a -

Appendix A —Opinion of the District Court

Food Serv., Inc., CCH Fep. Sec. L. Rep. $91,317 (N.D. Il.

1964). The phrase ‘‘in connection with the purchase or

sale of : ny security’’ has been broadly construed ‘‘to carry

out the intent of the Act, which is designed to protect in-

vestors against fraud.’’ Stockwell v. Reynolds & Co., (5507)

CCH Fep. Sec. L. Rep. 991,579 at 95,198 (S.D.N.Y. 1965) ;

Cooper v. North Jersey Trust Co., 226 F. Supp. 972, 978

(S.D.N.Y. 1964).

During the first week of April, rumors of a copper dis-

covery by TGS on the Kidd 55 segment were circulating in

Canada. These rumors intensified, and on April 9 Toronto

newspapers reported that TGS had discovered ‘‘one of the

largest copper deposits in North America,’’ ‘‘a major

copper strike.’’ On April 10, defendant Stephens telephoned

defendant Lamont seeking his advice as to what action TGS

should take with respect to the rumors. Lamont advised

that TGS should take no action unless the rumors reached

the New York press or until TGS had sufficient information

available to issue an appropriate press release.

On Saturday morning, April 11, 1964, defendant Steph-

ens, while at his home in Greenwich, Connecticut, read the

articles appearing in the New York Times and the New

York Herald Tribune. The Herald Tribune article an-

nounced that TGS had ‘‘the biggest ore strike since gold

was discovered more than 60 years ago in Canada. . .

a bed of copper sulphide 600 feet wide with a possible over-

all copper return of 2.87% through most of its width.’’;

(5508) that TGS had four drill rigs in operation with four

more to go into operation the following week; and that the

richness of the copper was so great that it had been flown

out of Canada to be assayed.

Stephens telephoned defendant Fogarty at the latter’s

home in Rye, New York and told him about the articles.

Fogarty read the articles and called Stephens back. Fogar-

03a

Appendix A —Opinion of the District Court

ty testified that he and Stephens ‘‘were quite upset...

because certainly they [the articles] were full of exaggera-

tions and what I considered to be erroneous statements.’

Stephens advised Fogarty that TGS should issue a press

release to clarify the rumors, referring to his April 10 con-

versatiou with defendant Lamont. Stephens asked Fogarty

to contact Carroll of Doremus & Co., the Company’s public

relations firm, who also lived in Rye. Fogarty did so, and

Carroll agreed that TGS should issue a press release.

At about 1:00 p-m. on Saturday afternoon, April 11, Fo-

garty telephoned defendant Mollison at his home in Green-

wich, Connecticut, and asked for a review of the situation

at the Kidd 55 segment. At about 5:00 p-m. he went to

Mollison’s home to discuss the matter further. Mollison

had been on (5509) the Kidd 55 segment on the mcrning

of Aprii 10 and had been advised by defendant Holyk as

to the drilling results to 7:00 p.m. on April 10. At that

time drill holes K-55-1, K-55-3 and K-55-4 had been com-

pleted; drilling of K-55-5 had started on Section 2200 S

and had been drilled to 97 feet, encountering mineraliza-

tion on the last 42 feet: and drilling of K-55-6 had been

started on Section 2400 S and had been drilled to 569 feet,

encountering mineralization over the last 127 feet.

In reporting the situation on the Kidd 55 segment, Mol-

lison told Fogarty that the only known mineral occurrences

in the area had been at Kamkotia and that these consisted

of a series of small disconnected sulphide masses. Mollison

advised that it was too early to state what TGS had and

‘‘it was impossible at that time . . . to understand the

structure, to make the projections from one hole to

another.’’ Fogarty went home and drafted notes for a

press release which he took to Carrull’s house so that they

could be put in shape by Carroll for release on Sunday,

the following day. He had telephoned defendant Hunting-

o4a

Appendix A —Opinion of the District Court

ton, one of TGS’s lawyers, reading his notes to him. Hunt-

ington made one or two suggestions and advised Fogarty

that he thought the release would be all right legally.

(5510) On Sunday morning, April 12, Fogarty telephoned

Mollison to see if he had any additional information, and

instructed Mollison to return with Holyk to Timmins as

soon as possible to ‘‘move things along.’’ Fogarty and

Carroll then completed the final draft of the press release

at Carroll’s house. Fogarty telephoned Stephens and read

the tinal draft to him, Stephens asking certain questions

and making minor changes. Stephens instructed Fogarty

to have the release issued as promptly as possible so that

it would be on the wires on Sunday afternoon.

From the foregoing, it is apparent that the purpose of

the April 12 press release was an attempt to meet the

rumors which were circulating with respect to the Kidd 55

segment. There is no evidence that TGS derived any direct

benefit from the issuance of the press release or that any

of the defendants who participated in its preparation used

it to their personal advantage. The issuance of the release

produced no unusual market action. In the absence of a

showing that the purpose of the April 12 press release was

to affect the market price of TGS stock to the advantage

of TGS or its insiders, the issuance of the press release

did not constitute a violation of Section 10(b) or (5511)

Rule 10b-5 since it was not issued ‘‘in connection with the

purchase or sale of any security.’’

However, even if it had been established that the April

12 release was issued in connection with the purchase or

sale of any security, the Commission has failed to demon-

strate that it was false. misleading or deceptive. The sig-

nificance of the drilling results known to TGS by 7:00 p.m.

on April 10 was the subject of detailed and conflicting tes-

=

55a

Appendir A —Opinion of the District Court

timony at the trial. Adelstein defined proven ore and prob-

able ore. His definitions Were substantially ‘the same as

the definitions used in the General Rules and Regulations

under the Securities Act of 1933, Appendix I, Form 1-A,

Notification Under Regulation A, Schedule I, Item 8A(ce),

which provide:

‘The term ‘proven ore’ means a body of ore so

extensively sampled that the risk of failure in con-

tinuity of the ore in such body is reduced to a mini-

mum. The term ‘probable ore’ means ore as to which

the risk of failure in continuity is greater than for

proven ore, but as to which there is sufficient Warrant

for assuming continuity of the ore.”’

Based on these definitions and the drilling done to 7:00 p.m.

on April 10, Adelstein was of the opinion that TGS could

have calculated 8.33 million tons of proven ore. Penne-

baker, (5512) the other Commission expert, was of the

opinion that TGS could have calculated 6.2 million tons of

Proven ore. Both of the Commission experts stressed that

the drilling showed substantial mineralization in the cores

and sabstantial copper mineralization on the eastern edge

of the anomaly. Since they could make estimates as to the

size and grace of ore on the basis of information to 7:00

p.m. on April 10, the Commission contends that the use of

the word ‘‘prospect”’ in the April 12 press release was mis-

leading. Adelsteir. defined a “‘prospect’’ as a property

where there is no assurance that commercially mineable

reserves exist.

The opinions of Adelstein and Pennebaker were centra-

dicted by Forrester, Park. Wiles, Walkey, Lacy and Me-

Laughlin, independent experts called by TGS (see footnote

(9)).

PASTA MEAN ARREST aa

PENT AO REY MONTE IE Or

mS ia

56a

Appendix A—Opinion of the District Court

(5513) TGS’s experts were unanimously of the opinion

that at 7:00 p.m. on April 10 the Kidd 55 segment was still

a prospect and that no estimates as to proven or probable

ore could be made. They all agreed that the April 12 press

release accurately set forth the situation as it was known

at the time. None thought that TGS could have estimated

proven ore, and the (ommission’s expert, Pennebaker,

agreed that this was a matter on which there could be dif-

ferences of opinion. Defendants’ experts testified that on

the basis of the drilling to that time there was no assurance

of coniinuity in the mineralized zone and that, without fur-

ther drilling, the results of one hole could not be correlated

with the results of others.

The Commission contends none the less that the press re-

lease was misleading and deceptive because the defendants

who prepared the release believed that TGS had a mine.

The Commission points to the fact that drilling of K-55-8,

the mill test hole, was commenced on April 11, and must

have been ordered by the defendants at an earlier time. Both

Adelstein and Pennebaker testified that a company does not

drill a mill test hole on a ‘‘ prospect.”’

