PRIVATE INFORMATION, whether of distant public events,impending business developments, or even the health of politicalfigures, has always been a valuable commodity to traders insecurities—so valuable that some commentators have suggestedthat stock exchanges are markets for such information just asmuch as for stocks. The money value that a market puts oninformation is often precisely measurable in terms of the changein stock prices that it brings about, and the information isalmost as readily convertible into money as any othercommodity; indeed, to the extent that it is used for barterbetween traders, it is a kind of money. Moreover, until quiterecently, the propriety of the use of inside dope for their ownenrichment by those fortunate enough to possess it went largelyunquestioned. Nathan Rothschild’s judicious use of advancenews of Wellington’s victory at Waterloo was the chief basis ofthe Rothschild fortune in England, and no Royal commission orenraged public rose to protest; similarly, and almostsimultaneously, on this side of the Atlantic John Jacob Astormade an unchallenged bundle on advance news of the Ghenttreaty ending the War of 1812. In the post-Civil War era in theUnited States the members of the investing public, such as itwas, still docilely accepted the right of the insider to trade onhis privileged knowledge, and were content to pick up anycrumbs that he might drop along the way. (Daniel Drew, avintage insider, cruelly denied them even this consolation bydropping poisoned crumbs in the form of misleadingmemoranda as to his investment plans, which he wouldelaborately strew in public places.) Most nineteenth-centuryAmerican fortunes were enlarged by, if they were not actuallyfounded on, the practice of insider trading, and just howdifferent our present social and economic order would be ifsuch trading had been effectively forbidden in those daysprovides a subject for fascinating, if bootless, speculation. Notuntil 1910 did anyone publicly question the morality ofcorporate officers, directors, and employees trading in theshares of their own companies, not until the nineteen twentiesdid it come to be widely thought of as outrageous that suchpersons should be permitted to play the market game withwhat amounts to a stacked deck, and not until 1934 didCongress pass legislation intended to restore equity. Thelegislation, the Securities Exchange Act, requires corporateinsiders to forfeit to their corporations any profits they mayrealize on short-term trades in their own firms’ stock, andprovides further, in a section that was implemented in 1942 bya rule designated as 10B-5, that no stock trader may use anyscheme to defraud or “make any untrue statement of amaterial fact or … omit to state a material fact.”
Since omitting to state material facts is the essence of usinginside information, the law—while it does not forbid insiders tobuy their own stock, nor to keep the profits provided they holdonto the stock more than six months—would seem to outlawthe stacked deck. In practice, though, until very recently the1942 rule was treated almost as if it didn’t exist; it wasinvoked by the Securities and Exchange Commission, the federalenforcement body set up under the Securities Exchange Act,only rarely and in cases so flagrant as to be probablyprosecutable even without it, under common law. And therewere apparent reasons for this laxity. For one thing, it hasbeen widely argued that the privilege of cashing in on theircorporate secrets is a necessary incentive to business executivesto goad them to their best efforts, and it is coolly contendedby a few authorities that the uninhibited presence of insiders inthe market, however offensive to the spirit of fair play, isessential to a smooth, orderly flow of trading. Moreover, it iscontended that the majority of all stock traders, whether or notthey are technically insiders, possess and conceal insideinformation of one sort or another, or at least hope andbelieve that they do, and that therefore an even-handedapplication of Rule 10B-5 would result in nothing less thanchaos on Wall Street. So in letting the rule rest largelyuntroubled in the rulebook for twenty years, the S.E.C. seemedto be consciously refraining from hitting Wall Street in one ofits most vulnerable spots. But then, after a couple ofpreliminary jabs, it went for the spot with a vengeance. Thelawsuit in which it did so was a civil complaint against theTexas Gulf Sulphur Company and thirteen men who weredirectors or employees of that company; it was tried without ajury in the United States District Court in Foley Square onMay 9th through June 21st, 1966, and as the presiding judge,Dudley J. Bonsal, remarked mildly at one point during the trial,“I guess we all agree that we are plowing new ground here tosome extent.” Plowing, and perhaps sowing too; Henry G.
Manne, in a recent book entitled “Insider Trading and theStock Market,” says that the case presents in almost classicterms the whole problem of insider trading, and expresses theopinion that its resolution “may determine the law in this fieldfor many years to come.”
THE events that led to the S.E.C.’s action began in March,1959, when Texas Gulf, a New York City-based company thatwas the world’s leading producer of sulphur, began conductingaerial geophysical surveys over the Canadian Shield, a vast,barren, forbidding area of eastern Canada that in the distantbut not forgotten past had proved to be a fertile source ofgold. What the Texas Gulf airmen were looking for was neithersulphur nor gold. Rather, it was sulphides—deposits of sulphuroccurring in chemical combination with other useful minerals,such as zinc and copper. What they had in mind wasdiscovering mineable veins of such minerals so that Texas Gulfcould diversify its activities and be less dependent upon sulphur,the market price of which had been slipping. From time totime during the two years that the surveys went onintermittently, the geophysical instruments in the scanning planeswould behave strangely, their needles jiggling in such a way asto indicate the presence of electrically conductive material in theearth. The areas where such things happened, called“anomalies” by geophysicists, were duly logged and mapped bythe surveyors. All told, several thousand anomalies were found.
It’s a long way from an anomaly to a workable mine, as mustbe evident to anyone who knows that while most sulphides areelectrically conductive, so are many other things, includinggraphite, the worthless pyrites called fool’s gold, and evenwater; nevertheless, several hundred of the anomalies that theTexas Gulf men had found were considered to be worthy ofground investigation, and among the most promising-looking ofall was one situated at a place designated on their maps as theKidd-55 segment—one square mile of muskeg marsh, lightlywooded and almost devoid of outcropping rocks, about fifteenmiles north of Timmins, Ontario, an old gold-mining town thatis itself some three hundred and fifty miles northwest ofToronto. Since Kidd-55 was privately owned, the company’s firstproblem was to get title to it, or to enough of it to makepossible exploratory ground operations; for a large company toacquire land in an area where it is known to be engaged inmining exploration obviously involves delicacy in the extreme,and it was not until June, 1963, that Texas Gulf was able toget an option permitting it to drill on the northeast quartersection of Kidd-55. On October 29th and 30th of that year aTexas Gulf engineer, Richard H. Clayton, conducted a groundelectromagnetic survey of the northeast quarter, and wassatisfied with what he found. A drill rig was moved to the site,and on November 8th, the first test drill hole was begun.
