The opinion of the court was delivered by: BONSAL
Plaintiff, Securities and Exchange Commission (Commission), has instituted this action charging each of the defendants with violations of Section 10(b) of the Securities Exchange Act (15 U.S.C. § 78j(b)) and Rule 10b-5 (17 C.F.R. 240; 10b-5) promulgated thereunder by the Commission. 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 Sulphur Company (TGS) on the Kidd 55 segment near Timmins, Ontario, between November 12, 1963 and April 16, 1964. TGS is alleged to have violated Section 10(b) and Rule 10b-5 by issuing a false press release regarding these activities on April 12, 1964. Each of the individual defendants was a director, officer or employee of TGS. Individual 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 information as to TGS's exploratory activities on the Kidd 55 segment, 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 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 Gulf Sulphur Company (TGS)
In 1963-64 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. 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 December 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
$1.2 $1.26 $1.21 $0.93 $1.15
From 1955 to 1963 TGS's annual sales declined from $93,000,000 in 1955 to $62,000,000 in 1963 and its 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.
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 3/4 in March to 19 3/8 in November and to 21 7/8 at the end of the year. In 1964 the price rose from a low of 21 1/8 in January to a high of 30 1/4 on April 15. On April 16, the day of TGS's public announcement of the Kidd mine, the price rose from a low of 30 1/8 to a high of 37, closing at 36 3/8. The price continued to rise during the balance of April 1964 to a high of 58 3/8 on April 30, on which day the stock closed at 54 3/4.
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 1963 were the highest in four years, up 5.56% from 1962.
TGS's 1963 earnings were adversely affected by the mysterious loss of the S.S. MARINE SULPHUR 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 sulphur 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 500 tons per day.
Apart from its primary sulphur business, TGS was engaged 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 phosphate, 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 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 to proceed with a 3,000,000 ton-per-year phosphate program in North Carolina at a cost of $45,000,000.
TGS had been engaged in exploration for sulphide deposits 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 described hereafter.
The Individual Defendants
The individual defendants are directors, officers and employees of TGS as follows:
Claude O. Stephens President and Director
Charles F. Fogarty Executive Vice President* and 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
Defendant Thomas P. O'Neill was an accountant with TGS. He was served with 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 of TGS's Exploratory Activities on the Kidd 55 Segment
Exploration on the Canadian Shield:
In 1957 TGS initiated an exploration program for sulphides
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 structure consists of Pre-Cambrian rocks, dating from an early geologic time, and is complex and distorted.
Beginning in March, 1959, an exploration group - headed by defendant Mollison, a mining engineer, and consisting of defendant Holyk, the chief geologist; defendant Clayton, an electrical engineer and geophysicist; and defendant 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 quantity and concentration and are not too deeply buried beneath the earth's surface.
In the course of this aerial exploration, TGS detected several thousand anomalies - unusual variations in the conductivity of rocks. In the opinion of the exploration group several hundred of these anomalies were worthy of further investigation, and rights to land around them were 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-55-1, K-55-3, K-55-4, K-55-5, K-55-6, K-55-7 and K-55-10 at the locations shown on the accompanying Plan Map of the Kidd 55 segment.
[SEE ILLUSTRATION IN ORIGINAL]
On October 29 and 30, 1963, defendant Clayton conducted a ground geophysical survey on the northeast quarter section which confirmed the existence of the anomaly previously detected by the aerial survey. Defendant Clayton interpreted 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 nearest outcroppings of rock were located more than 1,000 feet from the property), diamond core drilling was necessary for 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 quantities 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 Holyk, Clayton and Darke, who considered the results of the geophysical 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-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 percentages of copper and zinc mineralization 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.
As a result of the visual examination of the core, TGS determined to acquire the three other quarter sections making 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 suspended and members of the exploration group were instructed to keep the results of K-55-1 confidential. The drill rig at the site of K-55-1 was moved away and cut saplings 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 chemical assay. In mid-December, TGS received reports from the assay which revealed an average metal content of approximately 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.
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.
On March 31, the drilling of K-55-3 was commenced on section line 2400 S approximately 75 feet west of the western 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 zinc 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 progress of K-55-3 and of the subsequent drill holes were made by defendants Mollison and Holyk to defendants Stephens and Fogarty.
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-55-1, and was drilled westerly on an angle of 45 degrees, parallel to K-55-1. 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 completed to a length of 579 feet on April 10 at 7:00 p.m. without 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 average zinc content of 8.24%. Like K-55-1 and K-55-3, K-55-4 encountered substantial copper mineralization on the eastern edge of the anomaly.
Drill Holes K-55-6 and K-55-5
On April 8, drilling of K-55-6 was commenced with a second 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,
no immediate visual estimates of the core were available. It was apparent, however, by the evening of April 10 that the hole had encountered substantial 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 drill 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 that the hole had intersected substantial copper mineralization 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 morning 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 copper mineralization of 0.82% and an average zinc mineralization of 4.2%. By 7:00 a.m. on April 13, K-55-6 had encountered mineralization to the 946-foot mark. It was subsequently drilled to a length of 1180 feet without intersecting 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 2 1/4 inches in diameter as compared with the 1 1/8 inch diameters of the other holes, and was intended to be used for metallurgical 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 metallurgical tests of the core were reported prior to April 16.
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 length of 707 feet, but encountered only 26 more feet of mineralization between the 425-foot and the 451-foot marks.
Purchase of TGS Stock and Calls on TGS Stock by Certain Defendants and "Tippees" between November 12, 1963 and April 16, 1964
The evidence established that all of the individual defendants except Stephens and Kline purchased shares of TGS and/or calls on TGS stock between November 12, 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 received directly or indirectly from defendants Darke, Coates and Lamont. The following table lists these purchases (including those of defendant Holyk's wife), but does not include the shares covered by stock options granted by TGS to certain defendants on February 20, 1964.