(5514) Park, Lacy and Forrester found nothing unusual

in this procedure, and Wiles testified that it was usual to

begin collecting metallurgical samples as the drilling pro-

gresses. With a direct conflict in testimony between the

Commission’s and defendants’ expert witnesses, it cannot

be concluded that instructions to drill K-55-8 established

that TGS knew that the Kidd 55 segment was no longer a

‘*prospect.”’

The Commission also points to the Northern Miner article

which was drafted in Timmins on April 13. Even if it is

assumed that Mollison, Holyk and Darke suggested the con-

tents of that article to Ackerley, this wonid not establish

that the April 12 press release was false or . - -eptive. Using

57a

Appendix A —Opinion of the District Court

the Commission’s figures, over 30% of the relevant drilling

was done between 7:00 p.m. on April 10 and 7:00 a.m. on

April 13. K-55-5 was drilled an additional 507 feet; K-55-6

was drilled an additional 375 feet; drilling of K-55-7 was

commenced on April 12 on Section 2000 S and was drilled

to a length of 146 foet by 7:00 a.m. on April 13. The de-

fendants are to be judged on the facts known to them when

the April 12 press release was issued. Mollison and Holyk

were not at the site but were in or near New York (5515)

while the release was being prepared. There is no evidence

that the drilling results after 7:00 p.m. on April 10 were

known to the framers of the April 12 press release, so there

is NO more reason for charging TGS with this knowledge

than with knowledge of the statement drafted by Mollison

for the Ontario Minister of Mines on April 15, or with

knowledge of the information that was available to TGS

when it made its announcement on April 16.

Moreover, the circumstances under which the April 12

release was prepared indicate that defendants Fogarty and

Mollison were under considerable pressure. If they said

too much, they would have been open to criticism and pos-

sible liability if it turned out that TGS had not discovered

& commercial mine. If they said too little éid later an-

nounced a mine, they subjected themselves to the charge

that their press release was misleading or deceptive—and,

indeed, this is what has happened. If they had announced

the drilling results in terms of number of drill holes, footage

drilled and mineralization intersected, they would have en-

couraged the rumor mill which they were seeking to allay.

Perhaps they should have waited until they could have

obtained more probative information before issuing a press

release, particularly (5516) since developments were break-

ing so rapidly. However, as above stated, TGS must not be

judged by hindsight. In seeking the advice of Mollison, the

SST MereeRD Dry, area

ANION IR TE Tx

Siege verre.

08a

Appendix A —Opinion of the District Court

-ad of TGS’s exploration group, in consulting with TGS’s

-..Dlie relations firm, and in clearing the release with one

! TGS’s lawyers, Stephens and Fogarty exercised reason-

iole business judgment under the circumstances. While, in

:etrospect, the press reiease may appear gloomy or incom-

»lete, this does not make it misleading or deceptive on the

basis of the facts then known."®

Accordingly, in issuing the April 12 press release TGS

did not violate Section 10(b) or Rule 10b-5.

ConcLUSION

The foregoing constitutes the Court’s findings of fact

and conclusions of law (Rule 52(a), Fed. R. Civ. P.).

There appearing no just reason for delay, the Clerk is

directed to enter judgment dismissing the complaint against

defendants Texas Gulf Sulphur Company, Charles F.

Fogarty, Richard D. Mollison, Walter Holyk, Kenneth H.

Darke, Thomas S. Lamont, Francis G. Coates, Claude O.

Stephens, John A. Murray, Earl L. Huntington and Harold

B. Kline (Rule 58(1), Fed. R. Civ. P.).

(5517) Defendants Richard H. Clayton and David M.

Crawford are found to have violated Section 10(b) of the

Act and Rule 10b-5. In accordance with the agreement be-

tween the parties, the Commission tmay notice a hearing to

determine the remedy to be accorded with respect to these

two defendants.

It is so ordered.

Dated: New York, N. Y.

August 16, 1966.

Dunp.ey B. Bonsar.

U.8.% J.

Filed August 19, 1966

59a

Appendix 4 —Opinion of the District Court

(9518) Footnotes to Opinion in Securities and Exchange

Commission v. Texas Gulf Sulphur Company, et al. 65 Ciy.

1182

(1) At least 49 private actions are now pending in this

court against TGS, defendants named in the Commicsion’s

action, and others, arising out of the transactions which are

the subject matter of the Commission’s action. Some 16

of these are individual] actions, 31 are said to be class ac-

tions, and one is a derivative action. At least 475 persons

are included as plaintiffs. While many of the complaints

do not specify the damages claimed, others, in the aggregate,

claim compensatory damages in excess of $2,800,000 and

punitive damages in excess of $77,000,

(2) Certain minerals combine with sulphur to form sul-

phides. Some sulphides, such as chalcopyrite (copper sul-

phide) and sphalerite (zine sulphide), may be commercially

mined if found in sufficient quantities ; others, such as pyrite

and pyrrhotite (iron sulphides), have no commercial value.

(3) The electromagnetic instruments used in the aerial

geophysicial surveys indicate only that a conductor of elec-

tricity exists. There are many good conductors besides

sulphides. For example, graphite and even water are good

conductors. On the other hand, zine sulphides are not con-

ductors.

(4) Prior to April 7a shortage of water needed for drill-

ing prevented the operation of more than one drill rig. The

second rig was put into operation on April 8, and the third

and fourth rigs were put into operation on April 10 and 12

respectively.

(9) Seven feet of snow on the ground during this period

impeded travel between the Kidd d9 segment and Timmins,

15 miles away, the trip taking as long as four hours.

(6) Rule 10b-5 is general in terms. Other rules under

Section 10(b) are more specific. See Rule 10b-6, which

applies Section 10(b) to underwriters, issuers, brokers, deal-

ers, ete. Compare also Rule 10b-2 with reference to solici-

tation of purchases on an exchange to facilitate a distribu-

tion of securities.

(5519) (7) Inits briefs and at trial the Commission made

no distinction between the three sections of Rule 10b-5, rely-

60a

Appendix A—Opinion of the District Court

ing on Last v. Fashion Park, Inc., 340 F. 2d 457, 462 (2d Cir.

i%o5,, where the court noted that as long as a violation

of the Rule is alleged, it makes little difference which section

oi the Rule is invoked. There was no evidence, however,

_ that the defendants employed ‘‘any device, scheme, or arti-

fice to defraud’’ under section (1) or made any representa-

tions under section (2). Therefore, only section (3) is

applicable to the facts of this case.

(S) Section 20c provides in part that:

‘*It shall be unlawful for any investment adviser,

by use of the mails or any means or instrument :lity

of interstate commerce, directly or indirectly—

(1) to employ any device, scheme, or artifice to

defraud any client or prospective client;

(2) to engage in any transaction, practice, or

course of business which operates as a fraud or

deceit upon any client or prospective client; ...’’

(9) At the trial, the Commission called as expert wit-

nesses Benjamin Adelstein and Edwin M. Pennebaker. Mr.

Adelstein has been the Chief Mining Engineer for the Com-

mission since 1941. He was previously employed by Ana-

conda Copper Compary and by the United States Coast and

Geodetie Survey and the United States Corps of Engineers.

Mr. Pennebaker is a mining geologist from Scottsdale, Ari-

zona with many years of experience, who was appointed

Consulting Geologist to the Commission in November 1965.

TGS called as expert witnesses: James D. Forrester,

geologist, Dean of the University of Arizona School of

Mines and Director of the Arizona Bureau of Mines, Tuc-

son, Arizona; Charles F. Park, Jr., geologist, Professor of

Geology at Stanford University, where he was Dean of the

School of Earth Sciences from 1950-1965; Cloyd M. Wiles,

mining engineer with National Lead Company from 1942

until his retirement in 1963; Graham Walkey, mining engi-

neer and geologist with Kamkotia Mines, which is located

approximately 12 miles from the Kidd 05 segment; Willard

C. Lacy, geologist, professor at the University of Arizona

and head of the University’s Department of Mining and

Engineering; Donald McLaughlin, g« logist, Chairmaia vt

the Board and fcrmerly president ‘1 Homestake Min..::

ae es

61la

Appendix A —Opinion of the District Court

Company ; John B. Boniwell, geophysicist with eight years’

expericnee on the Canadian Shield; Douglas H. Bellemore,

security analyst, Professor of Finance at the Graduate

School of Business (0920) Administration at New York

University; and Alvin W. Pearson, security analyst, presi-

dent of Lehman Corporation and chairman of its Portfolio

Committee.