There followed a thrilling, if uncomfortable, several days atKidd-55. The man in charge of the drilling crew was a youngTexas Gulf geologist named Kenneth Darke, a cigar smokerwith a rakish gleam in his eye, who looked a good deal morelike the traditional notion of a mining prospector than that ofthe organization man he was. For three days the drilling wenton, bringing out of the earth a cylindrical core of material aninch and a quarter in diameter, which served as the first actualsample of what the rock under Kidd-55 contained. As the corecame up, Darke studied it critically, inch by inch and foot byfoot, using no instruments but only his eyes and his knowledgeof what various mineral deposits look like in their natural state.
On the evening of Sunday, November 10th, by which time thedrill was down one hundred and fifty feet, Darke telephonedhis immediate superior, Walter Holyk, Texas Gulf’s chiefgeologist, at his home in Stamford, Conn. to report on hisfindings so far. (He made the call from Timmins, since therewas no telephone at the Kidd-55 drill site.) Darke, Holyk hassince said, was “excited.” And so, apparently, was Holyk afterhe had heard what Darke had to say, because he immediatelyset in motion quite a corporate flap for a Sunday night. Thatsame evening, Holyk called his superior, Richard D. Mollison, aTexas Gulf vice president who lived near Holyk in Greenwich,and—still the same evening—Mollison called his boss, Charles F.
Fogarty, executive vice president and the company’s No. 2man, in nearby Rye, to pass Darke’s report on up the line.
Further reports were made the next day through the samelabyrinth of command—Darke to Holyk to Mollison to Fogarty.
As a result of them, Holyk, Mollison, and Fogarty all decided togo to Kidd-55 to see for themselves.
Holyk got there first; he arrived at Timmins on November12th, checked in at the Bon Air Motel, and got out to Kidd-55by jeep and muskeg tractor in time to see the completion ofthe drill hole and to help Darke visually estimate and log thecore. By this time the weather, which had hitherto beenpassable for Timmins in mid-November, had turned nasty. Infact, it was “quite inclement,” Holyk, a Canadian in his fortieswith a doctorate in geology from Massachusetts Institute ofTechnology, has since said. “It was cold, windy, threateningsnow and rain, and … we were much more concerned withpersonal comfort than we were with the details of the corehole. Ken Darke was writing, and I was looking at the core,trying to make estimates of the mineral content.” To add to thedifficulty of working outdoors under such conditions, some ofthe core had come out of the ground covered with dirt andgrease, and had to be washed with gasoline before its contentscould even be guessed at. Despite all difficulties, Holyksucceeded in making an appraisal of the core that was, to saythe least, startling. Over the six hundred or so feet of its finallength, he estimated, there appeared to be an average coppercontent of 1.15% and an average zinc content of 8.64%. ACanadian stockbroker with special knowledge of the miningindustry was to say later that a drill core of such length andsuch mineral content “is just beyond your wildest imagination.”
TEXAS Gulf didn’t have a surefire mine yet; there was alwaysthe possibility that the mineral vein was a long, thin one, toolimited to be commercially exploitable, and that by a fantasticchance the drill had happened to go “down dip”—that is,straight into the vein like a sword into a sheath. What wasneeded was a pattern of several drill holes, beginning atdifferent spots on the surface and entering the earth atdifferent angles, to establish the shape and limits of the deposit.
And such a pattern could not be made until Texas Gulf hadtitle to the other three quarter-segments of Kidd-55. Getting titlewould take time if it were possible at all, but meanwhile, therewere several steps that the company could and did take. Thedrill rig was moved away from the site of the test hole. Cutsaplings were stuck in the ground around the hole, to restorethe appearance of the place to a semblance of its natural state.
A second test hole was drilled, as ostentatiously as possible,some distance away, at a place where a barren core wasexpected—and found. All of these camouflage measures, whichwere in conformity with long-established practice among minerswho suspect that they have made a strike, were supplementedby an order from Texas Gulf’s president, Claude O. Stephens,that no one outside the actual exploration group, even withinthe company, should be told what had been found. Late inNovember, the core was shipped off, in sections, to the unionAssay Office in Salt Lake City for scientific analysis of itscontents. And meanwhile, of course, Texas Gulf began discreetlyputting out feelers for the purchase of the rest of Kidd-55.
And meanwhile other measures, which may or may not havebeen related to the events north of Timmins, were being taken.
On November 12th, Fogarty bought three hundred shares ofTexas Gulf stock; on the 15th he added seven hundred moreshares, on November 19th five hundred more, and onNovember 26th two hundred more. Clayton bought twohundred on the 15th, Mollison one hundred on the same day;and Mrs. Holyk bought fifty on the 29th and one hundredmore on December 10th. But these purchases, as things turnedout, were only the harbingers of a period of apparently intenseaffection for Texas Gulf stock among certain of its officers andemployees, and even some of their friends. In mid-December,the report on the core came back from Salt Lake City, and itshowed that Holyk’s rough-and-ready estimate had beenamazingly accurate; the copper and zinc contents were foundto be almost exactly what he had said, and there were 3.94ounces of silver per ton thrown in as a sort of bonus. Late inDecember, Darke made a trip to Washington, D.C. and vicinity,where he recommended Texas Gulf stock to a girl he knewthere and her mother; these two, who came to be designatedin the trial as the “tippees,” subsequently passed along therecommendation to two other persons who, logically enough,thereby became the “sub-tippees.” Between December 30th andthe following February 17th, Darke’s tippees and sub-tippeespurchased all told 2,100 shares of Texas Gulf stock, and inaddition they purchased what are known in the brokeragetrade as “calls” on 1,500 additional shares. A call is an optionto buy a stated amount of a certain stock at a fixedprice—generally near the current market price—at any timeduring a stated period. Calls on most listed stocks are alwayson sale by dealers who specialize in them. The purchaser paysa generally rather moderate sum for his option; if the stockthen goes up during the stated period, the rise can easily beconverted into almost pure profit for him, while if the stockstays put or goes down, he simply tears up his call the way ahorseplayer tears up a losing ticket, and loses nothing but thecost of the call. Therefore calls provide the cheapest possibleway of gambling on the stock market, and the most convenientway of converting inside information into cash.
