Diamond v. Oreamuno

New York Court of Appeals · 1969 · Corporations

CorporationsFiduciary dutyDerivative actionsInside informationcorporate fiduciariesinside informationsecret profitsderivative suit

Facts

A shareholder of Management Assistance, Inc. alleged that MAI's chairman, Oreamuno, and president, Gonzalez, learned through their corporate positions that MAI's August 1966 earnings had sharply declined because IBM had increased service charges. Before that information was publicly disclosed in October 1966, they sold a total of 56,500 shares of MAI stock at $28 per share. After the earnings drop became public, the stock price fell to $11 per share. The complaint alleged that by using confidential inside information unavailable to others, they realized about $800,000 more than they otherwise would have and that those profits belonged to the corporation.

Issue

May corporate officers and directors be held accountable to their corporation, in a shareholder derivative action, for profits realized from selling the corporation's stock on the basis of material inside information acquired solely by virtue of their positions, even when the complaint does not allege direct damage to the corporation?

Rule

A fiduciary who acquires confidential or special information by virtue of a fiduciary relationship may not exploit that information for personal gain and must account to the principal for profits derived from it. Applied to corporations, officers and directors entrusted with material inside information may be required to disgorge to the corporation profits obtained by using that information in stock transactions, and a complaint stating such misuse is sufficient even without alleging specific corporate damages.

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Blue Mesa Robotics, Inc., a New York corporation based in Buffalo, discovers internally that a major product recall will erase most of its quarterly earnings. Before any public announcement, its chief executive, Lena Morris, sells 40,000 shares she owns and avoids a steep market decline. A shareholder in Rochester files a derivative suit seeking Lena's trading profits for the corporation but does not allege any direct monetary loss to Blue Mesa.

Under the governing rule, is the complaint most likely sufficient to survive a motion to dismiss?

Explanation. The majority held that officers and directors who exploit material inside information acquired solely through their fiduciary positions for personal profit may be compelled in a derivative action to disgorge those profits to the corporation. A specific allegation of direct monetary damage to the corporation is not essential to state the claim, because the action serves deterrence and prevents unjust enrichment as well as compensation.