(10) Adelstein testified that on the basis of work done to

7:00 p.m. on April 9 TGS could have calculated ore reserves

of 7.7 million tons with a fTOSS assay value of $204,200,000.

Pennebaker testified that TGS could have calculated ore re-

serves of 5.5 million tons with a gross assay value of

197,200,000. Adelstein defined gross assay value to mean

‘‘the sum of the products of the number of units of each

metal of commercial value times the prevailing price for

each metal ...’’ Since grass assay value does not take

account of the costs of mining, milling, smelting, sales, over-

head, cost of capital, et., it can be misleading and its use

in registration statements is prohibited by the Commission.

For example, Wiles estimated that 95.2% of the gross assay

value of the ore deposit on the Kidd 55 segment would be

expended for the above purposes. Although his figures ap-

pear to be conservative:and though ore with a much lower

<TOss assay value than that on the Kidd 55 segment is com-

mercially mined, his testimony illustrates why gross assay

value is not a good indicator.

(11) Members of the TGS exploration group could not

state with certainty that K-55-1 had not been drilled down

dip. Jn a memorandum written on November 14, 1963,

defendant Holyk stated that:

‘‘While there are some indications that the drill

hole is drilling across the dip, there are also numer-

ous instanees of bedding and minerals stratification

fo be almost parallel te the core axis. Accordingly,

it is impossible to estimate the true width of the sul-

phide zone until a second drill hole is directed across

this intersection from west to east. It may well be

that the zone is quite narrow in the event that the

drill hole has been directed down dip.’’

62a

Appendix A —Opinion of the District Court

The Commission offered testimony as to banding, mineral

stratification within the drili core, to establish that K-55-1

had been drilled across the mineral zone and not down dip.

The significance of banding, particularly without more drill-

ing, was strongly disputed by defendants’ experts.

(5520) (12) In a symposium held on November 22, 1969,

former Commission Chairman Cary stated:

‘Directly related is the question when insiders can

trade. Again, I doubt whether we can supply a

definitive answer. In general, the answer may be:

not prior to the time the news has been absorb. 4

by the market. The President of the New York Stock

Exchange has suggested thirty days, beginning one

week after the distribution of a comprehensive an-

tual report ... This line, | think, is strict; it goes

beyond law, and is reaily a policy doctrine that he

has enunciated. It goes beyond what a lawyer might

advise.’’ (Symposium, ‘‘Insider Trading in Stocks,

The Business Lawyer, Vol. XXI, 1009, 1014-1015

(1966).)

Fleischer has written:

‘*As a general principle, an insider might be held to

violate rule 10b-5 whenever he trades before the

effect of the news in question has been absorbed by

the market.

* * * .

‘*As a matter of corporate practice, it would be

advisable for any insider to forego any trading for.

say, an arbitrary twenty-four hour period after im-

portant news is released to the public.’’ (Fleischer,

‘‘Securities Trading and Corporate Information

Practices: The Implications of the Texas Gulf Sul-

phur Proceeding,”’ 51 Va. L. Rev. 1271, 1291 (1965).)

(13) Since no violations of Section 10(b) or Rule 10b-5

have been found as to those defendants whe recommended

TGS stock to others, it is not necessary to consider whether

an insider who violates the Statute or the Rule may be

liable fur purchases made by his ‘‘tippees.’’

63a

Appendix A —Opinion of the District Court

(14) The stock options accepted by these defendants were

as follows:

Stephens for 12,800 shares

Fogarty ” 7,300 a

Kline *? 4,300 ”

Mollison ” 4,300

Holyk ” 2,000 =»

Stock options were granted to 21 other officers and em-

ployees at the same time, and the total number of shares

covered by stock options granted on February 20, 1964 was

89,950.

(9921) (15) The Plan provided that the options would

run for ten years from the date of issue, subject to auto-

matic termination in the event of the death or termination

any previous qualified or restricted option was held by the

optionee. The options provided that the optionees could

exercise up to 40% at any time after 18 months, 70% at

any time after three years and 100% at any time after

four years.

(16) The Board was not informed until] its meeting on

April 16, 1964, when the Directors were given copies of the

Press release which was issued following the meeting.

(17) After the Commission instituted this action, the

Board of Directors, en July 15, 1965, ratified the issuance

of the stock options to Kline, Mollison and Holyk. Stephens

and Fogarty surrendered to TGS the options which they _

received, and these options have been cancelled.

(18) That the drilling results to 7:00 p.m. on April 9

have been held to be mi:oria] information does not lead

to the conclusion tha‘ the Widd 55 Segment was either a

mine or a prospect ty e7 ‘Ys. ur hours later, I¢ means only

that insiders eould go ‘>. this material information to

their own advantag- + ~ ty its disclosure to the Public.

;

:

E

§

:

AVBOIIE ALM EIN Pe teIIRE Re,

a ia a) ot aT ee

64a

Appendix A — Judgment of the District Court

(Entered August 22, 1966)

UNITED STATES DISTRICT COURT

SouTHERN District or New York

[Same Trr.e]

The defendant Thomas P. O'Neill having been served

with a summons and complaint, and said defendant having

failed to answer or appear herein, and the plaintiff having

moved for a default judgment in a separate proceeding,

and allt the remaining parties having waived a jury and

having agreed that trial should first be had on the issue of

whether defendants or any of them had violated Section

10(b) and Rule 10b-5 reserving for a later hearing the issue

of the remedy to be applied in the event such violations are

found, and the said issue having been brought on regularly

for trial before the Honorable Dudley B. Bonsal, United

States District Judge, on May 9, 10, 11, 12, 13, 23, 24, 25, 26,

27, 31 and June 1, 2, 3, 6, 7, 8 and 21, 1966, and the Court

having reserved decision at the conclusion of the evidence,

and the Court thereafter having handed down its opinion

decision, dated August 16, 1966 and filed on August 19, 1966

constituting the Court’s findings of fact and conclusions of

law dismissing the complaint as to all defendants except

Richard H. Clayton and David M. Crawford, and the Court

having found that the defendants Richard H. Clayton and

David M. Crawford had violated Section 10(h) of the Act

and Rule 10b-5, and the Court in its opinion decision having

stated that there was no just reason for delay of entry of

this Judgment, it is

65a

Appendix A — Judgment of the District Court

ORDERED, ADJUDGED AND DecreeD: That the defendants,

Texas Gulf Sulphur Company, a Texas corporation, Charles

F. Fogarty, Richard D. Mollison, Walter Hoiyk, Kenneth

H. Darke, Thomas S. Lamont, Francis G. Coates, Claude O.

Stephens, Jonn A, Murray, Earl L. Huntington and Harold

B. Kline have judgment against the plaintiff Securities and

Exchange Commission dismissing the complaint, and it is

further,

ORDERED, ADJUDGED AND DECREED: That the defendants

Richard H. Clayton and David M. Crawford have violated

Section 10(b) of the Act and Rule 10b-5, and pursuant to

agreement between the parties, the Securities and Exchange

Commission may notice a hearing to determine the remedy

to be accorded with respect to these two defendants.

Dated: New York, N.Y.

August 22, 1966

John J. Olear, Jr.

Clerk

66a

Appendix A — Opinion of the Court of Appeals

UNITED STATES COURT OF APPEALS

For THE Seconp Circuit

—

No. 296—September Term, 1966.

a>.

~

(Argued March 20, 1967

Submitted to the in banc Court May 2, 1968

Decided August 13, 1968.)

Docket No. 30882

n.

SEcURITIES AND ExcHancE CoMMISSION,

Plaintiff-Appellant,

—V =

Texas GutrF SutpHur Co., a Texas Corporation, CHARLES

F. Focarty, Ricuarp D. Motiison, WALTER Ho.yk, KeEn-

NETH H. Darke, Francis G. Coates, CLaupE O. STEPHENS,

Joun A. Mvrray, Eart L. Huntincton, and Harotp B.

