Chapter 42
Securities Law and
Corporate Governance
Case 42.1
401 F.2d 833
SEC, Plaintiff-Appellant,
v.
TEXAS GULF SULPHUR CO., a Texas Corporation, Charles F. Fogarty, Richard D. Mollison,
5) (the Rule), promulgated thereunder, and to compel the rescission by the individual defendants of securities transactions
assertedly conducted contrary to law.(FN1) The complaint alleged (1) that defendants Fogarty, Mollison, Darke, Murray,
Huntington, O’Neill, Clayton, Crawford, 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
Timmins, Ontario, while such information remained undisclosed to the investing public generally or to the particular sellers;
(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 remand, 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 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 injunction, 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 dismissal of the complaint and remand with directions to issue an
order rescinding the option and for a determination of any other appropriate remedy in connection therewith.
(6) As to Fogarty, Mollison, Holyk, Darke, and Huntington, as purchasers of stock or calls thereon between Novermber 12, 1963,
(7) As to Clayton, although the district judge did not specify that the complaint be dismissed with respect to 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 by all the parties, for a determination of the appropriate remedy.
(8) As to Darke, as one who passed on information to tippees, we reverse the dismissal of the complaint and remand, 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
(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.
646 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
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
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
55-1, but he, too, knew that a hole containing favorable bodies of copper and zinc ore had been drilled in Timmins. 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. 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 degrees 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 defendants Stephens and Fogarty (President and Executive Vice President
of TGS) by Holyk and Mollison. 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. 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 degrees angle, was commenced and mineralization was encountered over 366 of its 579-foot length. Visual
55-5, 200 feet north of K-55-1, parallel to the prior holes, and slanted westerly at a 45 degrees angle. By the evening of April 10 in
this hole, too, substantial copper mineralization had been encountered over the last 42 feet of its 97-foot length. Meanwhile,
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 647
remors 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
“During the past few days, the exploration activities of Texas Gulf Sulphur in the area of Timmins, Ontario, have been widely
reported in the press, coupled with rumors of a substantial copper discovery 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 exploring in the Timmins area for six years as part of its overall search in Canada and
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 order to clarify the Timmins project.’
The release purported to give the Timmins drilling results as of the release date, April 12. From Mollison Fogarty had been told of
the developments through 7:00 P.M. on April 10, and of the remarkable discoveries made up to that time, detailed supra, which
discoveries, according to the calculations of the experts who testified for the SEC at the hearing, demonstrated that TGS had
16) we had a Dow Jones saying that they (TGS) didn’t 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. The trial court stated only that “While,
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 degrees 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
648 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
additional mineralization during a 26-foot length between the 425 and 451-foot marks. A mill test hole, K-55-8, had been drilled and
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.
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
continued to ascend to 30 1/8 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 30 1/8, rose
immediately to a high of 32 and gradually tapered off to close at 30 7/8. It closed at 30 1/4 the next day, and at 29 3/8 on April 15.
On April 16, the day of the official announcement of the Timmins discovery, the price climbed to a high of 37 and closed at 36 3/8.
By May 15, TGS stock was selling at 58 1/4.
(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.
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).(FN8) By that Act Congress purposed to prevent inequitable and unfair practices and to
insure fairness in securities transactions generally, whether conducted face–to-face, over the counter, or on exchanges, see 3
Loss, Securities Regulation 1455-56 (2d ed. 1961). The Act and the Rule apply to the transactions here, all of which were
consummated on exchanges. See List v. Fashion Park, Inc., 340 F.2d 457, 461-62 (2 Cir.), cert. denied, 382 U.S. 811, 86 S.Ct. 23,
15 L.Ed.2d 60 (1965); Cochran v. Channing Corp., 211 F.Supp. 239, 243 (SDNY 1962). Whether predicated on traditional fiduciary
concepts, see, e.g., Hotchkiss v. Fisher, 136 Kan. 530, 16 P.2d 531 (Kan.1932), or on the “special facts’ doctrine, see, e.G., Strong
v. Repide, 213 U.S. 419, 29 S.Ct. 521, 53 L.Ed. 853 (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
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 649
Cary, Insider Trading in Stocks, 21 Bus.Law. 1009, 1010 (1966), Fleischer, Securities Trading and Corporation Information
Practices: The Implications of the Texas Gulf Sulphur Proceeding, 51 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 dealing,’ i.E., the investing public. Matter of Cady, Roberts & Co., 40
SEC 907, 912 (1961). Insiders, as directors or management officers are, of course, by this Rule, precluded from so unfairly
dealing, but the Rule is also applicable to one possessing the information who may not be strictly termed an “insider’ within the
meaning of Sec. 16(b) of the Act. Cady, Roberts, supra. Thus, anyone in possession of material inside information must either
disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses
not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains
undisclosed. So, it is here no justification for insider activity that disclosure was forbidden by the legitimate corporate objective of
acquiring options to purchase the land surrounding the exploration site; if the information was, as the SEC contends,
material,(FN9) its possessors should have kept out of the market until disclosure was accomplished. Cady, Roberts, supra at 911.
