401 F.2d 833, cert. denied, 404 U.S. 1005 (1971)
Texas Gulf Sulphur Company began exploratory activities on the Canadian Shield in eastern Canada in 1957.1
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.2 The group included defendant Holyk, TGS’s chief geologist, defendant Clayton, an electrical engineer and geophysicist, and defendant Darke, a geologist.3 These operations resulted in the detection of numerous anomalies, one of which was on the Kidd 55 segment of land located near Timmins, Ontario.4
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.5 Drilling of the initial hole, K-55-1, at the strongest part of the anomaly was commenced on November 8 and terminated on November 12 at a depth of 655 feet.6 Visual estimates by Holyk of the core of K-55-1 indicated an average copper content of 1.15% and an average zinc content of 8.64% over a length of 599 feet.7 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% zinc, and 3.94% ounces of silver per ton over a length of 602 feet.8 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.9 The trial court concluded that 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.10 TGS President Stephens instructed the exploration group to keep the results of K-55-1 confidential and undisclosed even as to other officers, directors, and employees of TGS to facilitate acquisition of the remainder of the Kidd 55 segment.11
During the period from November 12, 1963 when K-55-1 was completed, to March 31, 1964 when drilling was resumed, the individual defendants and persons said to have received tips from them purchased TGS stock or calls thereon.12 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.13 On February 20, 1964, TGS issued 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.14 At this time, neither the TGS Stock Option Committee nor its Board of Directors had been informed of the results of K-55-1.15
When drilling was resumed on March 31, hole K-55-3 was commenced 510 feet west of K-55-1.16 Visual estimates of K-55-3 revealed an average mineral content of 1.12% copper and 7.93% zinc over 641 of the hole's 876-foot length.17 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 encountered over 366 of its 579-foot length.18 Meanwhile, rumors that a major ore strike was in the making had been circulating throughout Canada.19 On the morning of Saturday, April 11, Stephens at his home in Greenwich, Connecticut, 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.20
While no visual estimates of its core were immediately available, 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 569-foot length.21 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 million ton ore strike.22 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, somewhat later than expected, over the Dow Jones ticker tape at 10:54 A.M.23
Between the time the first press release was issued on April 12 and the dissemination of the TGS official announcement 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.24 This action was commenced in the United States District Court for the Southern District of New York by the Securities and Exchange Commission pursuant to Sec. 21(e) of the Securities Exchange Act of 1934 against Texas Gulf Sulphur Company and several of its officers, directors and employees.25 The case was tried at length before Judge Bonsal of the Southern District of New York, sitting without a jury.26
Whether the results of drill hole K-55-1 constituted material information that required disclosure before TGS insiders purchased company securities or accepted stock options?27
Rule 10b-5 prohibits any person from employing a device to defraud or making an untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, or 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.28 An insider in possession of material nonpublic information must disclose it or abstain from trading.29 Materiality exists when a reasonable investor would attach importance to the fact in determining a choice of action.30 This is assessed by balancing the indicated probability that the event will occur against the anticipated magnitude of the event in light of the totality of company activity.31
Yes. The visual estimates by Holyk of the core of K-55-1 indicated an average copper content of 1.15% and an average zinc content of 8.64% over a length of 599 feet. 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% zinc, 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. During this period, from November 12, 1963 when K-55-1 was completed, to March 31, 1964 when drilling was resumed, the individual defendants and persons said to have received tips from them purchased TGS stock or calls thereon. On February 20, 1964, also during this period, TGS issued 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. At this time, neither the TGS Stock Option Committee nor its Board of Directors had been informed of the results of K-55-1, presumably because of the pending land acquisition program which required confidentiality.
All of the foregoing defendants accepted the options granted them.
The results of K-55-1 constituted material information that required disclosure before insiders purchased securities or accepted stock options.32
Whether defendants who purchased TGS stock or calls between November 12, 1963, and April 9, 1964, violated Section 10(b) and Rule 10b-5?33
Section 10(b) and Rule 10b-5 are violated when an insider trades in securities while in possession of material nonpublic information without first disclosing that information to the investing public.34 The rule implements the congressional purpose that all investors have equal access to material information.35 It prohibits trading on the basis of information intended only for a corporate purpose.36
Yes. During this period, from November 12, 1963 when K-55-1 was completed, to March 31, 1964 when drilling was resumed, the individual defendants and persons said to have received 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. The timing of these purchases, including acquisitions by individuals who had never before purchased TGS stock or calls, demonstrates that the insiders were influenced by the undisclosed drilling results rather than by any other factor.37
Defendants who purchased TGS stock or calls between November 12, 1963, and April 9, 1964, violated Section 10(b) and Rule 10b-5.38
Whether defendants Stephens, Fogarty, Mollison, Holyk, and Kline violated Section 10(b) and Rule 10b-5 by accepting stock options on February 20, 1964, without disclosing drilling results?39
An insider who accepts a stock option while possessing material nonpublic information violates Rule 10b-5 if the information is not disclosed to the issuer's stock option committee or board.40 The acceptance constitutes a purchase of securities on the basis of inside information.41 The duty to disclose arises from the insider's access to information intended solely for corporate purposes.42
Yes. On February 20, 1964, also during this period, TGS issued 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. At this time, neither the TGS Stock Option Committee nor its Board of Directors had been informed of the results of K-55-1, presumably because of the pending land acquisition program which required confidentiality. All of the foregoing defendants accepted the options granted them.