Kung,

Defendants-Appellees.

<

SEcuRITIES AND Excaance CoMMISSION,

Plaintiff-Appellec,

—Vi—

Davin M. Crawrorp and Ricwarp H. CiayrTon,

Defendants-A ppellants.

ear

67a

Appendix A — Opinion of the Court of Appeals

Before:

LumBarp, Chief Judge,

WaTERMAN, Moorz, FRIENDLY, SMITH, Kaurman, Hays,

ANDERSON and FEINBERG, Circuit Judges.

—_

In the United States District Court for the Southern

District of New York the Securities and Exchange Com-

mission commenced its action pursuant to 15 U. S. C. §§78u,

78aa, against Texas Gulf Sulphur Company and thirteen

individuals alleging violations by the fourteen defendants

of the provisions of Section 10b of the Securities Ex-

change Act of 1934, 15 U.S. ¢. §78}(b), and its Rule 10b-5

(wr. R 240.10b-5) promulgated pursuant to the au-

thority granted to it in Section 10b.

The court below, Bonsal, J., found that two of the in-

dividual defendants, Clayton and Crawford, had violated

Section 10b and Rule 10b-5, but otherwise the Commis.

sion’s complaint was ordered dismissed, 258 F. Supp. 262

(1966).

Appeals were taken by the Commission and by Clayton

and Crawford. Eleven of the thirteen original individual

defendants, and the corporation, are parties in the pro-

ceedings before us.

The appeals were argued before a division of the court

consisting of Judges Waterman, Moore, and Hays. When

the opinions prepared by them were distributed to the other

Judges of the court it was ordered on May 2, 1968 that the

case should, without further arguinent, be considered in

banc upon the record and briefs the parties had filed and

upon the opinions that had been prepared and distributed

by the panel judges. After in banc consideration the opin-

ions appearing hereafter were prepared. The results

reached in Judge Waterman’s opinion for the court are

OPEN SE i Saha ees RS CORAL Aaa:

%

r

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68a

Appendix A — Opinion of the Court of Appeals

concurred in unanimously as to appellee Coates, and ap-

pellants Clayton and Crawford; as to the remaining con-

tested issues that opinion represents results concurred in

either generally or in separate statements by a majority

of the judges.

The dispositions below as to appellants Clayton and

Crawford are affirmed. As to one of the appellees, Murray,

the disposition below is affirmed. As to the remaining in-

dividual appellees and the corporation, the order dismissing

the complaint is reversed and the cause remanded for fur-

ther proceedings below consistent with the opinion of the

court.

yo

~~

Puitie A. Loomis, Jr., Gen. Counsel; Davin

Ferber, Solicitor; Roczer S. Foster, Spec.

Counsel, Ofe. of Policy Research, SEC;

Frank E. Kennamer, Jr, Asst. Gen. Coun-

sel; DonaLp M. Feverstein, Atty., SEC, for

Securities and Exchange Commission.

Orison S. Marpen, White & Case, Wituiam D.

ConwELL, Epwarp C. ScuMu tts, P. R. Kon-

RAD KnakeE, THomas McGanney, PETER G.

Erxenserry, New York City, for Texus

Gulf Sulphur, Fogarty, Moliison, Holyk,

Darke, Stephens, Murray, Huntington and

Kline, Crawford and Clayton.

AuBerT R. Conne.tty, Donatp I. STRAvsBer,

Cravath, Swaine & Moore, New York City,

for Coates.

»

Waterman, Circuit Judge:

This action was commenced in the United States District

Court for the Southern District of New York by the

69a

Appendix A —- Opinion of the Court of Appeais

E

=

Securities and Exchange Commission (the SEC) pursuant :

to See. 21(e) of the Securities Exchange Act of 1934 (the

Act), 15 U. S. C. §78u(e), against Texas Gulf Sulphur

Company (TGS) and several of its Officers, directors and

employees, to enjoin certain conduct by TGS and the in-

dividual defendants said to violate Section 10(b) of the

Act, 15 U. S. C. Section 78j(b), and Rule 10b-5 (17 CFR

240.10b-5) (the Rule), promulgated thereunder, and to com-

pel the rescission by the individual defendants of secur-

ities transactions assertedly conducted contrary to law.

The complaint alleged (1) that defendants Fogarty, Molli-

son, Darke, Murray, Huntington, O'Neill, Clayton, Craw-

ford, and Coates had either personally or through agents

purchased TGS stock or calls thereon from November 12,

1963 through April 16, 1964 on the basis of material inside

information concerning the results of TGS drilling in Tim-

mins, Ontario, while such information remained undis-

closed to the investing public generally or to the particular ;

sellers?; (2) that defendants Darke and Coates had di-

LEER EI ORO MIA TIM RET fe

PE ATES FEN NS ANE RRS Se

x y

hi. Cady adage nny

1 Pursuant to a stipulation by all parties, the question of the appro-

priate remedies to be applied was deferred pending a final determina-

tion whether the defendants or any of them had vivlated Section 10(b)

and Rule 10b-5 and therefore that question is not now before us.

(aba

2 The purchases by the parties during this period were:

Purchase Shares Cails

Date Purchaser Number Price Number Price

Hole K-55-1 Completed November 12, 1963

1963

Nov. 12 Fogarty 300 17%-18

15 Clayton 200 17%

15 Fogarty 700 17%-17%

15 Mollison 100 17%

19 Fogarty 500 18%

26 Fogarty 200 17%

29 Holyk (Mrs.) 50 18

Chemical Assays of Drill Core of K-55-1 Received December 9-13, 1963

(footnote continued on nezt page)

a ee nes an peed hee ee

70a

Appendix A — Opinion of the Court of Appeals

vulged such information to others for use in purchasing

TGS stock or calls* or recommended its purchase while the

Purchase Shares Calls

Date Purchaser Number Price Number Price

1963

Dee. 10 Holyk ( Mrs.) 100 20%

i2 Holyk (or wife) 200 21

13 Mollison 100 21%

30 Fogarty 200 22

31 Fogarty 100 2314

1964

Jan. 6 Holyk (or wife) 100 23%

8 Murray 400 2314

24 Holyk (or wife) 200 2214 -22%

Feb. 10 Fogarty 300 2214-2214

20 ~=- Darke 300 241%

24 Clayton ; 400 23%

24 Holyk (or wife) 200 24%

26 Holyk (or wife) 200 2338

26 Huntington 50 23%

27 Darke (Moran as nominee) 1000 2256 -22%,

Mar. 2 Holyk (Mrs.) 200 22%

3 Clayton 100 22

16 Huntington 100 22

16 Holyk (or wife) 300 2314

17 Holyk (Mrs.) 100 23%

23 Darke 1000 24%

26 Clayton 200 25

Land Acquisition Completed March 27, 1964

Mar. 30 Darke 1000 25%

30 Holyk (Mrs.) 100 25%

Core Drilling of Kidd Segment Resumed March 31, 1964

April 1 Clayton 6C 2614

1 Fogarty 400 26%

2 Clayton 100 26%

6 Fogarty 400 2814-28%

8 Mollison (Mrs.) 100 28%

First Press Release Issued April 12, 1964

April 15 Clayton 200 29%

16 Crawford (and wife) 600 501%-30%

Second Press Release Issued 10:00-10:10 or 10:15 A.M., April i6, 1964

April 16 (app. 10:20 A.M.)

Coates (for family trusts) 2000 31-31%

3 A “call” is a negotiable option contract by which the bearer has the

right to buy from the writer of the contract a certain number of shares

of a particular stock at a fixed price on or before a certain agreed-upon

date.

