A banker sits on a company's board and also has a place on the investment committee of his bank's trust department. Almost simultaneously he learns that the company's profits will be disappointing and that someone in his trust department wants to buy the company's stock. Should he warn the bank not to buy?
A lawyer on the board of another company finds out that the firm will soon market a profitable new product. But one of his law partners is an adviser to several estates and intends to unload the company's shares. Should the lawyer dissuade his partner?
A corporate executive lunches with his firm's president and discovers that hard times are ahead. Would he be wrong to dump his own holdings in the corporation's stock?
These are typical of the problems of capital and conscience that plague some of the nation's businessmen. The issue of conflict of interest is as old as business, yet it has never been quite so urgent or confusing. It was brought to a boil by the still continuing Texas Gulf Sulphur case, involving stock purchases by company officers who had confidential information of a Canadian mineral strike, and by last month's charge by the Securities and Exchange Commission that 14 executives and salesmen of Merrill Lynch had illegally fed "inside" information to mutual funds and other institutional investors. The two cases have inspired a run of stockholder suits and general jitters among corporate insiders. One measure of the concern is the rising cost of directors' liability insurance. Since July, rates have increased by as much as 400%.
Mistake or Stupidity. The controversy centers on corporate insiders' rights, responsibilities and restrictions-and, indeed, on just who qualifies as an insider. For years, the definition came from Section 16 of the Securities Exchange Act of 1934, which rather narrowly considers as an insider any corporate director or officer, or any stockholder with more than a 10% stock interest. Primarily, Section 16 prohibits short-swing trading—buying and selling stocks within a six-month period.
Under Manuel Cohen, the SEC's activist chairman since 1964, the insider has become a much more visible target. The key to the SEC's current approach is Rule 10b-5 of the 1934 act. A broadly worded regulation against fraud in trading, 10b-5 has been interpreted in the courts to mean that all investors must be guaranteed "equal access" to "material information" that might influence stock prices. In effect, it broadens the definition of insider to include anyone privy to information and requires him not to act on it before it becomes public knowledge.
There seems almost no limit to the situations that could fall under 10b-5. Speaking to security analysts in Atlanta last week, Philip A. Loomis Jr., the commission's general counsel, warned that if a company officer "by mistake or stupidity" leaves an analyst with a choice bit of inside information, the analyst ought to make it public as soon as possible. Companies, too, might face SEC investigation and possible lawsuits if their officers remain silent about important corporate developments.