Back in Timmins, Darke, put temporarily out of business as ageologist by the winter freeze and the land-ownership problemat Kidd-55, seems to have managed to keep time from hangingheavy on his hands. In January, he entered into a privatepartnership with another Timmins man who wasn’t a TexasGulf employee to stake and claim Crown lands around Timminsfor their own benefit. In February, he told Holyk of a barroomconversation that had occurred in Timmins one gelid winterevening, in which an acquaintance of his had let fall that he’dheard rumors of a Texas Gulf strike nearby and was thereforegoing to stake a few claims of his own. Horrified, Holyk, as herecalled later, told Darke to reverse the previous policy ofavoiding Kidd-55 like the plague, and to “go right into the …area and stake all the claims we need;” also to “steer awaythis acquaintance. Give him a helicopter ride or anything, justget him out of the way.” Darke presumably complied with thisorder. Moreover, during the first three months of 1964 hebought three hundred shares of Texas Gulf outright, boughtcalls on three thousand more shares, and added several morepersons, one of them his brother, to his growing list of tippees.
Holyk and Clayton were somewhat less financially active duringthe same period, but they did add substantially to their TexasGulf holdings—in the case of Holyk and his wife, particularlythrough the use of calls, which they’d scarcely even heard ofbefore, but which were getting to be quite the rage in TexasGulf circles.
Signs of spring began to come at last, and with them came atriumphant conclusion to the company’s land acquisitionprogram. By March 27th, Texas Gulf had pretty much what itneeded; that is, it had either clear title or mineral rights to thethree remaining segments of Kidd-55, except for ten-per-centprofit concessions on two of the segments, the stubborn ownerof the concession in one case being the Curtis PublishingCompany. After a final burst of purchases by Darke, histippees, and his sub-tippees on March 30th and 31st (amongthem all, six hundred shares and calls on 5,100 more sharesfor the two days), drilling was resumed in the still-frozenmuskeg at Kidd-55, with Holyk and Darke both on the site thistime. The new hole—the third in all, but only the secondoperational one, since one of the two drilled in November hadbeen the dummy intended to create a diversion—was begun ata point some distance from the first and at an oblique angle toit, to advance the bracketing process. Observing and logging thecore as it came out of the ground, Holyk found that he couldscarcely hold a pencil because of the cold; but he must havebeen warmed inwardly by the fact that promising mineralizationbegan to appear after the first hundred feet. He made his firstprogress report to Fogarty by telephone on April 1st. Now agruelling daily routine was adopted at Timmins and Kidd-55.
The actual drilling crew stayed at the site continuously, whilethe geologists, in order to keep their superiors in New Yorkposted, had to make frequent trips to telephones in Timmins,and what with the seven-foot snowdrifts along the way thefifteen-mile trek between the town and the drilling campcustomarily took three and a half to four hours. One afteranother, new drill holes, begun at different places around theanomaly and pitched at different angles to it, were plunged intothe earth. At first, only one drill rig could be used at a timebecause of a shortage of water, which was necessary to theoperation; the ground was frozen solid and covered by deepsnow, and water had to be laboriously pumped from under theice on a pond about a half mile from Kidd-55. The third holewas finished on April 7th, and a fourth immediately begun withthe same rig; the following day, the water shortage havingeased somewhat, a fifth hole was inaugurated with a seconddrill rig, and two days after that—on the 10th—a third rig waspressed into service to drill still another hole. All in all, duringthe first days of April the principals in the affair were keptbusy; in fact, during that period their buying of calls on TexasGulf seems to have come to a standstill.
Bit by bit the drilling revealed the lineaments of a huge oredeposit; the third hole established that the original one had notgone “down dip” as had been feared, the fourth establishedthat the mineral vein was a satisfactorily deep one, and so on.
At some point—the exact point was to become a matter ofdispute—Texas Gulf came to know that it had a workable mineof considerable proportions, and as this point approached, thefocus of attention shifted from drillers and geologists to staffmen and financiers, who were to be the principal object of theS.E.C.’s disapproval later on. At Timmins, snow fell so heavilyon April 8th and most of the 9th that not even the geologistscould get from the town to Kidd-55, but toward evening on the9th, when they finally made it after a hair-raising journey ofseven and a half hours, with them was no lesser light thanVice President Mollison, who had turned up in Timmins theprevious day. Mollison spent the night at the drill site and leftat about noon the next day—in order, he explained later, toavoid the outdoorsmen’s lunch they served at Kidd-55 whichwas too hearty for a deskbound man like him. But beforegoing he issued instructions for the drilling of a mill test hole,which would produce a relatively large core that could be usedto determine the amenability of the mineral material to routinemill processing. Normally, a mill test hole is not drilled until aworkable mine is believed to exist. And so it may have been inthis case; two S.E.C. mining experts were to insist later, againstcontrary opinions of experts for the defense, that by the timeMollison gave his order, Texas Gulf had information on thebasis of which it could have calculated that the ore reserves atKidd-55 had a gross assay value of at least two hundredmillion dollars.
THE famous Canadian mining grapevine was humming by now,and in retrospect the wonder is that it had been relatively quietfor so long. (A Toronto broker was to remark during the trial,“I have seen drillers drop the goddam drill and beat it for abrokerage office as fast as they can … [or else] they pick upthe telephone and call Toronto.” After such a call, the brokerwent on, the status of every Bay Street penny-stock toutdepends, for a time, on how close a personal acquaintance hecan claim with the driller who made the strike, just as aracetrack tout’s status depends sometimes on the degree ofintimacy he can claim with a jockey or a horse.) “Themoccasin telegraph has Texas Gulf’s activity centered in KiddTownship. A battery of drills are reported to be at work,” saidThe Northern Miner, a Toronto weekly of immense influencein the mining-stock set, on the 9th, and the same day theToronto Daily Star declared that Timmins was “bug-eyed withexcitement” and that “the magic word on every street cornerand in every barber shop is ‘Texas Gulf.’” The phones inTexas Gulf’s New York headquarters were buzzing with frenziedqueries, which the officers coldly turned aside. On the 10th,President Stephens was concerned enough about the rumors toseek counsel from one of his most trusted associates—ThomasS. Lamont, senior member of the Texas Gulf board ofdirectors, former second-generation Morgan partner, holder ofvarious lofty offices, past and present, in the Morgan GuarantyTrust Company, and bearer of a name that had long been oneto conjure with in Wall Street. Stephens told Lamont what hadbeen going on north of Timmins (it was the first Lamont hadheard of it), made it clear that he himself did not yet feel thatthe evidence justified bug eyes, and asked what Lamontthought ought to be done about the exaggerated reports. Aslong as they stayed in the Canadian press, Lamont replied, “Ithink you might be able to live with them.” However, he added,if they should get into the papers in the United States, it mightbe well to give the press an announcement that would set therecord straight and avoid undue gyrations in the stock market.