7la

Appendix A ~ Opinion of the Court of Appeals

information was undisclosed to the public or to the sellers ;*

that defendants Stephens, Fogarty, Mollison, Holyk, and

EEE IE RARE NON

4 ‘The purchases made by “tippees” during this period were:

Purchase Shares Calls

Date Purchaser Number Price Number Price [

Chemicals Assays of K-55-1 Received Dec. 9-13, 1963 4

1963 4

Dee. 30 Caskey (Darke) 300 22% é

1964 : 4

Jan. 16 Westreich ( Darke} 2000 2114-21% d

Feb. 17 Atkinson (Darke) 50 234% 200 23% =:

17 Westreich ( Darke) 50 23% 1000 2314 -23% 7

24 Miller (Darke) 200 23% ,

25 Miller (Darke) 300 2356-2314

Mar. 3 E. W. Darke ( Darke) 500 2214-225

17 E. W. Darke (Darke) 200 23% ]

Land Acquisition Completed Mar. 27, 1964 .

1964 :

Mar. 30 Atkinson (Darke) 400 25% -25% ’

Caskey (Darke) 100 25% ’

E. W. Darke (Darke) 1000 25% -25%

Miller ( Darke ) 200 25%

Westreich (Darke) 500 25%

30-31 Klotz (Darke) 2000 2514-2614

Second Press Release Issued Apri! 16, 1964 ( Reported over Dow Jones tape at

10:54 A.M.)

April 16 (from 10:31 A.M.)

Haemisegger (Coates) 1500 31% -35

In this connection, we point out that, though several of the Holyk

purchases of shares and calls made between November 29, 1963 and

March 30, 1964 were in the name of Mrs. Holyk or were in the names

of both spouses, we have treated these Purchases as if made in the

name of defendant Holyk alone.

Defendant Mollison purchased 100 shares on November 15 in his

name only and on April 8 100 shares were purchased in the name of

Mrs. Mollisun. We haye made no distinction between those purchases.

Defendant Crawford ordered 300 shares about midnight on April 15

and 300 more shares the following morning, to be purchased for him-

self, and his wife, and these purchases are treated as having been made

by the defendant Crawford.

In these particulars we have followed the lead of the court below.

See the table at 258 F. Supp. 273-275 and the Special references to the

Holyk purchases at 273, and the Crawford Purchases at 287. It would

by other than the defendants, and unrealistic to include them as having

been made by members of the general public receiving “tips” from in.

~

3

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5

Pig AES OTST LRP NIT ORE RRNA M7

72a

Appendix A — Opinion of the Court of Appeals

Kline had accepted options to purchase TGS stock on Feb.

20, 1964 without disclosing the material information as to

the drilling progress to either the Stock Option Committee

or the TGS Board of Directors; and (4) that TGS. issued

a deceptive press release on April 12, 1964. The case was

tried at lengih before Jucge Bonsal of the Southern Dis-

trict of New York, sitting without a jury. Judge Bonsal

in a detailed opinion’ decided, inter alia, that the insider

activity prior to April 9, 1964 was not illegal because the

drilling results were not “material” until then; that Clay-

ton and Crawford had traded in violation of law because

they traded after that date; that Coates had committed

no violation as he did not trade before disclosure was made;

and that the issuance of the press release was not unlawful

because it was not issued fer the purpose of benefiting the

corporation, there was no evidence that any insider used

the release to his personal advantage and it was not “mis-

leading, or deceptive on the basis of the facts then known,”

258 F. Supp. 262, at 292-296 (SDNY 1966). Defendants

Clayton and Crawford appeal from that part of the deci-

sion below which held that they had violated Sec. 10(b)

and Rule 10b-5 and the SEC appeals from the remainder

of the decision which dismissed the complaint against de-

fendants TGS, Fogarty, Mollison, Holyk, Darke, Stephens,

Kline, Murray, and Coates.°

5 258 F. Supp. 262 (SDNY 1966).

6 Defendant O'Neill did not appear to answer the charge against him;

the SEC motion to enter a default judgment against him was denied

without prejudice to its renewal upon completion of this appeal.

Shortly after the appeal was argued defendant Lamont passed away,

and by agreement of the parties an order was entered discontinuing his

appeal and directing that the judgment below dismissing the action

against him be severed from the judgment as to the other defendants.

The SEC loes not contest the alternative holding below that Holyk

and Mollison, not being members of TGS's top management, had no

duty of disclosure prior to acceptance of stock options.

{-

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73a

Appendir A Opinion of the Court 6} Appeals

For reasons which appear below, we decide the various

issues presented as follows:

(1) As to Clayton and Crawford, as purchasers of

stock on April 15 and 16, 1964, we affirm the finding that

they violated 15 U. S. C. §78j(b) and Rule 10b-5 and re-

mand, pursuant to the agreement by all the parties, for a

determination of the appropriate remedy.

(2) As to Murray, we affirm the dismissal of the com-

piaint.

(3) As to Mollison and Holyk, as recipients of certain

stock options, we affirm the dismissal of the complaint.

(4) As to Stephens and Fogarty, as recipients of stock

options, we reverse the dismissal of the complaint and

remand for a further determination as to whether an in-

junction, in the exercise of the trial court’s discretion,

should issue.

(5) As to Kline, as a recipient of a stock option, we

reverse the dismissai of the complaint and remand with

directions to issue an order rescinding the option and for

a determination of any other appropriate remedy in con-

nection therewith.

(6) As to Fogarty, Mollison, Holyk, Darke, and Hun-

tington, as purchasers of stock or calls thereon between

November 12, 1963, and April 9, 1964, we reverse thie dis-

missal of the complaint and find that they violated 15

U. 5. C. §78j(b) and Rule 10b-5, and remand, pursuant to

the agreement of all the parties, for a determination. of the

appropriate remedy.

(7) As to Clayton, although the district judge did not

specify that the complaint be dismissed with respect to

Bi RATS ROR eS cae Rodin k BCE ene etn te ALTER RET

74a

Aye e L—Opinicn of the Court of Appeals

his purchases of TGS stock before April 9, 1964, such a

dismissal is implicit in his treatment of the individual

appellees who acted similarly. Consequently, although

Clayton is named only as an appellant our decision with

respect to the materiality of K-55-1 renders it necessary

to treat him also as an appellee. Thus, as to him, as one

who purchased stock between November 12, 1963 and April

9, 1964, we reverse the implicit dismissal of the complaint.

find that he violated ¢78j(b) and Rule 10b-5, and remand,

pursuant to the agreement bv all the parties, for a de-

termination of the appropriate remedy.

(8) As to Drake, as one who passed on information to

tippees, we reverse the dismissal of the complaint and

reinand, pursuant to the agreement by all the parties, for

a determination of the appropriate remedy.

(9) As to Coates, as one who on April 16th purchased

stock and gave information on which his son-in-law broker

and the broker’s customers purchased shares, we reverse

the dismissal of the complaint, find that he violated 15

U.S §78j(b) and Rule 10b-5, and remand, pursuant to

the agreement by all the parties, for a determination of

the appropriate remedy.

(10) As to Texas Gulf Sulphur, we reverse the dismissal

of the complaint and remand for a further determination

by the district judge in the light of the approach taken in

this opinion.

The occurrences out of which this litigation arose are

not set forth hereafter in as detailed a manner as they are

set out in the published opinion of the court below, but are

stated sufficiently, we believe, for the exposition of the issues

raised by the several appeals to us.

a

7 |

75a

anperdiv I — Opinion of the Court of Appeals

Tue Facrvuau Sertine

This action derives from the exploratory activities of

TGS begun in 1957 on the Canadian Shield in eastern Can-

ada. In March of 1959, aerial geophysical surveys were

conducted over more than 15,000 square miles of this area

by a group led by defendant Mollison, a mining engineer

and a Vice President of TGS. The group included defen-

dant Holyk, TGS's chief geologist, defendant Clayton, an

electrical engineer and geophysicist, and defendant Darke,

a geologist. These operations resulted in the detection of

numerous anomalies, i.e., extraordinary variations in the

conductivity ef rocks, one of which was on the Kidd 55

segment of land located near Timmins, Ontario.

