On the Inside Track

The insider -- an officer, director or major stockholder of a corporation --is a powerful cog in the complicated machinery of business, usually privy to a company's secrets and aware of important developments before the public hears of them. Most insiders, of course, are also aware of their responsibilities and careful in their dealings, but the Securities and Exchange Commission has become increasingly concerned about possible abuses. Last week, the SEC threw a glaring light on the insider's role in a case that involved one of the hottest business developments of recent times: the announcement last spring of Texas Gulf Sulphur's rich mineral discovery near Timmins, Ont., which set off a stampede of prospecting and stock speculation.

The SEC charged that 13 Texas Gulf officers, directors and employees had deliberately kept the discovery a secret for four months while they "illegally" bought up or acquired options to buy more than 45,000 shares of the company's stock. The charges stunned Wall Street, involved a venerable banking house and brought the resignation of an Assistant Secretary of Commerce. The defendants in the case included Claude O. Stephens, the president of Texas Gulf; Charles F. Fogarty, the executive vice president; Richard D. Mollison, a vice president; two company geologists, Walter Holyk and Kenneth H. Darke; and a director, Thomas S. Lament, the former vice chairman of Morgan Guaranty Trust.

By withholding important news of the company while buying up its stock, the SEC charged in a civil law suit filed in a New York federal district court, the Texas Gulf insiders had violated the antifraud section of the Securities Exchange Act, which declares it unlawful to buy or sell securities while concealing any pertinent facts. In a departure from precedent, the SEC not only sued to have the practice stopped--its usual aim in noncriminal suits of this sort--but, for the first time, to have the stock purchases canceled and any profits returned to the previous owners.

The Chronology. As the SEC told it, the case involved camouflaged claims, secret pacts, whispered tips to friends, a "false and misleading" press release and some substantial paper fortunes. The SEC chronology: On Nov. 10, 1963, Texas Gulf geologists, headed by Kenneth Darke, were drilling on a claim near Timmins when Darke pulled out an impressive core sample of high-grade copper and zinc--so impressive that he hiked ten miles in the snow to reach his Jeep, then drove into town to call company officials. They notified President Stephens immediately, told the geologists to keep in daily touch. The company officials who got the news then swore themselves to secrecy. They had trees planted in and around the drill holes to conceal the site, moved the rig to a new location and left a worthless core on the ground to confuse any possible snoopers.

In the next few weeks, most of these Texas Gulf insiders began buying up the company's stock in hopes that the lode was as good as the core looked. By early April 1964, rumors of the strike had flitted from Timmins to Toronto to Wall Street. When the New York Times printed a story of reports of a "great deposit" found at Timmins by Texas Gulf, the company promptly slapped the report down as "without factual basis." In a press release on April 12, the company discounted the Timmins core: "Any statement as to the size and grade of ore would be premature and probably misleading."

As the rumors became more persistent, Texas Gulf officials finally decided to release the news. They did so at a board meeting in New York on April 16, first announcing the discovery to their directors, most of whom had been kept just as much in the dark as the public. After telling the directors, they called in the press at 10 a.m. and announced a "major discovery." In the hour between the disclosure to the press and the first publication of the confirmed news on the Dow-Jones wire, Lament got on the phone and called Morgan Guaranty, his old employer. Hearing the news, the bank immediately bought 8,000 shares of Texas Gulf. Lament bought no stock for himself, said that he gave the news to Morgan Guaranty because he believed it had become public with the announcement to the press.

By the time that the discovery was made public, four months after the excitement of the first core, twelve of the 13 defendants had bought 9,100 shares of Texas Gulf stock, bought options on an additional 5,200 shares, or received company stock options to buy another 31,200 shares. In that time, the price of the stock had climbed from 17 to 34; it stood at 71 when the SEC filed its lawsuit last week.

The insiders had also let in a few outsiders. Geologist Darke told a number of his friends, and at least eleven outsiders bought 12,100 shares and 14,100 options. These included Assistant Secretary of Commerce Herbert Klotz, 48, who bought 2,000 call options to buy Texas Gulf stock on a tip from a fellow employee, who was a friend of Darke's. Though Klotz was accused of no illegal conduct--"I got a stock tip pure and simple like you'd hear in a barbershop"--he submitted his resignation last week "to draw the fire away from the Administration, which I have loved working for." The resignation was immediately accepted by President Johnson. Klotz's paper profit on his Texas Gulf dealings: $14,600.

On the Trail. The SEC first got on the trail of the insiders more than a year ago, when it spotted an unusual price pattern in Texas Gulf stock. If it had not been for the difference in tone between the April 12 press release dampening speculation and the April 16 one confirming a discovery, however, the SEC might well have never pursued the case. After months of secret investigations, a six-man team under SEC Attorney Herbert Pollack nosed around for more than half a year interviewing brokers and the defendants, combing the testimony of Texas Gulf officials before a Canadian commission that was investigating the Windfall Mines bubble (TIME, Aug. 14).

The SEC even sent an engineer to inspect the claim at Timmins.

After Texas Gulf officials found out about the investigation, Stephens and Fogarty offered to turn back their stock options and reimburse the company for any profits. Stephens bought no Texas Gulf stock outright during the period in question, but he had received options on 12,800 shares from Texas Gulf.

The SEC turned the two men down.

Stephens later insisted that the insiders' dealings had been "legally and morally correct." At the Texas Gulf annual meeting in Houston last week, he announced that the company's directors had conducted their own "independent" investigation of the whole affair--and had found "no element of bad faith or overreaching."

For former Texas Gulf stockholders, the SEC action was an open invitation to join the battle. Some of them had, in fact, sniffed something wrong independently of the SEC charges. Last year stockholders filed two suits against many of the same Texas Gulf officers, demanding that they pay the company the profits from their purchases of stock; last week another former stockholder sued Texas Gulf, the 13 insiders and Morgan Guaranty Trust for $25 million in punitive damages. For Wall Street, the Texas Gulf case left nagging worries that it might produce a residue of public distrust of the stock market and the American business executive. The insider was in the spotlight as he rarely has been in recent years, and the SEC's case --which is sure to be bitterly fought --might well produce some seriously needed guidelines about his duty to his stockholders.

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