The following day, Saturday the 11th, the reports reached theUnited States papers with a bang. The Times and HeraldTribune both ran accounts on the Texas Gulf discovery, andthe latter, putting its story on the front page, spoke of “thebiggest ore strike since gold was discovered more than sixtyyears ago in Canada.” After reading these stories, perhaps witheyes bugging slightly, Stephens notified Fogarty that a pressrelease should be issued in time for Monday’s papers, and overthe weekend Fogarty, with the help of several other companyofficials, worked one up. Meanwhile, things were not standingstill at Kidd-55; on the contrary, later testimony held that onSaturday and Sunday, as more and more core came up fromthe drill holes full of copper and zinc ore, the calculable valueof the mine was increasing almost hour by hour. However,Fogarty did not communicate with Timmins after Friday night,so the statement that he and his colleagues issued to the presson Sunday afternoon was not based on the mostup-to-the-minute information. Whether because of that or forsome other reason, the statement did not convey the idea thatTexas Gulf thought it had a new Comstock Lode. Characterizingthe published reports as exaggerated and unreliable, it admittedonly that recent drilling on “one property near Timmins” hadled to “preliminary indications that more drilling would berequired for proper evaluation of the prospect;” went on to saythat “the drilling done to date has not been conclusive;” andthen, putting the same thought in what can hardly be calledanother way, added that “the work done to date has not beensufficient to reach definite conclusions.”
The idea thus couched, or perhaps one should say beddeddown, evidently came across to the public when it appeared inMonday morning’s newspapers, because Texas Gulf stock wasnot nearly so buoyant early that week as it might have beenexpected to be if the enthusiastic Times and Herald Tribunestories had gone unchallenged. The stock, which had beenselling at around 17 or 18 the previous November and hadcrept up over the intervening months to around 30, openedMonday on the New York Stock Exchange at 32—a rise ofnearly two points over Friday’s closing—only to reverse directionand sink to 30? before the day’s trading, was over, and toslip off still further on the following two days and at one pointon Wednesday touch a low of 28?. Evidently, investors andtraders had been considerably impressed by Texas Gulf’sSunday mood of deprecation. But on those same three days,Texas Gulf people in both Canada and New York seem tohave been in quite another mood. At Kidd-55 on Monday the13th, the day the low-keyed press release was reported innewspapers, the mill test hole was completed, drills continued togrind away on three regular test holes, and a reporter for TheNorthern Miner was shown around and briefed on thefindings by Mollison, Holyk, and Darke. The things they toldthe reporter make it clear, in retrospect, that whatever thedrafters of the release may have believed on Sunday, the menat Kidd-55 knew on Monday that they had a mine and a bigone. However, the world was not to know it, or at least notfrom that source, until Thursday morning, when the next issueof the Miner would appear in subscribers’ mail and onnewsstands.
Tuesday evening, Mollison and Holyk flew to Montreal, wherethey were planning to attend the annual convention of theCanadian Institute of Mining and Metallurgy, a gathering ofseveral hundred leading mining and investment people. Uponarriving at the Queen Elizabeth Hotel where the convention wasin progress, Mollison and Holyk were startled to find themselvesgreeted like film stars. The place had evidently been hummingall day with rumors of a Texas Gulf discovery and everyonewanted to be the first to get the firsthand lowdown on it; infact, a battery of television cameras had been set up for theexpress purpose of covering such remarks as the emissariesfrom Timmins might want to make. Not being authorized tomake any remarks, Mollison and Holyk turned abruptly ontheir heels and fled the Queen Elizabeth, holing up for thenight in a Montreal airport motel. The following day,Wednesday the 15th, they flew from Montreal to Toronto in thecompany, by prearrangement, of the Minister of Mines of theProvince of Ontario and his deputy; en route they briefed theminister on the Kidd-55 situation, whereupon the ministerdeclared that he wanted to clear the air by making a publicannouncement on the matter as soon as possible, and then,with Mollison’s help, he drafted such an announcement.
According to a copy that Mollison made and kept, theannouncement stated, in part, that “the information now inhand … gives the company confidence to allow me toannounce that Texas Gulf Sulphur has a mineable body of zinc,copper, and silver ore of substantial dimensions that will bedeveloped and brought to production as soon as possible.”
Mollison and Holyk were given to believe that the ministerwould make his statement in Toronto at eleven o’clock thatevening, over radio and television, and that thus Texas Gulf’sgood news would become public property a few hours beforeThe Northern Miner appeared early the next day. But forreasons that have never been given, the minister didn’t makethe announcement that evening.
At Texas Gulf headquarters, at 200 Park Avenue, there was asimilar air of mounting crisis. The company happened to havea regular monthly board-of-directors meeting scheduled forThursday morning, and on Monday Francis G. Coates, adirector who lived in Houston, Texas, and who hadn’t heard ofthe Kidd-55 strike, telephoned Stephens to inquire whether heought to bother to come. Stephens said he ought, but didn’texplain why. Better and better news kept filtering in from thedrill site, and some time on Wednesday, the Texas Gulf officersdecided that it was time to write a new press release, to beissued at a press conference that would follow theThursday-morning directors’ meeting. Stephens, Fogarty, andDavid M. Crawford, the company’s secretary, composed therelease that afternoon. This time around, the release was basedon the very latest information, and moreover, its language washappily devoid of both repetition and equivocation. It read, inpart, “Texas Gulf Sulphur Company has made a major strikeof zinc, copper, and silver in the Timmins area … Seven drillholes are now essentially complete and indicate an ore body ofat least 800 feet in length, 300 feet in width, and having avertical depth of more than 800 feet. This is a majordiscovery. The preliminary data indicate a reserve of more than25 million tons of ore.” As to the striking difference betweenthis release and the one of three days earlier, the new onestated that “considerably more data has been accumulated” inthe interim. And no one could deny this; a reserve of morethan twenty-five million tons of ore meant that the value of theore was not the two hundred million dollars that was alleged tohave been calculable a week earlier, but many times that much.