On October 29 and 30, 1963, Clayton conducted a ground

geophysical survey on the northeast portion of the Kidd 55

segment which confirmed the presence of an anomaly and

indicated the necessity of diamond core drilling for further

evaluation. Drilling of the initial hole, K-55-1, at the

strongest part of the anomaly was commenced on Novem-

ber 8 and terminated on November 12 at a depth of 655

feet. Visual estimates by Holyk of the core of K-55-1 in-

dicated an average copper content of 1.15% and an average

zine content of 8.64% over a length of 599 feet. This visual

estimate convinced TGS that it was desirable to acquire

the remainder of the Kidd 55 segment, and in order to

facilitate this acquisition TGS President Stephens _in-

structed the exploration group to keep the results of

K-55-1 confidential and undisclosed even as to other officers,

directors, and employees of TGS. The hole was concealed

and a barren core was intentionally drilled off the anomaly.

Meanwhile, the core of K-55-1 had been shipped to Utah for

chemical assay which, when received in early December,

revealed an average mineral content of 1.18% copper, 8.26%

EER OE “AIRE hoe ReneS Sag NN

aan teats ce ie et ee

ha

boptoeret ab Gyticun of tec Court of Appeals

zine, and 3.94% ounces of silver per ton over a length of

602 feet. These results were so remarkable that neither

Clayton, an experienced geophysicist, nor four other TGS

expert witnesses, had ever seen or heard of a comparable

initial exploratory drill hole in a base metal deposit. So,

the trial court concluded, “There is no doubt that the drill

core of K-55-1 was unusually good and that it excited the

interest and speculation of those who knew about it.” Jd.

at 282. By March 27, 1964, TGS decided that the land

acquisition program had advanced to such a point that the

company might well resume drilling, and drilling was re-

sumed on March 31.

During this period, from November 12, 1963 when K-55-1

was completed, to March 31, 1964 when drilling was re-

sumed, certain of the individual defendants listed in fn. 2,

supra, and persons listed in fn. 4, supra, said to have re-

ceived “tips” from them, purchased TGS stock or calls

thereon. Prior to these transactions these persons had

owned 1135 shares of TGS stock and possessed no calls;

thereafter they owned a total of 8235 shares and possessed

12,300 calls.

On February 20, 1964, also during t! is period, TGS is-

sued stock options to 26 of its officers and employees whose

salaries exceeded a specified amount, five of whom were the

individual defendants Stephens, Fogarty, Mollison, Holyk,

and Kline. Of these, only Kline was unaware of the de-

tailed results of K-55-1, but he, too, knew that a hole con-

taining favorable bodies of copper and zine ore had been

drilled in Timmins. At this time, neither the TGS Stock

Option Committee nor its Board of Directors had been in-

formed of the results of K-55-1, presumably because of the

pending land acquisition program which required confiden-

tiality. All of the foregoing defendants accepted the options

granted them. —

77a

Appendix A — Opinion of the Court of Appeals

When drilling was resumed on March 31, hole K-55-3 was

commenced 510 feet west of K-55-1 and was drilled easterly

at a 45° angle so as to cross K-55-1 in a vertical plane.

Daily progress reports of the drilling of this hole K-55-3

and of all subsequently drilled holes were sent to defen. -

dants Stephens and Fogarty (President and Executive Vice

President of TGS) by Holyk and Mollison. Visual esti-

mates of K-55-3 revealed an average mineral content of

1.12% copper and 7.93% zine over 641 of the hole’s 876.

foot length. On April 7, drilling of a third hole, K-55-4,

200 feet south of and parallel to K-55-1 and westerly at a

45° angle, was commenced and mineralization was en-

countered over 366 of its 579-foot length. Visual estimates

indicated an average content of 1.14% copper and 8.24%

zinc. Like K-55-1, both K-55-3 and K-55-4 established sub-

stantial copper mineralization on the eastern edge of the

anomaly. On the basis of these findings relative to the

foregoing drilling results, the trial court concluded that the

vertical plane created by the intersection cf K-55-1 and

K-55-3, which measured at least 350 feet wide by 500 feet

deep extended southward 200 feet to its intersecticn with

K-55-4, and that “There was real evidence that a body of

commercially mineable ore might exist.” Id. at 281-82.

On April 8 TGS began with a second drill] rig to drill

another hole, K-55-6, 300 feet easterly of K-55-1. This

hole was drilled westerly at an angle of 60° and was in-

tended to explore mineralization beneath K-55-1. While no

visual estimates of its core were immediately availabie,

it was readily apparent by the evening of April 10 that

substantial copper mineralization had been encountered

over the last 127 feet of the hole’s 469-foot length. On

April 10, a third drill rig commenced drilling yet another

hole, K-55-5, 200 feet north of K-55-1, parallel to the prior

FOAM ONE TWH “RY NOIR RES FN OMEN ETI RY GETS Re METI

SERPENT IROL FORA MET

Pare at ata

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4

3

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AE Del DSS Ore e Cee By Me

isa

peed eh —Opricton of the Court of Appeals

holes, and slanted westerly at a 45° angle. By the evening

of April 10 in this hole, too, substantial copper mineraliza-

tion had been encountered over.the last 42 feet of its 97-

foot length.

Meanwhile, rumors that a major ore strike was in the

making had been circulating throughout Canada. On the

morning of Saturday, April 11, Stephens at his home in

Greenwich, Conn. read in the New York Herald Tribune

and in the New York Times unauthorized reports of the

TGS drilling which seemed to infer a rich strike from the

fact that the drill cores had been flown to the United States

for chemical assay. Stephens immediately contacted

Fogarty at his home in Rye, N. Y., who in turn telephoned

and later that day visited Mollison at Mollison’s home in

Greenwich to obtain a current report and evaluation of

the drilling progress." The following morning, Sunday,

Fogarty again telephoned Mollison, inquiring whether Mol-

lison had any further information and told him to return

to Timmins with Holvk, the TGS Chief Geologist, as soon

as possible “to move things along.” With the aid of one

Carroll, a public relations consultant, Fogarty drafted a

press release designed to quell the rumors, which release,

after having been channeled through Stephens and Hun-

tington, a TGS attorney, was issued at 3:00 P.M. on Sun-

day, April 12, and which appeared in the morning news-

papers of general circulation on Monday, April 13. It read

in pertinent part as follows:

7 Mollison had returned to the United States for the weekend. Friday

morning, April 10, he had been on the Kidd tract “and had been ad-

vised by defendant Holyk as to the drilling results to 7:00 p.m. on

April 10. At that time drill holes K-55-1, K-55-3 and K-55-4 had been

completed; drilling of K-55-5 had started on Section 2200 S and had

been drilled to 97 feet, encountering mineralization on the last 42 feet;

and drilling of K-55-6 had been started on Seetion 2400 S and had

teen drilled to 569 feet, encountering mincralization over the last 127

feet.” Id. at 294.

79a

Appendix A — Opinion of the Court of Appeals

New York, April 12—The following statement was

made today by Dr. Charles F. Fogarty, executive vice

president of Texas Gulf Sulphur Company, in regard

to the company’s drilling operations near Timmins,

Ontario, Canada. Dr. Fogarty said:

“During the past few days, the exploration activities

of Texas Gulf Sulphur in the area of Timmins, On-

tario, have been widely reported in the press, coupled

with rumors of a substantial copper discovery there.

These reports exaggerate the scale of operations, and

inention plans and statistics of size and grade of ore

that are without factual basis and have evidently

originated by speculation of people not connected with

TGS.

“The facts are as follows. TGS has been exploring

in the Timmins area for six years as part of its over-

all search in Canada and elsewhere for various min-

erals—lead, copper, zinc, ete. During the course of

this work, in Timmins as well as in Eastern Canada,

TGS has conducted exploration entirely on its own,

without the participation by others. Numerous pros-

pects have been investigated by geophysical means and

a large number of selected ones have been core-drilled.

These cores are sent to the United States for assay

and detailed examination as a matter of routine and

on advice of expert Canadian legal counsel. No in-

ferences as to grade can be drawn from this procedure.

“Most of the areas drilled in Eastern Canada have

revealed either barren pyrite or graphite without

value; a few have resulted in discoveries of small or

marginal sulphide ore bodies.

“Recent drilling on one property near Timmins has

led to preliminary indications that more drilling would

ie.

f

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§

ra

SRW EES

80a

y * oo Otto, of the Court of Appeals

be required for proper evaluation of this prospect.