B. Material Inside Information
This is not to suggest, however, as did the trial court, the “the test of materiality must necessarily be a conservative one,
particularly since many actions under Section 10(b) are brought on the basis of hindsight,’ 258 F.Supp. 262 at 280, in the sense
that the materialith of facts is to be assessed solely by measuring the effect the knowledge of the facts would have upon prudent or
conservative 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 Harper & James, Torts 565-66.’ 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 A.L.R.3d 486 (7 Cir. 1963). Such a fact is a material fact
and must be effectively disclosed to the investing public prior to the commencement of insider trading in the corporation’s
securities. The speculators and chartists of Wall and Bay Streets are also “reasonable’ investors entitled to the same legal
protection afforded conservative traders.(FN10) Thus, material facts include not only information disclosing the earnings and
distributions of a company but also those facts which affect the probable future of the company and those which may affect the
desire of investors to buy, sell, or hold the company’s securities.
650 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
Finally, a major factor in determining whether the K-55-1 discovery was a material fact is the importance attached to the drilling
results by those who knew about it. In view of other unrelated recent developments favorably affecting TGS, participation by an
informed person in a regular stock-purchase program, or even sporadic trading by an informed person, might lend only nominal
support to the inference of the materiality of the K-55-1 discovery; nevertheless, the timing by those who knew of it of their stock
purchases and their purchases of short-term calls- purchases in some cases by individuals who had never before purchased calls
or even TGS stock- virtually compels the inference that the insiders were influenced by the drilling results. This insider trading
activity, which surely constitutes highly pertinent evidence and the only truly objective evidence of the materiality of the K-55–1
discovery, was apparently disregarded by the court below in favor of the testimony of defendants’ expert witnesses, all of whom
“agreed that one drill core does not establish an ore body, much less a mine,’ 258 F.Supp. at 282-283. Significantly, however, the
court below, while relying upon what these defense experts said the defendant insiders ought to have thought about the worth to
TGS of the K-55-1 discovery, and finding that from November 12, 1963 to April 6, 1964 Fogarty, Murray, Holyk and Darke spent
more than $100,000 in purchasing TGS stock and calls on that stock, made no finding that the insiders were motivated by any
factor other than the extraordinary K–55-1 discovery when they bought their stock and their calls. No reason appears why outside
investors, perhaps better acquainted with speculative modes of investment and with, in many cases, perhaps more capital at their
disposal for intelligent speculation, would have been less influenced, and would not have been similarly motivated to invest if they
had known what the insider investors knew about the K-55-1 discovery.
The core of Rule 10b-5 is the implementation of the Congressional purpose that all investors should have equal access to the
rewards of participation in securities transactions. It was the intent of Congress that all members of the investing public should be
subject to identical market risks,- which market risks include, of course the risk that one’s evaluative capacity or one’s capital
available to put at risk may exceed another’s capacity or capital. The insiders here were not trading on an equal footing with the
outside investors. They alone were in a position to evaluate the probability and magnitude of what seemed from the outset to be a
major ore strike; they alone could invest safely, secure in the expectation that the price of TGS stock would rise substantially in the
event such a major strike should materialize, but would decline little, if at all, in the event of failure, for the public, ignorant at the
outset of the favorable probabilities would likewise be unaware of the unproductive exploration, and the additional exploration costs
would not significantly affect TGS market prices. Such inequities based upon unequal access to knowledge should not be
shrugged off as inevitable in our way of life, or, in view of the congressional concern in the area, remain uncorrected.