In the course of the same hectic day in New York, theengineer Clayton and the company secretary Crawford foundtime to call their brokers and order themselves some TexasGulf stock—two hundred shares in Clayton’s case, threehundred in Crawford’s. And Crawford soon decided that hehadn’t plunged deeply enough; shortly after eight o’clock thenext morning, after an apparently preoccupied night at the ParkLane Hotel, he awakened his broker with a second call anddoubled his order.
ON Thursday morning, the first hard news of the Timminsstrike spread through the North American investment world,rapidly but erratically. Between seven and eight o’clock, mailmenand newsstands in Toronto began distributing copies of TheNorthern-Miner containing the piece by the reporter who hadvisited Kidd55, in which he described the strike with a gooddeal of mining jargon but did not omit to call it, in languagecomprehensible enough for anyone, “a brilliant explorationsuccess” and “a major new zinc-copper-silver mine.” At aboutthe same time, the Miner was on its way out to subscriberssouth of the border in Detroit and Buffalo, and a few hundrednewsstand copies appear to have arrived in New York betweennine and ten o’clock. The paper’s physical appearance here,however, was preceded by telephone reports on its contentsfrom Toronto, and by about 9:15 the news that Texas Gulfhad hit it big for sure was the talk of New York brokerageoffices. A customer’s man in the Sixtieth Street office of E. F.
Hutton & Company complained later that his broker cronieshad been so eager to natter on the telephone about Texas Gulfearly that morning as to substantially prevent him fromcommunicating with his customers; however, he did manage tosqueeze in a call to two of them, a husband and wife forwhom he was able to turn a rather quick profit in TexasGulf—to be exact, a profit of $10,500 in less than an hour. (“Itis clear that we are all in the wrong business,” Judge Bonsalwas to comment when he heard this. Or as the late WielandWagner once remarked in another context, “I shall be quiteexplicit. Valhalla is Wall Street.”) At the Stock Exchange itselfearly that day, the traders in the Luncheon Club, which beforethe ten-o’clock opening serves as a breakfast club, were allmunching on the Texas Gulf situation along with their toast andeggs.
At the directors’ meeting at 200 Park, which began promptlyat nine, the directors were shown the new statement that wasshortly to be released to the press, and Stephens, Fogarty,Holyk, and Mollison, as representatives of the exploration group,commented in turn on the Timmins discovery. Stephens alsostated that the Ontario Minister of Mines had announced itpublicly in Toronto the previous evening (a misstatement, ofcourse, although an unintentional one; actually, the minister wasmaking his announcement to the Ontario Parliament pressgallery in Toronto at almost the same moment Stephens wasspeaking). The directors’ meeting ended at about ten o’clock,whereupon a clutch of reporters—twenty-two of them,representing many of the major United States newspapers andmagazines, general and financial—trooped into the board roomfor the press conference, the Texas Gulf directors all remainingin their places. Stephens distributed copies of the press releaseto the reporters and then, in fulfillment of a curious ritual thatgoverns such affairs, read it aloud. While he was engaged inthis redundant recital various reporters began to drift away(“they began sort of leaking out of the room” was the wayLamont put it later) to telephone the sensational news to theirpublications; still more of them slipped away during the eventsthat subsequently rounded out the press conference—theshowing of some innocuous colored slides of the countrysidearound Timmins, and an exhibition and explanation by Holyk ofsome drill cores—and by the time it ended, at around 10:15,only a handful of reporters were left. This certainly didn’t meanthat the affair had been a flop. On the contrary, a pressconference is perhaps the only kind of show whose success isin direct proportion to the number of people who leave beforeit is over.
The actions of two of the Texas Gulf directors, Coates andLamont, during the next half hour or so were to give rise tothe most controversial part of the S.E.C.’s complaint, and, sincethe controversy has now been inscribed in the law, thoseactions are likely to be studied for at least a generation byinside stock traders seeking guidance as to what they must doto be saved, or at least to avoid being damned. The essence ofthe controversy was timing, and in particular, the timing ofCoates’ and Lamont’s maneuvers in relation to that of thedissemination of the Texas Gulf news by the Dow Jones NewsService, the familiar spot-news facility for investors. Fewinvestment offices in the United States are without the service,and its prestige is such that in some investment circles themoment a piece of news becomes public is considered to bedetermined by the moment it crosses the broad tape. As to themorning of April 16th, 1964, a Dow Jones reporter was notonly among those at the Texas Gulf press conference but wasamong those who left early to telephone the news to his office.
According to his recollection, the reporter made his call between10:10 and 10:15, and normally an item of such importance asthe one he sent would begin to be printed out by Dow Jonesmachines in offices from coast to coast within two or threeminutes after being telephoned in. In fact, though, the TexasGulf story did not begin to appear until 10:54, an entirelyinexplicable forty-odd minutes later. The mystery of the broadtape message, like the mystery of the Minister of Mines’
announcement, was left unraveled in the trial on grounds ofirrelevance; an engaging aspect of the rules of evidence is theirtendency to leave a few things to the imagination.
Coates, the Texan, was the first director to embark upon whathe can hardly have thought of at the time as a historicallysignificant course. Either before or immediately after the end ofthe press conference he went into an office adjoining the boardroom, where he borrowed a telephone and called hisson-in-law, H. Fred Haemisegger, who is a stockbroker inHouston. Coates, as he related later, told Haemisegger of theTexas Gulf discovery and added that he had waited to call until“after the public announcement” because he was “too old toget into trouble with the S.E.C.” He then placed an order fortwo thousand shares of Texas Gulf stock for four family trustsof which he was a trustee, though not personally a beneficiary.
The stock, which had opened on the Stock Exchange sometwenty minutes earlier at a fraction above 30 in very active butby no means decisively bullish trading, was now rapidly on itsway up, but by acting quickly Haemisegger managed to buythe block for Coates at between 31 and 31?, getting his ordersin to his firm’s floor broker well before the unaccountablydelayed news began to come out on the broad tape.