; The drilling done to date has not been conclusive, but

| the statements made by many outside quarters are un-

‘ reliable and include information and figures that are

t not available to TGS.

“The work done to date has not been sufficient to

‘ reach definite conclusions and any statement as to size

; and grade of ore would be premature and_ possibly

j iisleading. When we have progressed to the point

where reasonable and logical conclusions can be made,

TGS will issue a definite statement to its stockholders

; and to the publie in order to clarify the Timmins

F project.”

: * * eo * *

i The release purported to give the Timmins drilling re-

fl sults as of the release date, April 12. From Mollison

‘ Fogarty had been told of the developments through 7:00

i P.M. on April 10, and of the remarkable discoveries made

f up to that time. detailed supra, which discoveries, accord-

ing to the calculations of the experts who testified for the

SEC at the hearing, demonstrated that TGS had already

discovered 6.2 to 8.3 million tons of proven ore having

gross assay values from $26 to $29 per ton. TGS experts,

on the other hand, denied at the hearing that proven or

probable ore could have been calculated on April 11 or 12

because there was then no assurance of continuity in the

mineralized zone.

The evidence as to the effect of this release on the invest-

ing publie was equivocal and less than abundant. On April

13 the New York Herald Tribune in an article head-noted

“Copper Rumor Deflated” quoted from the TGS release of

April 12 and backtracked from its original Avril 31 report

8la

eipeiedee a4 On neon uf the Court of Appeals

0: a major strike but nevertheless inferred from the TGS

release that “recent mineral exploratory activity near Tim-

mins, Ontario, has provided preliminary favorable results,

sufficient at least to require a step-up in drilling operations.”

Some witnesses who testified at the hearing stated that

they found the release encouraging. On the other hand, a

Canadian mining security specialist, Roche, stated that

“earlier in the week [before Aprii 16] we had a Dow Jones

saying that they [TGS] didn’t have anything basically”

anda TGS tock specialist for the Midwest Stock Exchange

became concerned about his long position in the stock after

reading the release. The trial court stated only that “While,

in retrospect, the press release may appear gloomy or in-

complete, this does not make it misleading or deceptive on

the basis of the facts then known.” Jd. at 296.

Meanwhile, drilling operations continued. By the morn-

ing of April 13, in K-55-5, the fifth drill hole, substantial

copper mineralization had been encountered to the 580

foot mark, and the hole was subsequently drilled to a

length of 757 feet without further results. Visual estimates

revealed an average content of 0.82% copper and 4.2%

zine over a 525-foot section. Also by 7:00 A.M. on April

13, K-55-6 had found mineralization to the 946-foot mark.

On April 12 a fourth drill rig began to drill K-55-7, which

was drilled westerly at a 45° angle, at the eastern edge of

the anomaly. The next morning the 137 foot mark had

been reached, fifty feet of which showed mineralization.

By 7:00 P.M. on April 15, the hole had been completed to

a length of 707 feet but had only encountered additional

mineralization during a 26-foot length between the 425

and 451-foot «.arks. A mill test hole, K-55-8, had been

drilled and ».; -omplete by the evening of April 13 but its

mineralizat«. ad not been reported upon prior to April

82a

Appendix A — Opinion of the Court of Appeals

16. K-55-10 was drilled westerly at a 45° angle commencing

April 14 and had encountered mineralization over 231 of

its 249-foot length by the evening of April 15. It, too, was

drilled at the anomaly’s eastern edge.

While drilling activity ensued to completion, TGS officials

were taking steps toward ultimate disclosure of the dis-

eovery. On April 13, a previously-invited reporter for The

Northern Miner, a Canadian mining industry journal,

visited the drillsite, interviewed Mollison, Holyk and

Darke, and prepared an article which confirmed a 10 mil-

lion ton ore strike. This report, after having been submitted

to Mollison and returned to the reporter unamended on

April 15, was published in the April 16 issue. A statement

relative to the extent of the discovery, in substantial part

drafted by Mollison, was given to the Ontario Minister of

Mines for release to the Canadian media. ‘Mollison and

Holyk expected it to be released over the airways at 11

P.M. on April 15th, but, for undisclosed reasons, it was not

released until 9:40 A.M. on the 16th. An official detailed

statement, announcing a strike of at least 25 million tons

of ore, based on the drilling data set forth above, was read

to representatives of American financial media from 10:00

A.M. to 10:10 or 10:15 A.M. on April 16, and appeared

over Merrill Lynch’s private wire at 10:29 A.M. and, some-

what later than expected, over the Dow Jones ticker tape

at 10:54 A.M.

Between the time the first press release was issued on

April 12 and the dissemination of the TGS official : an-

nouncement on the morning of April 16, the only defendants

before us on appeal who engaged in market activity were

Clayton and Crawford and TGS director Coates. Clayton

ordered 200 shares of TGS stock through his Canadian

83a

Appendix A — Opinion of the Court of Appeals

broker on April 15 and the order was executed that day

over the Midwest Stock Exchange. Crawford ordered 300

shares at midnight on the 15th and another 300 shares at

8:30 A.M. the next day, and these orders were executed

over the Midwest Exchange in Chicago at its opening on

April 16. Coates left the TGS press conference and called

his broker son-in-law Haemisegger shortly before 10:20

A.M. on the 16th and ordered 2,00€ shares of TGS for fam-

ily trust accounts of which Coates was a trustee but not

a beneficiary; Haemisegger executed this order over the

New York and Midwest Exchanges, and he and his cus-

tomers purchased 1500 additional shares.

During the period of drilling in Timmins, the market

price of TGS stock fluctuated but steadily gained overall.

On Friday, November 8, when the drilling began, the stock

closed at 1734; on Friday, November 15, after K-55-1 had

been completed, it closed at 18. After a slight decline to

16% by Friday, November 22, the price rose to 20% by

December 13, when the chemical assay results of K-55-1

were received, and closed at a high of 241% on February

21, the day after the stock options had been issued. It had

reached a price of 26 by March 31, after the land acquisi-

tion program had been completed and drilling had been

resumed, and continued to ascend to 3014 by the close of

trading on April 10, at which time the drilling progress

up to then was evaluated for the April 12th press release.

On April 13, the day on which the April 12 release was

disseminated, TGS opened at 301%, rose immediately to

a high of 32 and gradually tapered off to close at 30%. It

closed at 301, the next day, and at 293% on April 15. On

April 16, the day of the official announcement of the Tim.

mins discovery, the price climbed to a high of 37 and

closed at 36%. By May 15, TGS stock was selling at 5814.

&4a

Appendix A — Opinion of the Court of Appeals

I. Tue InpDivipvaL DEFENDAN:S

A. Introductory

Rule 10b-5, 17 CFR 240.10b-5, on which this action is

predicated, provides:

It shall be unlawful for eny person, directly or in-

directly, by the use of any means or instrumentality

of interstate commerce, or of the mails, or of any

facility of any national securities exchange,

(1) to employ any device, scheme, or artifice to de-

fraud,

( 2) to make any unirue statement of a material fact

or to omit to state a material fact necessary in

order to make the statements made, isi the light

of the circumstances under which they were

made, not misleading, or

(3) to engage in any act, practice, or course of

business which operates or would operate as a

fraud or deceit upon any person,

in connection with the purchase or sale of any security.

Rule 10b-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 (15 U. S. C. 78j(b).°

8 15 U. S. C. §78j reads in pertinent part as follows:

§$78j. Manipuletive and deceptive devices

It shall be unlawful for any person, directly or indirectly, by

the use of any means or instrumentality of interstate commerce

or of the mails, or of any facility of any national securities ex-

change—

* * * * *

(b) To use or employ, in connection with the purchase or sale

of any security registered on a nationa! securities exchange or

any secnrity~not so registered, any manipulative or deceptive device

408

bpp vidia ak - Cy inion of the Court of Appeals

By that Act Congress purposed to prevent inequitable and

unfair practices and to insure fairness in securities trans-

actions generally, whether conducted face-to-face, over the

counter, or on exchanges, see 3 Loss, Securities Regulation

1455-56 (2d ed. 1961). Tiie Act and the Rule apply to the

transactions here, all of which were consummated on ex-

changes. See List v. Fashion Park, I nc., 340 F, 2d 457, 461-

62 (2 Cir.), cert. denied, 362 U. S. 811 (1965) ; Cochran v.