We hold, therefore, that all transactions in TGS stock or calls by individuals apprised of the drilling results(FN14) of K–55-1 were
made in violation of Rule 10b-5.(FN15) Inasmuch as the visual evaluation of that drill core (a generally reliable estimate though
less accurate than a chemical assay) constituted material information, those advised of the results of the visual evaluation as well
as those informed of the chemical assay traded in violation of law. The geologist Darke possessed undisclosed material
information and traded in TGS securities. Therefore we reverse the dismissal of the action as to him and his personal transactions.
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 651
The tril court also found, 258 F.Supp. at 284, that Darke, after the drilling of K-55-1 had been completed and with detailed
knowledge of the results thereof, told certain outside individuals that TGS “was a good buy.’ These individuals thereafter acquired
TGS stock and calls. 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, see
footnote 4, supra, 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.’ 258 F.Supp. at 284. Obviously if such a resumption were to have any
meaning to such “tippees,’ they must have previously been told of K-55–1.
With reference to Huntington, the trial court found that he “had no detailed knowledge as to the work’ on the Kidd-55 segment, 258
F.Supp. 281. Nevertheless, the evidence shows that he knew about and participated in TGS’s land acquisition program which
followed the receipt of the K–55-1 drilling results, and that on February 26, 1964 he purchased 50 shares of TGS stock. Later, on
March 16, he helped prepare a letter for Dr. Holyk’s signature in which TGS made a substantial offer for lands near K–55-1, and on
the same day he, who had never before purchased calls on any stock, purchased a call on 100 shares of TGS stock. We are
satisfied that these purchases in February and March, coupled with his readily inferable and probably reliable, understanding of the
highly favorable nature of preliminary operations on the Kidd segment, demonstrate that Huntington possessed material inside
information such as to make his purchase violative of the Rule and the Act.
C. When May Insiders Act?
Appellant Crawford, who ordered(FN17) the purchase of TGS stock shortly before the TGS April 16 official announcement, and
defendant Coates, who placed orders with and communicated the news to his broker immediately after the official announcement
was read at the TGS-called press conference, concede that they were in possession of material information. They contend,
however, that their purchases were not proscribed purchases for the news had already been effectively disclosed. We disagree.
Crawford telephoned his orders to his Chicago broker about midnight on April 15 and again at 8:30 in the morning of the 16th, with
instructions to buy at the opening of the Midwest Stock Exchange that morning. The trial court’s finding that “he sought to, and did,
“beat the news,”” 258 F.Supp. at 287, is well documented by the record. The rumors of a major ore strike which had been
circulated in Canada and, to a lesser extent, in New York, had been disclaimed by the TGS press release of April 12, which
significantly promised the public an official detailed announcement when possibilities had ripened into actualities. 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
Coates was absolved by the court below because his telephone order was placed shortly before 10:20 A.M. on April 16, which was
after the announcement had been made even though the news could not be considered already a matter of public information. 258
F.Supp. at 288. This result seems to have been predicated upon a misinterpretation of dicta in Cady, Roberts, where the SEC
instructed insiders to “keep out of the market until the established procedures for public release of the information are carried out
instead of hastening to execute transactions in advance of, and in frustration of, the objectives of the release,’ 40 SEC at 915. The
reading of a news release, which prompted Coates into action, is merely the first step in the process of dissemination required for
compliance with the regulatory objective of providing all investors with an equal opportunity to make informed investment
judgments. Assuming that the contents of the official release could instantaneously be acted upon,(FN18) at the minimum Coates
652 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
should have waited until the news could reasonably have been expected to appear over the media of widest circulation, the Dow
Jones broad tape, rather than hastening to insure an advantage to himself and his broker son-in-law.(FN19)
D. Is An Insider’s Good Faith A Defense Under 10b-5?
824, 839-44 (1965); Note, 63 Mich.L.Rev. 1070, 1079-81 (1965).
Absent any clear indication of a legislative intention to require a showing of specific fraudulent intent, see Note, 63 Mich.L.Rev.
1070, 1075, 1076 n. 29 (1965), the securities laws should be interpreted as an expansion of the common law(FN21) both to
effectuate the broad remedial design of Congress, see SEC v. Capital Gains Research Bureau, supra, 375 U.S. at 195, 84 S.Ct.