Lamont, in the Wall Street tradition of plungers rather thanthe Texas one, made his move with decision but with anelegant, almost languorous lack of hurry. Instead of leaving theboard room at the conclusion of the press conference, hestayed there for some twenty minutes, not doing much ofanything. “I milled around … and listened to some of themchatter and talk with each other, and slapped people on theback,” he recounted later. Then, at 10:39 or 10:40, he went toa nearby office and telephoned a colleague and friend of his atthe Morgan Guaranty Trust Company—Longstreet Hinton, thebank’s executive vice president and the head of its trustdepartment. Earlier in the week Hinton had asked Lamont ifhe, as a Texas Gulf director, could shed any light on therumors of an ore discovery that were appearing in the press,and Lamont had replied that he couldn’t. Now Lamont, as herecalled later, told Hinton “that there was news which hadcome out, or was shortly coming out, on the ticker, whichwould be of interest to him, regarding Texas Gulf Sulphur.” “Isit good?” Hinton asked, and Lamont replied that it was “prettygood” or “very good.” (Neither man is sure which he said, butit doesn’t matter, since in New York bankerese “pretty good”
means “very good.”) In any case, Hinton did not follow theadvice to look at the Dow Jones ticker, even though a machinewas ticking twenty feet from his office; instead, he immediatelycalled the bank’s trading department and asked for a marketquotation on Texas Gulf. After getting it, he placed an order tobuy 3,000 shares for the account of the Nassau Hospital, ofwhich he was treasurer. All this occupied no more than twominutes from the time Lamont had left the press conference.
The order had been transmitted from the bank to the StockExchange and executed, and Nassau Hospital had its stock,before Hinton would have seen anything about Texas Gulf onthe broad tape if he had been looking at it. But he was notlooking at it; he was otherwise occupied. After placing theNassau Hospital order, he went to the office of the MorganGuaranty officer in charge of pension trusts and suggested thathe buy some Texas Gulf for the trusts. In a matter of lessthan a half an hour, the bank had ordered 7,000 shares forits pension fund and profit-sharing account—two thousand ofthem before the announcement had begun to appear on thebroad tape, and the rest either while it was appearing or withina few minutes afterward. A bit more than an hour afterthat—at 12:33 p.m.—Lamont bought 3,000 shares for himselfand members of his family, this time having to pay 34? forthem, since Texas Gulf by that time was on its way up for fair.
As it was to continue to be for days, months, and years. Itclosed that afternoon at 36?, it reached a high of 58? laterthat month, and by the end of 1966, when commercialproduction of ore was at last under way at Kidd-55 and theenormous new mine was expected to account for one-tenth ofCanada’s total annual production of copper and one-quarter ofits total annual production of zinc, the stock was selling at over100. Anyone who had bought Texas Gulf between November12th, 1963 and the morning (or even the lunch hour) of April16th, 1964 had therefore at least tripled his money.
PERHAPS the most arresting aspect of the Texas Gulf trial—apartfrom the fact that a trial was taking place at all—was thevividness and variety of the defendants who came before JudgeBonsal, ranging as they did from a hot-eyed mining prospectorlike Clayton (a genuine Welchman with a degree in mining fromthe University of Cardiff) through vigorous and harriedcorporate nabobs like Fogarty and Stephens to a Texaswheeler-dealer like Coates and a polished Brahmin of financelike Lamont. (Darke, who had left Texas Gulf’s employ soonafter April, 1964 to become a private investor—which may ormay not indicate that he had become a man of independentmeans—declined to appear at the trial on the ground that hisCanadian nationality put him beyond the reach of subpoena bya United States court, and the S.E.C. grieved loudly over thisrefusal; defense counsel, however, scornfully insisted that theS.E.C. was really delighted to have Darke absent, thus allowingplaintiff to paint him as Mephistopheles hiding in the wings.)The S.E.C, after its counsel, Frank E. Kennamer Jr., hadannounced his intention to “drag to light and pillory themisconduct of these defendants,” asked the court to issue apermanent injunction forbidding Fogarty, Mollison, Clayton,Holyk, Darke, Crawford, and several other corporate insiderswho had bought stock or calls between November 8th, 1963and April 15th, 1964, from ever again “engaging in any act …which operates or would operate as a fraud or deceit uponany person in connection with purchase or sale of securities”;further—and here it was breaking entirely new ground—itprayed that the Court order the defendants to make restitutionto the persons they had allegedly defrauded by buying stock orcalls from them on the basis of inside information. The S.E.C.
also charged that the pessimistic April 12th press release wasdeliberately deceptive, and asked that because of it Texas Gulfbe enjoined from “making any untrue statement of material factor omitting to state a material fact.” Apart from any question ofloss of corporate face, the nub of the matter here lay in thefact that such a judgment, if granted, might well open the wayfor legal action against the company by any stockholder whohad sold his Texas Gulf stock to anybody in the interimbetween the first press release and the second one, and sincethe shares that had changed hands during that period had runinto the millions, it was a nub indeed.
Apart from legal technicalities, counsel based its defense of theearly insider stock purchases chiefly on the argument that theinformation yielded by the first drill hole in November hadmade the prospect of a workable mine not a sure thing butonly a sporting proposition, and to buttress this argument, itparaded before the judge a platoon of mining experts whotestified as to the notorious fickleness of first drill holes, someof the witnesses going so far as to say that the hole mightvery well have turned out to be not an asset but a liability toTexas Gulf. The people who had bought stock or calls duringthe winter insisted that the drill hole had had little or nothingto do with their decision—they had been motivated simply bythe feeling that Texas Gulf was a good investment at thatjuncture on general principles; and Clayton attributed his abruptappearance as a substantial investor to the fact that he hadjust married a well-to-do wife. The S.E.C. countered with itsown parade of experts, maintaining that the nature of the firstcore had been such as to make the existence of a rich minean overwhelming probability, and that therefore those privy tothe facts about it had possessed a material fact. As the S.E.C.
put it saltily in a post-trial brief, “the argument that thedefendants were free to purchase the stock until the existenceof a mine had been established beyond doubt is equivalent tosaying that there is no unfairness in betting on a horse enteredin a race, knowing that the animal has received an illegalstimulant, because in the homestretch the horse might dropdead.” Defense counsel declined to be drawn into argument onthe equine analogy. As to the pessimistic April 12th release, theS.E.C. made much of the fact that Fogarty, its chief drafter,had based it on information that was almost forty-eight hoursold when it was issued, despite the fact that communicationsbetween Kidd-55, Timmins, and New York were relatively goodat the time, and expressed the view that “the most indulgentexplanation for his strange conduct is that Dr. Fogarty simplydid not care whether he gave the shareholders of Texas Gulfand the public a discouraging statement based on staleinformation.” Brushing aside the question of staleness, thedefense asserted that the release “accurately stated the status ofthe drilling in the opinion of Stephens, Fogarty, Mollison, Holyk,and Clayton,” that “the problem presented was obviously one ofjudgment,” and that the company had been in a particularlydifficult and sensitive position in that if it had, instead, issuedan overly optimistic report that had later proved to have beenbased on false hopes, it could just as well have then beenaccused of fraud for that.