Purchase Purchaser Shares Calls
Number Price Number Price
HOLE K-55-1 COMPLETED NOVEMBER 12, 1963
Nov 12 Fogarty 300 17 3/4-18
15 Clayton 200 17 3/4
15 Fogarty 700 17 5/8-17 7/8
15 Mollison 100 17 7/8
19 Fogarty 500 18 1/8
26 Fogarty 200 17 3/4
29 Holyk (Mrs.) 50 18
CHEMICAL ASSAYS OF DRILL CORE OF K-55-1 RECEIVED DECEMBER 9-13,1963
Dec 10 Holyk (Mrs.) 100 20 3/8
12 Holyk (or wife) 200 21
13 Mollison 100 21 1/8
30 Caskey*a 300 22 1/4
30 Fogarty 200 22
31 Fogarty 100 23 1/4
Jan 6 Holyk (or wife) 100 23 5/8
8 Murray 400 23 1/4
16 Westreich*a 2000 21 1/4-21 3/4
24 Holyk (or wife) 200 22 1/4-22 3/8
Feb 10 Fogarty 300 22 1/8-22 1/4
17 Atkinson*a 50 23 1/4 200 23 1/8
17 Westreich*a 50 23 1/4 1000 23 1/4-23 5/8
20 Darke 300 24 1/8
24 Clayton 400 23 7/8
24 Holyk (or wife) 200 24 1/8
24 Miller*a 200 23 3/4
25 Miller*a 300 23 3/8-23 1/2
26 Holyk (or wife) 200 23 3/8
26 Huntington 50 23 1/4
27 Darke (Moran
as nominee) 1000 22 5/8-22 3/4
Mar 2 Holyk (Mrs.) 200 22 3/8
3 Clayton 100 22 1/4
3 E. W. Darke*a 500 22 1/2-22 5/8
16 Huntington 100 22 3/8
16 Holyk (or wife) 300 23 1/4
17 Holyk (Mrs.) 100 23 7/8
17 E. W. Darke*a 200 23 3/8
23 Darke 1000 24 3/4
26 Clayton 200 25
LAND ACQUISITION COMPLETED MARCH 27, 1964
Mar 30 Atkinson*a 400 25 3/4-25 7/8
30 Caskey*a 100 25 7/8 1000 25 3/4-25 7/8
30 Darke 1000 25 1/2
30 E. W. Darke*a 200 25 1/2
30 Holyk (Mrs.) 100 25 7/8
30-31 Klotz*a 2000 25 1/2-26 1/8
30 Miller*a 500 25 1/2-25 7/8
30 Westreich*a 500 25 3/4
CORE DRILLING OF KIDD 55 SEGMENT RESUMED MARCH 31, 1964
Apr 1 Clayton 60 26 1/2
1 Fogarty 400 26 1/2
2 Clayton 100 26 7/8
6 Fogarty 400 28 1/8-28 7/8
8 Mollison (Mrs.) 100 28 1/8
421 FEET KIDD-55-4 COMPLETED APRIL 9, 1964, 7 P.M.
TGS PRESS RELEASE ISSUED APRIL 12, 1964
Apr 15 Clayton 200 29 3/8
16 Crawford (and
wife) 600 30 1/8-30 1/4
TGS PRESS RELEASE AND PRESS CONFERENCE APRIL 16, 1964, 10 A.M.
Apr 16 Coates(for family
trusts) 2000 31-31 5/8
16 Haemisegger 300 32 1/2
16 Robt. L. Arm-
strong**a 200 31 1/4-34 1/2
16 Charles Cal-
lery**a 300 32 1/2
16 James A. Baker
III**a 200 32 5/8
16 Malcolm G. Baker,
Jr.**a 500 34 1/2-35
16 Morgan Guaranty
Trust Co.***a 10,000 32 5/8-34
16 Lamont and
family**** 3,000 34 1/2
The Securities Exchange Act of 1934 (the Act) and Rule 10b-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 jurisdiction of violations of the Act or of the rules and regulations 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 thereunder.
The preamble of the Act states that it is "to provide for the regulation of securities exchanges and of over-the-counter markets operating in interstate and foreign commerce 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 conducted upon securities exchanges and over-the-counter markets are affected with a national public interest 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 principal security holders, . . . and to impose requirements necessary to make such regulation and control reasonably complete and effective, in order to protect interstate commerce . . . and to insure the maintenance of fair and honest markets in such transactions . . . ."
Section 2(2) (15 U.S.C. § 78b(2)) provides:
"The prices established and offered in such transactions are generally disseminated and quoted throughout the United States and foreign countries and constitute a basis for determining and establishing the prices at which securities are bought and sold . . . ."
Section 2(3) (15 U.S.C. § 78b(3)) states that:
"Frequently the prices of securities on such exchanges and markets are susceptible to manipulation and control . . . ."
Section 4(a) (15 U.S.C. § 78d(a)) provides for the establishment of the Commission as the agency charged with the administration of the Act.
Section 10 of the Act (15 U.S.C. § 78j) provides:
"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 -
"(b) To use or employ, in connection with the purchase 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 appropriate in the public interest or for the protection of investors."
Pursuant to the authority conferred on the Commission by Section 10(b), in May, 1942 the Commission promulgated Rule 10b-5 (17 C.F.R. 240; 10b-5), which provides:
"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 language was also used in Section 206 of the Investment Advisers 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 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 Commission contends that the defendants engaged in a "course of business" which operated "as a fraud or ...