Stephens and Fogarty, as senior officers, had an obligation to inform the committee that the timing was inappropriate.43 Kline, as general counsel and a member of top management present when the options were granted, likewise had a duty to disclose before accepting his option.44
Defendants Stephens, Fogarty, and Kline violated Section 10(b) and Rule 10b-5 by accepting stock options without disclosure, while the claims against Mollison and Holyk were not appealed.45
Related opinions on this issue
A rule requiring a minor officer to reject an option so tendered would not comport with the realities either of human nature or of corporate life.46 If the SEC had appealed the ruling dismissing this portion of the complaint as to Holyk and Mollison, I would have upheld the dismissal quite apart from the special circumstance that a refusal on their part could well have broken the wall of secrecy it was important for TGS to preserve.47 Stephens, Fogarty and Kline stand on an altogether different basis.
As senior officers they had an obligation to inform the Committee that this was not the right time to grant options at 95% of the current price. Silence, when there is a duty to speak, can itself be a fraud.48
Whether defendant Darke violated Section 10(b) and Rule 10b-5 by passing material information to tippees?49
Rule 10b-5 is violated when an insider who possesses material nonpublic information passes that information to others for use in purchasing securities.50 The prohibition extends to tipping.
Yes. The trial court also found that later, as of March 30, 1964, Darke not only used his material knowledge for his own purchases but that the substantial amounts of TGS stock and calls purchased by these outside individuals on that day was strong circumstantial evidence that Darke must have passed the word to one or more of his tippees that drilling on the Kidd 55 segment was about to be resumed.51 Obviously if such a resumption were to have any meaning to such tippees, they must have previously been told of K-55-1.52 As it is our holding that the information acquired after the drilling of K-55-1 was material, we, on the basis of the findings of direct and circumstantial evidence on the issue that the trial court has already expressed, hold that Darke violated Rule 10b-5 (3) and Section 10(b) by tipping.53
Defendant Darke violated Section 10(b) and Rule 10b-5 by passing material information to tippees.54
Whether defendants Clayton, Crawford, and Coates violated Section 10(b) and Rule 10b-5 by purchasing TGS securities on April 15 and 16, 1964?55
Insiders who possess material information may not trade until the information has been effectively disclosed to the investing public through established procedures such as a formal announcement to the financial news media.56 The rule requires equal access. The mere existence of rumors or partial Canadian disclosures does not constitute effective public dissemination.57
Yes. Between the time the first press release was issued on April 12 and the dissemination of the TGS official announcement 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 broker on April 15 and the order was executed that day over the Midwest Stock Exchange.58 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 16.59
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 2,000 shares of TGS for family trust accounts of which Coates was a trustee but not a beneficiary.60 The abbreviated announcement to the Canadian press at 9:40 A.M. on the 16th by the Ontario Minister of Mines and the report carried by The Northern Miner, parts of which had sporadically reached New York on the morning of the 16th through reports from Canadian affiliates to a few New York investment firms, are assuredly not the equivalent of the official 10-15 minute announcement which was not released to the American financial press until after 10:00 A.M. Crawford's orders had been placed before that.61
Defendants Clayton, Crawford, and Coates violated Section 10(b) and Rule 10b-5 by purchasing TGS securities before effective public disclosure.62
Whether the April 12, 1964 TGS press release was misleading or deceptive to reasonable investors?63
A corporate press release violates Rule 10b-5(2) if it is false, misleading, or so incomplete as to mislead a reasonable investor in the exercise of due care.64 The standard is whether the release conveyed to the public a false impression of the situation at the time of its issuance rather than whether it was issued with a wrongful purpose.65
No. The evidence as to the effect of this release on the investing public was equivocal and less than abundant.66 Some witnesses who testified at the hearing stated that they found the release encouraging.67 On the other hand, a Canadian mining security specialist, Roche, stated that earlier in the week before April 16 we had a Dow Jones saying that they TGS did not have anything basically and a TGS stock specialist for the Midwest Stock Exchange became concerned about his long position in the stock after reading the release.68 The trial court stated only that while, in retrospect, the press release may appear gloomy or incomplete, this does not make it misleading or deceptive on the basis of the facts then known.69
Its conclusion that the Commission has failed to demonstrate that it was false, misleading or deceptive, 258 F.Supp. at 294, seems to have derived from its views that the defendants are to be judged on the facts known to them when the April 12 release was issued, 258 F.Supp. at 295, that the draftsmen exercised reasonable business judgment under the circumstances, 258 F.Supp. at 296, and that the release was not misleading or deceptive on the basis of the facts then known, 258 F.Supp. at 296, rather than from an appropriate primary inquiry into the meaning of the statement to the reasonable investor and its relationship to truth.70
The April 12, 1964 TGS press release was not shown to be misleading or deceptive to reasonable investors on the present record.71
Related opinions on this issue
In my opinion the evidence establishes as a matter of law that the press release was misleading.72 Indeed, if the correct standard is applied, the finding of the trial court requires the conclusion that the press release was misleading. 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 market price of TGS stock.