275, and to insure uniformity of enforcement, see Note, 32 U.Chi.L.Rev. 824, 832 n. 36 (1965), citing McClure v. Borne Chemical
Co., 292 F.2d 824, 834 (3 Cir. 1961). Moreover, a review of other sections of the Act from which Rule 10b-5 seems to have been
drawn suggests that the implementation of a standard of conduct that encompasses negligence as well as active fraud comports
with the administrative and the legislative purposes underlying the Rule.(FN22) Finally, we note that this position is not, as
asserted by defendants, irreconcilable with previous language in this circuit because “some form of the traditional scienter
requirement,’ Barnes v. Osofsky, 373 F.2d 269, 272 (2 Cir. 1967), sometimes defined as “fraud,’ Fischman v. Raytheon Mfg. Co., 9
F.R.D. 707 (SDNY 1949), rev’d on other grounds, 188 F.2d 783, 786 (2 Cir. 1951) is preserved. This requirement, whether it be
termed lack of diligence, constructive fraud, or unreasonable or negligent conduct, remains implicit in this standard, a standard that
promotes the deterrence objective of the Rule.
Clayton, who was unaware of the April 16 disclosure announcement TGS was to make can, in support of his claim that the
favorable news was public, rely only on the rumors and on the phone calls received by TGS prior to the placing of his order from
those who seemed to have heard some version or rumors of the news. His awareness of the contents of the April 12 release
renders unreasonable any claim that he believed the news was truly public.
Finally, Coates, as we have already indicated in fn. 19, supra, could not reasonably have expected the official release to have
been disseminated when he placed his order before 10:20 for immediate execution nor were the Canadian disclosures relied on by
Crawford sufficient to render the conduct of Coates permissible under the circumstances.(FN23)
E. May Insiders Accept Stock Options Without Disclosing Material Information To the Issuer?
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 653
Contrary to the belief of the trial court that Kline had no duty to disclose his knowledge of the Kidd project before accepting the
stock option offered him, we believe that he, a vice president, who had become the general counsel of TGS in January 1964, but
who had been secretary of the corporation since January 1961, and was present in that capacity when the options were granted,
and who was in charge of the mechanics of issuance and acceptance of the options, was a member of top management and under
a duty before accepting his option to disclose any material information he may have possessed, and, as he did not disclose such
information to the Option Committee we direct rescission of the option he received.(FN24) As to Holyk and Mollison, the SEC has
not appealed the holding below that they, not being then members of top management (although Mollison was a vice president)
had no duty to disclose their knowledge of the drilling before accepting their options. Therefore, the issue of whether, by accepting,
they violated the Act, is not beofre us, and the holding below is undisturbed.
II. THE CORPORATE DEFENDANT
Introductory
At 3:00 P.M. on April 12, 1964, evidently believing it desirable to comment upon the rumors concerning the Timmins project, TGS
issued the press release quoted in pertinent part in the text at page 845, supra. The SEC argued below and maintains on this
appeal that this release painted a misleading and deceptive picture of the drilling progress at the time of its issuance, and hence
violated Rule 10b-5(2).(FN25) TGS relies on the holding of the court below that “the issuance of the release produced no unusual
market action’ and “in the absence of a showing that the purpose of the April 12 press release was to affect the market price of
In adjudicating upon the relationship of this phrase to the case before us it would appear that the court below used a standard that
does not reflect the congressional purpose that prompted the passage of the Securities Exchange Act of 1934.
The dominant congressional purposes underlying the Securities Exchange Act of 1934 were to promote free and open public
securities markets and to protect the investing public from suffering inequities in trading, including, specifically, inequities that
follow from trading that has been stimulated by the publication of false or misleading corporate information releases. Commenting
on the disclosure purposes of the House bill (H.R. 9323), the bill a Committee of Conference eventually integrated with a similar
Senate bill (S. 3420) to make the bill passed by both Houses of Congress that became the Securities Exchange Act of 1934, the
House Committee which reported out H.R. 9323 stated:
The idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers as to the fair
price of a security brings about a situation where the market price reflects as nearly as possible a just price. Just as artificial
manipulation tends to upset the true function of an open market, so the hiding and secreting of important information obstructs the
operation of the markets as indices of real value. There cannot be honest markets without honest publicity. Manipulation and
654 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
Section 10(b) of the Act (see footnote 8, supra) was taken by the Conference Committee from Section 10(b) of the proposed
Senate bill, S. 3420, and taken from it verbatim insofar as here pertinent. The only alteration made by the Conference Committee
was to substitute the present closing language of Section 10(b), “* * * 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’ for the closing
language of the original Section 10(b) of S. 3420, ‘* * * which the Commission may declare to be detrimental to the interests of
investors.’ 78 Cong.Rec. 10261 (1934). The Report of the Senate Committee which presented S. 3420 to the Senate summarized
Section 10(b) as follows: Subsection (b) authorizes the Commission by rules and regulations to prohibit or regulate the use of any
other manipulative or deceptive practices which it finds detrimental to the interests of the investor. S.Rep.No. 792, 73rd Cong., 2d
Sess. 18 (1934).