Weighing the crucial question of whether the informationobtained from the first drill hole had been “material,” JudgeBonsal concluded that the definition of materiality in suchinstances must be a conservative one. There was, he pointedout, a question of public policy involved: “It is important underour free-enterprise system that insiders, including directors,officers, and employees, be encouraged to own securities oftheir company. The incentive that comes with stock ownershipbenefits both the company and the stockholders.” Keeping hisdefinition conservative, he decided that up until the evening ofApril 9th, when three converging drill holes positively establishedthe three-dimensionality of the ore deposit, material informationhad not been in hand, and the decisions of the insiders to buyTexas Gulf stock before that date, even if based on the drillingresults, were no more than perfectly sporting, and legal,“educated guesses.” (A newspaper columnist who disagreed withthe judge’s finding was to remark that the guesses had beenso educated as to qualify for summa cum laude.) In the caseof Darke, the judge found that the spate of stock purchases byhis tippees and sub-tippees on the last days of March seemedhighly likely to have been instigated by word from Darke thatdrilling at Kidd-55 was about to be resumed; but even here,according to Judge Bonsal’s logic, material information did notyet exist and therefore could neither be acted upon nor passedalong to others.
Case was therefore dismissed against all educated guesserswho had bought stock or calls, or made recommendations totippees, before the evening of April 9th. With Clayton andCrawford, who had been so injudicious as to buy or orderstock on April 15th, it was another matter. The judge found noevidence that they had intended to deceive or defraud anyone,but they had made their purchases with the full knowledge thata great mine had been found and that it would be announcedthe next day—in short, with material private information inhand. Therefore they were found to have violated Rule 10B-5,and in due time would presumably be enjoined from doingsuch a thing again and made to offer restitution to the personsthey bought their April 15th shares from—assuming, of course,that such persons can be found, the complexities ofstock-exchange trading being such that it isn’t always an easymatter to figure out exactly whom one has been dealing withon any particular transaction. The law in our time is, andprobably ought to remain, almost unrealistically humanistic; in itseyes, corporations are people, stock exchanges are street-cornermarketplaces where buyer and seller haggle face to face, andcomputers scarcely exist.
As for the April 12th press release, the judge found it inretrospect “gloomy” and “incomplete,” but he acknowledged thatits purpose had been the worthy one of correcting theexaggerated rumors that had been appearing and decided thatthe S.E.C. had failed to prove that it was false, misleading, ordeceptive. Thus he dismissed the complaint that Texas Gulf haddeliberately tried to confuse its stockholders and the public.
UP to this point, it was two wins against a whole string oflosses for the S.E.C., and the right of a miner to drop his drilland run for a brokerage office appeared to have retained mostof its sanctity, provided at least that his drill hole is the first ofa series. But there remained to be settled the matter that, ofall those contested in the case, was of the most consequence tostockholders, stock traders, and the national economy, asopposed to the members of corporate mining explorationgroups. It was the matter of the April 16th activities of Coatesand Lamont, and its importance lay in the fact that it turnedon the question of precisely when, in the eyes of the law, apiece of information ceases to be inside and becomes public.
The question had never before been subjected to anything likeso exacting a test, so what came out of the Texas Gulf casewould instantly become the legal authority on the subject untilsuperseded by some even more refined case.
The basic position of the S.E.C. was that the stock purchasesof Coates, and the circumspect tip given by Lamont to Hintonby telephone, were illegal use of inside information because theywere accomplished before the announcement of the ore strikeon the Dow Jones broad tape—an announcement that theS.E.C.’s lawyers kept referring to as the “official” one, althoughthe Dow Jones service, much as it might like to, derives nosuch status from any authority other than custom. But theS.E.C. went further than that. Even if the two directors’
telephone calls had been made after the “official”
announcement, it contended, they would have been improperand illegal unless enough time had elapsed for the news to bethoroughly absorbed by members of the investing public notprivileged to attend the press conference or even to bewatching the broad tape at the right moment. Defense counselsaw things rather differently. In its view, far from being culpableregardless of whether or not they had acted before or after thebroad tape announcement, its clients were innocent in eithercase. In the first place, the lawyers contended, Coates andLamont had every reason to believe the news was out, sinceStephens had said during the directors’ meeting that it hadbeen released by the Ontario Minister of Mines the previousevening, and therefore Coates and Lamont acted in good faith;in the second place, counsel went on, what with the buzzing inbrokerage offices and the early-morning excitement at the StockExchange, to all intents and purposes the news really was out,via osmosis and The Northern Miner, considerably before itappeared on the ticker or before the mooted telephone callswere made. Lamont’s lawyers argued that their client hadn’tadvised Hinton to buy Texas Gulf stock, anyhow; he’d merelyadvised him to look at the broad tape, an act as innocent torecommend as to perform, and what Hinton had done thenhad been entirely on his own hook. In sum, the lawyers forthe two sides could agree on neither whether the rules hadbeen violated nor what the rules actually were; indeed, it wasone of the defense’s contentions that the S.E.C. was asking thecourt to write new rules and then apply them retroactively,while the plaintiff insisted that he was merely asking that an oldrule, 10B-5, be applied broadly, in the spirit of the Marquis ofQueensberry. Near the end of the trial Lamont’s lawyers,bearing down hard, created a courtroom sensation byintroducing a surprise exhibit, a large, elaborate map of theUnited States dotted with colored flags, some blue, some red,some green, some gold, some silver—each flag, the lawyersannounced, denoting a place where the Texas Gulf news hadbeen disseminated before Lamont had acted or it had reachedthe broad tape. On questioning, it came out that all but eightof the flags represented offices of the brokerage firm of MerrillLynch, Pierce, Fenner & Smith, on whose interoffice wire thenews had been carried at 10:29; but while this revelation ofthe highly limited scope of the dissemination may have mitigatedthe legal force of the map, it apparently did not mitigate theesthetic impression on the judge. “Isn’t that beautiful?” heexclaimed, while the S.E.C. men fumed in chagrin, and whenone of the proud defense lawyers noticed a couple of locationson the map that had been overlooked and pointed out thatthere should really be even more flags, Judge Bonsal, stillbemused, shook his head and said he was afraid that wouldn’twork, since all known colors seemed to have been usedalready.