The evidence in the record in support of this finding is overwhelming.73 Assuming arguendo that the corporation cannot be enjoined except on a showing of lack of due diligence, since Fogarty and those who assisted him in the preparation of the press release were aware of the drilling results to which the district court's finding refers, they obviously did not use due diligence in the preparation of the misleading press release.74 I would grant the application for an injunction.75
I find it equally plain, as Judge Waterman's opinion convincingly demonstrates, that the release did not properly convey the information in the hands of the draftsmen on April 12, even granting, as I would, that in a case like this a court should not set the standard of care too high.76 To say that the drilling at Timmins had afforded only preliminary indications that more drilling would be required for proper evaluation of this prospect, was a wholly insufficient statement of what TGS knew.77 Since the issue of negligence is open to full review, I see no need for a remand on that score.
It is an equally needless exercise to require the district court to determine whether a reasonable investor would have been misled.78 The text of the release and the three point drop in the market price following its issuance in the face of press reports that would normally have led to a large and, as matters developed, justified increase, are sufficient proof of that.79
Whether TGS violated Section 10(b) and Rule 10b-5 by issuing the April 12, 1964 press release?80
A corporation violates Rule 10b-5 when it issues a materially misleading statement in a manner reasonably calculated to influence the investing public, such as through the financial media. The phrase in connection with the purchase or sale of any security requires only that the device be of a sort that would cause reasonable investors to rely thereon and thereby purchase or sell the corporation's securities.81
No. The evidence as to the effect of this release on the investing public was equivocal and less than abundant. The trial court stated only that while, in retrospect, the press release may appear gloomy or incomplete, this does not make it misleading or deceptive on the basis of the facts then known. 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.82 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.83
The issuance of the release produced no unusual market action.84 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 Rule 10b-5 since it was not issued in connection with the purchase or sale of any security.85
TGS did not violate Section 10(b) and Rule 10b-5 on the present record, and the issue is remanded for further determination under the correct legal standard.86
Related opinions on this issue
Joined by Circuit Judge Moore
The District Court held that if TGS or its insiders had purchased TGS stock after issuing the allegedly misleading press release, the inference could be drawn that it was issued to reduce the price of the stock to facilitate purchases at bargain prices.87 Such a deceptive or manipulative practice would be prohibited by 10(b) and Rule 10b-5.88 But in this case the only purpose of the press release was to quell the extravagant rumors circulating about the Canadian exploration project.89
No facts whatsoever were adduced which would have justified a finding that the release was issued for a fraudulent or manipulative purpose.90 To hold that such a statement incurs 10b-5 liability is contrary to the intent of Congress in passing § 10(b) and settled judicial construction.91
Whether the district court applied the correct legal standard in determining that the April 12 press release did not violate Rule 10b-5?92
A court must determine whether a corporate statement is misleading by applying the objective standard of the reasonable investor rather than by inquiring into the issuer's purpose or by relying solely on the facts known to the draftsmen at the time of preparation.93
No. Its conclusion that the Commission has failed to demonstrate that it was false, misleading or deceptive, 258 F.Supp. at 294, seems to have derived from its views that the defendants are to be judged on the facts known to them when the April 12 release was issued, 258 F.Supp. at 295, that the draftsmen exercised reasonable business judgment under the circumstances, 258 F.Supp. at 296, and that the release was not misleading or deceptive on the basis of the facts then known, 258 F.Supp. at 296, rather than from an appropriate primary inquiry into the meaning of the statement to the reasonable investor and its relationship to truth.94 While we certainly agree with the trial court that in retrospect, the press release may appear gloomy or incomplete, 258 F.Supp. at 296, we cannot, from the present record, by applying the standard Congress intended, definitively conclude that it was deceptive or misleading to the reasonable investor, or that he would have been misled by it.95 Accordingly we remand this issue to the district court that took testimony and heard and saw the witnesses for a determination of the character of the release in the light of the facts existing at the time of the release by applying the standard of whether the reasonable investor, in the exercise of due care, would have been misled by it.96
The district court applied an incorrect legal standard, requiring remand for further proceedings.97
Related opinions on this issue
I concur in Judge Waterman's reasoned and thorough opinion and in the court's disposition of the instant appeal.98 I agree with Judge Friendly, however, that we should provide guidance to the District Courts with respect to pending private claims for damages based upon Rule 10(b) (5) arising out of the transactions now before us.99 I also concur in the discussion of law set forth in Part II of Judge Friendly's concurring opinion.