Indeed, from its very inception, Section 10(b), and the proposed sections in H.R. 1383 and S. 3420 from which it was derived, have
always been acknowledged as catchalls. See Bromberg, Securities Law: SEC Rule 10b-5, p. 19 (1967). In the House Committee
hearings on the proposed House bill, Thomas G. Corcoran, Counsel with the Reconstruction Finance Corporation and a
spokesman for the Roosevelt Administration, described the broad prohibitions contained in 9(c), the section which corresponded to
Section 10(b) of S. 3420 and eventually to Section 10(b) of the Act, as follows: “Subsection (c) says, “Thou shalt not devise any
other cunning devices’ * * *. Of course subsection (c) is a catch-all clause to prevent manipulative devices. I do not think there is
any objection to that kind of a clause. The Commission should have the authority to deal with new manipulative devices.’ Stock
Exchange Regulation, Hearings before the House Committee on Interstate and Foreign Commerce, 73rd Cong., 2d Sess. 115
(1934). Although several other witnesses objected to the breadth of the proposed prohibition that Corcoran was supporting, the
section as enacted did not in any way limit the broad scope of the “in connection with’ phrase. See 3 Loss, Securities Regulation,
1424 n. 7 (2d ed. 1961). Thus, the legislative history of Section 10(b) does not support the proposition urged upon us by Texas
at 16-17.
Therefore it seems clear from the legislative purpose Congress expressed in the Act, and the legislative history of Section 10(b)
that Congress when it used the phrase “in connection with the purchase or sale of any security’ intended only that the device
employed, whatever it might be, be of a sort that would cause reasonable investors to rely thereon, and, in connection therewith,
so relying, cause them to purchase or sell a corporation’s securities. There is no indication that Congress intended that the
corporations or persons responsible for the issuance of a misleading statement would not violate the section unless they engaged
in related securities transactions or otherwise acted with wrongful motives; indeed, the obvious purposes of the Act to protect the
investing public and to secure fair dealing in the securities markets would be seriously undermined by applying such a gloss onto
the legislative language. Absent a securities transaction by an insider it is almost impossible to prove that a wrongful purpose
motivated the issuance of the misleading statement. The mere fact that an insider did not engage in securities transactions does
not negate the possibility of wrongful purpose; perhaps the market did not react to the misleading statement as much as was
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 655
securities applied only to brokers and dealers,’ 8 SEC Ann.Rep. 10, and the Commission wished to make it emphatically clear that
the Rule was expected, inter alia, to close this loophole. The foregoing discussion demonstrates that Congress intended to protect
the investing public in connection with their purchases or sales on Exchanges from being misled by misleading statements
promulgated for or on behalf of corporations irrespective of whether the insiders contemporaneously trade in the securities of that
corporation and irrespective of whether the corporation or its management have an ulterior purpose or purposes in making an
official public release. Indeed, the Commission has been charged by Congress with the responsibility of policing all misleading
corporate statements from those contained in an initial prospectus to those contained in a notice to stockholders relative to the
need or desirability of terminating the existence of a corporation or of merging it with another. To render the Congressional purpose
ineffective by inserting into the statutory words the need of proving, not only that the public may have been misled by the release,
but also that those responsible were actuated by a wrongful purpose when they issued the release, is to handicap unreasonably
the Commission in its work. We should have in mind the wise words of Judge Learned Hand in Cawley v. United States, 272 F.2d
443, 445 (2 Cir. 1959), relative to an interpretation of the words contained within a congressional statute, that “* * * unless they
explicitly forbid it, the purpose of a statutory provision is the best test of the meaning of the words chosen. We are to put ourselves
so far as we can in the position of the legislature that uttered them, and decide whether or not it would declare that the situation
that has arisen is within what it wishes to cover. Indeed, at times the purpose may be so manifest as to override even the explicit
More important, however, is the realization which we must again underscore at the risk of repetition, that the investing public is hurt
by exposure to false or deceptive statements irrespective of the purpose underlying their issuance. (FN27) It does not appear to be
unfair to impose upon corporate management a duty to ascertain the truth of any statements the corporation releases to its
shareholders or to the investing public at large. Accordingly, we hold that Rule 10b-5 is violated whenever assertions are made, as
here, in a manner reasonably calculated to influence the investing public, e.g., by means of the financial media, Fleischer, supra,
51 Va.L.Rev. at 1294-95, if such assertions are false or misleading or are so incomplete as to mislead irrespective of whether the
issuance of the release was motivated by corporate officials for ulterior purposes. It seems clear, however, that if corporate
656 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
management demonstrates that it was diligent in ascertaining that the information it published was the whole truth and that such
diligently obtained information was disseminated in good faith, Rule 10b-5 would not have been violated.