Channing Corp., 211 F. Supp. 239, 243 (SDNY 1962).

Whether predicated on traditional fiduciary concepts, see,

e.g., Hotchkiss v. Fisher, 16 P. 2d 531 (Kan. 1932), or on

the “special facts” doctrine, see, e.g., Strong v. Repide, 213

U.S. 419 (1909), the Rule is based in policy on the justifiable

expectation of the securities marketplace that all investors

trading on impersonal exchanges have relatively equal

access to material information, see Cary, Insider Trading

in Stocks, 21 Bus. Law. 1009, 1010 (1966), Fleischer,

Securities Tiading and Corporation Information Practices:

The Implications of the Texas Gulf Sulphur Proceeding,

D1 Va. L. Rev. 1271, 1278-80 (1965). 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 deal-

ing,” i.e., the investing public. Matter of Cady, Roberts &

Co., 40 SEC 907, 912 (1961). Insiders, as directors or man-

agement officers are, cf course, by this Rule, precluded from

so unfairly dealing, but the Rule is also applicable to one

or contrivance in contravention of such rules and regulations as

the Commission may prescribe as recessary or appropriate in the

public interest or for the protection of investors,

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Appendix A — Opinion of the Court of Appeals

possessing the information who may not be strictly termed

an “insider” within the meanirg of Sec. 16(b) of the Act.

Cady, Roberts, supra. Thus, anyone in possession of ma-

terial inside ‘formation must either disclose it to the in-

vesting 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 inside information re-

mains undisclosed. So, it is here no justification for insider

activity that disclosure was forbidden by the legitimate cor-

porate 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.

Cady, Roberts, supra at 911.

B. Material Inside Information

An insider is not, of course, always foreclosed from in-

vesting in his own company merely because he may be

more familiar with company operations than are outside

investors. An insider’s duty to disclose information or his

duty to abstain from dealing in his company’s securities

arises only in “those situations which are essentially ex-

traordinary in nature and which are reasonably certain to

have a substantial effect on the market price of the security

if [the extraordinary situation is] disclosed.” Fleischer,

Securities Trading and Corporate Information Practices:

The Implications of the Texas Gulf Sulphur Proceeding,

51 Va. L. Rev. 1271, 1289.

9 Congress intended by the Exchange Act to eliminate the idea that

the use of inside information for personal advantage was a normal

emolument of corporate office. See Sections 2 and 16 of the Act;

H. BR. Rep. No. 1583, 73rd Cong., 2d Sess. 13 (1934}; S. Rep. No. 792,

73rd Cong., 2d Sess. 9 (1934); S. E. C., Tenth Annual Report 50 (i0s6).

See Cady, Roberts, supra at 912.

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Appendix A — Opinion of the Court of Appeals

Nor is an insider obligated to confer upon outside in-

vestors the benefit of his superior financial or other expert

analysis by disclosing his educated guesses or predictions.

3 Loss, op. cit. supra at 1463. The only regulatory objective

is that access to material information be enjoyed equally,

but this objective requires nothing more than the disclosure

of basic facts so that outsiders may draw upon their own

evaluative expertise in reaching their own investment de-

cisions with knowledge equal to that of the insiders.

This is not to suggest, however, as did the trial court,

that “the test of materiality must necessarily be a con-

servative one, particularly since many actions under Sec-

tion 10(b) are brought on the basis of hindsight,” 258 F.

Supp. 262 at 280, in the sense that the materiality of

facts is to be assessed solely by measuring the effect the

knowledge of the facts would have upon prudent or con-

servative investors. As we stated in List v. Fashion Park,

Inc., 340 F'. 2d 457, 462, “The basic test of materiality...

is whether a reasonable man would attach importance .. .

in determining his choice of action in the transaction in

question. Restatement, Torts §538(2)(a); accord Prosser,

Torts 554-55; I Har: er & James, Torts 565-66.” (Emphasis

supplied.) This, of course, encompasses any fact “. . .

which in reasonable and objective contemplation might

affect the value of the corporation’s stock or securities, ...”

List v. Fashion Park, Inc., supra at 462, quoting from

Kohler v. Kohler Co., 319 F. 2d 634, 642 (7 Cir. 1963).

(Emphasis supplied.) Such a fact is a material fact and

must be effectively disclosed to the investing publie 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

TROT ES

88a

Appendix A — Opinion of the Court of Appeals

legal protection afforded conservative traders.*° Thus, ma-

terial 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.

In each case, then, whether facts are material within Rule

10b-5 when the facts relate to a particular event and are

undisclosed by those persons who are knowledgeable thereof

will depend at any given time upon a balancing of both the

indicated probability that the event will occur and the an-

ticipated magnitude of the event in light of the totality

of the company activity. Here, notwithstanding the trial

court’s conelausion that the results of the first drill core,

K-55-1, were “too ‘remote’... to have had any significant

impact on the market, i.e., to be deemed material,” ** 258 F.

Supp. at 283, knowledge of the possibility, which surely was

10 The House of Representatives committee that reported out the bill

which eventually beeame the Act did so with the observation that “no

investor, no specuictor, can safely buy and sell securities upon ex-

changes without having an intelligent basis for forming his judgment

as to the value of the securities he buys or sells.” H. R. Rep. No. 1383,

73d Cong., 2d Sess. (1934), p. 11. (Emphasis supplied.)

Dr. Bellemore, the Texas Gulf defendants’ expert witness, has writ-

ten: “The intelligent speculator assumes that facts are available for a

thorough analysis. The speculetor then examines the facts to discover

and evaluate the risks that are present. He then balances these risks

against the apparent opportunities for capital gains and makes his

decision accordingly. He is, to the best of his ability, taking calculated

risks.” Bellemore, Investments: Principles, Practices and Analysis 4

(2d ed. 1962).

11 We are not, of course, bound by the trial court’s determination as

to materiality unless we find it “clearly erroneous” for that standard

of appellate review is applicable only to issues of basic fact and not

to issues of ultimate fact. See Baranow vy. Gibraltar Factors Corp.,

366 F. 2d 584, 587 (2 Cir. 1966); Mamiye Bros. v. Barber 8.8. Lines,

Inc., 360 F. 2d 774, 776-78 (2 Cir.), cert. denied, 385 U. S. 835 (1966) ;

see also SEC v.,R. A. Holman § Co., 366 F. 2d 456, 457-58 (2 Cir.

1966) (by implication).

89a

Appendix A — Opinion of the Court of Appeals

more than marginal, of the existence of a mine of the ‘ast

magnitude indicated by the remarkably rich drill cor _.o-

cated rather close to the surface (suggesting mine v

by the less expensive open-pit method) within the con

of a large anomaly (suggesting an extensive region

mineralization) might well have affected the price of TG.

stock and would certainly have been an important fact

to a reasonable, it speculative, investor in deciding whether

he should buy, sell, or hold. After all, this first drill core

Was “unusuaily good and ... excited the interest and specu-

lation of those who knew about it.” 258 F. Supp. at 282.

Our disagreement with the district judge on this issue

does not, then, go to his findings of basic fact, as to which

the “clearly erroneous” rule would apply, but to his under-

standing of the legal standard applicable to them. See In

re Hygrade Envelope Corp., 366 F. 2d 084, 587-89 (2 Cir.

1960), and cases cited in footnote 11 supra. Our survey of

the facts found below conclusively establishes that knowl-

edge of the results of the discovery hole, K-55-1, would

have been important to a reasonable investor and might

have affected the price of the stock2? On April 16, The

Northern Miner, a trade publication in wide circulation

among mining stock specialists, called K-55-1, the discovery

hole, “one of the most impressive drill holes completed in

12 We do not suggest that material facets must be disclosed immediately ;

the timing of diselosure is a matter for the business judgment of the

corporate Officers «ntrusted with the management of the corporation

within the affirmative diselosure requirements promulgated by the ex-

changes and by the SEC. Here, a valuable corporate purpose was

served by delaying the publication of the K-55-1 discovery. We do

intend to convey, however, that where a

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