Lamont’s fastidiousness in waiting until 12:33, almost twohours after his call to Hinton, before he bought stock forhimself and his family left the S.E.C. unimpressed—and it washere that the Commission took its most avant-garde stand andasked the judge for a decision that would forge most fearlesslyinto the legal jungles of the future. As the stand was set forthin the S.E.C. briefs, “It is the Commission’s position that evenafter corporate information has been published in the newsmedia, insiders, are still under a duty to refrain from securitiestransactions until there had elapsed a reasonable amount oftime in which the securities industry, the shareholders, and theinvesting public can evaluate the development and makeinformed investment decisions … Insiders must wait at leastuntil the information is likely to have reached the averageinvestor who follows the market and he has had someopportunity to consider it.” In the Texas Gulf case, the S.E.C.
argued, one hour and thirty-nine minutes after the start of thebroad-tape transmission was not long enough for thatevaluation, as evidenced by the fact that the enormous rise inthe price of Texas Gulf stock had hardly more than started bythat time, and therefore Lamont’s 12:33 purchases had violatedthe Securities Exchange Act. What, then, did the S.E.C. thinkwould be “a reasonable amount of time”? That would “varyfrom case to case,” the S.E.C.’s counsel Kennamer said in hissummation, according to the nature of the inside information;for example, word of a dividend cut would probably percolatethrough the dullest investor’s brain in a very short time, whilea piece of news as unusual and abstruse as Texas Gulf’s mighttake days, or even longer. It would, Kennamer said, be “anearly impossible task to formulate a rigid set of rules thatwould apply in all situations of this sort.” Therefore, in theS.E.C.’s canon, the only way an insider could find out whetherhe had waited long enough before buying his company’s stockwas by being haled into court and seeing what the judgewould decide.
Lamont’s counsel, led by S. Hazard Gillespie, went after thisstand with the same zeal, if not actually glee, that had markedits foray into cartography. First, Gillespie said, the S.E.C. hadcontended that Coates’ call to Haemisegger and Lamont’s toHinton had been wrong because they had been made beforethe broadtape announcement; then it had said that Lamont’slater stock purchase had been wrong because it had beenmade after the announcement, but not long enough after. Ifthese apparently opposite courses of action were both fraud,what was right conduct? The S.E.C. seemed to want to havethe rules made up as it went along—or, rather, to have thecourts make them up. As Gillespie put the matter moreformally, the S.E.C. was “asking the court to write … a rulejudicially and to apply it retroactively to adjudicate Mr. Lamontguilty of fraud because of conduct which he reasonably believedto be entirely proper.”
It wouldn’t stand up, Judge Bonsal agreed—and for thatmatter, neither would the S.E.C.’s contention that the time ofthe broad-tape transmission had been the time when the newshad become public. He took the narrower view that, based onlegal precedent, the controlling moment had been the one whenthe press release had been read and handed to the reporters,even though hardly any outsider—that is, hardly anybody atall—had known of it for some time afterward. Clearly troubledby the implications of this finding, Judge Bonsal added that “itmay be, as the Commission contends, that a more effective ruleshould be established to preclude insiders from acting oninformation after it has been announced but before it has beenabsorbed by the public.” But he didn’t think it was up to himto write such a rule. Nor did he think it was up to him todetermine whether or not Lamont had waited long enoughbefore placing his 12:33 order. If it were left to judges to makesuch determinations, he said, “this could only lead touncertainty. A decision in one case would not control anothercase with different facts. No insider would know whether hehad waited long enough … If a waiting period is to be fixed,this could be most appropriately done by the Commission.” Noone would bell the cat, and the complaints against Coates andLamont were dismissed.
THE S.E.C. appealed all the dismissals, and Clayton andCrawford, the only two defendants found to have violated theSecurities Exchange Act, appealed the judgments against them.
In its appeal brief the Commission painstakingly reviewed theevidence and suggested to the Circuit Court that Judge Bonsalhad erred in his interpretation of it, while the defense brief forClayton and Crawford concentrated on the possibly detrimentaleffects of the doctrine implied in the finding against them. Mightnot the doctrine mean, for example, that every security analystwho does his best to ferret out little-known facts about aparticular company, and then recommends that company’sstock to his customers as he is paid to do, could be adjudgedan insider improperly distributing tips precisely because of hisdiligence? Might it not tend to “stifle investment by corporatepersonnel and impede the flow of corporate information toinvestors”?
Perhaps so. At all events, in August, 1968, the U.S. Court ofAppeals for the Second Circuit handed down a decision whichflatly reversed Judge Bonsal’s findings on just about everyscore except the findings against Crawford and Clayton, whichwere affirmed. The Appeals Court found that the originalNovember drill hole had provided material evidence of avaluable ore deposit, and that therefore Fogarty, Mollison,Darke, Holyk, and all other insiders who had bought TexasGulf stock or calls on it during the winter were guilty ofviolations of the law; that the gloomy April 12th press releasehad been ambiguous and perhaps misleading; and that Coateshad improperly and illegally jumped the gun in placing hisorders right after the April 16th press conference. OnlyLamont—the charges against whom had been dropped followinghis death shortly after the lower court decision—and a TexasGulf office manager, John Murray, remained exonerated.
The decision was a famous victory for the S.E.C., and the firstreaction of Wall Street was to cry out that it would make forutter confusion. Pending further appeals to the Supreme Court,it would, at least, result in an interesting experiment. For thefirst time in the history of the world, the effort would have tobe made, in Wall Street, to conduct a stock market without theuse of a stacked deck.