C. Did the Issuance of the April 12 Release Violate Rule 10b-5?
so it could be that the reasonable inverstor would have read between the lines of what appears to us to be an inconclusive and
negative statement and would have envisioned the actual situation at the Kidd segment on April 12. On the other hand, in view of
the decline of the market price of TGS stock from a high of 32 on the morning of April 13 when the release was disseminated to 29
3/8 by the close of trading on April 15, and the reaction to the release by other brokers, it is far from certain that the release was
generally interpreted as a highly encouraging report or even encouraging at all. 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.
In the event that it is found that the statement was misleading to the reasonable investor it will then become necessary to
determine whether its issuance resulted from a lack of due diligence. The only remedly the Commission seeks against the
corporation is an injunction, see footnote 26, supra, and therefore we do not find it necessary to decide whether just a lack of due
diligence on the part of TGS, absent a showing of bad faith, would subject the Corporation to any liability for damages. We have
recently stated in a case involving a private suit under Rule 10b-5 in which damages and an injunction were sought, “”It is not
necessary in a suit for equitable or prophylactic relief to establish all the elements required in a suit for monetary damages.” Mutual
Shares Corp. v. Genesco, Inc., 384 F.2d 540, 547, quoting from SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 193,
84 S.Ct. 275, 11 L.Ed.2d 237 (1963)
We hold only that, in an action for injunctive relief, the district court has the discretionary power under Rule 10b-5 and Section
10(b) to issue an injunction, if the misleading statement resulted from a lack of due diligence on the part of TGS. The trial court did
not find it necessary to decide whether TGS exercised such diligence and has not yet attempted to resolve this issue. While the
trial court concluded that TGS had exercised “reasonable business judgment under the circumstances,’ 258 F.Supp. at 296 it
applied an incorrect legal standard in appraising whether TGS should have issued its April 12 release on the basis of the facts
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 657
In summary, therefore, we affirm the finding of the court below that appellants Richard H. Clayton and David M. Crawford have
violated 15 U.S.C. 78j(b) and Rule 10b-5; we reverse the judgment order entered below dismissing the complaint against appellees
Charles F. Fogarty, Richard H. Clayton, Richard D. Mollison, Walter Holyk, Kenneth H. Darke, Earl L. Huntington, and Francis G.
Coates, as we find that they have violated 15 U.S.C. 78j(b) and Rule 10b-5. As to these eight individuals we remand so that in
accordance with the agreement between the parties the Commission may notice a hearing before the court below to determine the
remedies to be applied against them. We reverse the judgment order dismissing the complaint against Claude O. Stephens,
Charles F. Fogarty, and Harold B. Kline as recipients of stock options, direct the district court to consider in its discretion whether to
issue injunction orders against Stephens and Fogarty, and direct that an order issue rescinding the option granted Kline and that
such further remedy be applied against him as may be proper by way of an order of restitution; and we reverse the judgment
dismissing the complaint against Texas Gulf Sulphur Company, remand the cause as to it for a further determination below, in the
light of the approach explicated by us in the foregoing opinion, as to whether, in the exercise of its discretion, the injunction against
it which the Commission seeks should be ordered.
1. Pursuant to a stipulation by all parties, the question of the appropriate remedies to be applied was deferred pending a final
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.
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.
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 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–
8. 15 U.S.C. 78j reads in pertinent part as follows:
78j. Manipulative and deceptive devices
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.R.Rep.No. 1383, 73rd Cong., 2d Sess. 13 (1934);
S.Rep.No. 792, 73rd Cong., 2d Sess. 9 (1934); S.E.C., Tenth Annual Report 50 (1944). See Cady, Roberts, supra at 912.
10. The House of Representatives committee that reported out the bill which eventually became the Act did so with the observation