24 N.Y.2d at 497-499, 248 N.E.2d at 912-913, 301 N.Y.S.2d at 80-82
MAI is in the business of financing computer installations through sale and lease back arrangements with commercial and industrial users.1 Under its lease provisions, MAI was required to maintain and repair the computers but, at the time of this suit, it lacked the capacity to perform this function itself and was forced to engage the manufacturer of the computers, International Business Machines (IBM), to service the machines.2 As a result of a sharp increase by IBM of its charges for such service, MAI's expenses for August of 1966 rose considerably and its net earnings declined from $262,253 in July to $66,233 in August, a decrease of about 75%.3 This information, although earlier known to the defendants, was not made public until October of 1966.4
Prior to the release of the information, however, Oreamuno and Gonzalez sold off a total of 56,500 shares of their MAI stock at the then current market price of $28 a share.5 After the information concerning the drop in earnings was made available to the public, the value of a share of MAI stock immediately fell from the $28 realized by the defendants to $11.6 Thus, the plaintiff alleges, by taking advantage of their privileged position and their access to confidential information, Oreamuno and Gonzalez were able to realize $800,000 more for their securities than they would have had this inside information not been available to them.7
The complaint was filed by a shareholder of Management Assistance, Inc. (MAI).8 It asserts a derivative action against its officers and directors to compel an accounting for profits allegedly acquired as a result of a breach of fiduciary duty.9 It charges that two of the defendants — Oreamuno, chairman of the board of directors, and Gonzalez, its president — had used inside information, acquired by them solely by virtue of their positions, to reap large personal profits from the sale of MAI shares and that these profits rightfully belong to the corporation.10 Other officers and directors were joined as defendants on the ground that they acquiesced in or ratified the assertedly wrongful transactions.11
A motion by the defendants to dismiss the complaint — pursuant to CPLR 3211 (subd. [a], par. 7) — for failure to state a cause of action was granted by the court at Special Term.12 The Appellate Division, with one dissent, modified Special Term's order by reinstating the complaint as to the defendants Oreamuno and Gonzalez.13 The appeal is before us on a certified question.14
Whether officers and directors may be held accountable to their corporation for gains realized by them from transactions in the company's stock as a result of their use of material inside information?15
It is well established, as a general proposition, that a person who acquires special knowledge or information by virtue of a confidential or fiduciary relationship with another is not free to exploit that knowledge or information for his own personal benefit but must account to his principal for any profits derived therefrom.16 This, in turn, is merely a corollary of the broader principle, inherent in the nature of the fiduciary relationship, that prohibits a trustee or agent from extracting secret profits from his position of trust.17 The function of such an action is not merely to compensate the plaintiff for wrongs committed by the defendant.18 Instead, it serves to prevent them by removing from agents and trustees all inducement to attempt dealing for their own benefit in matters which they have undertaken for others.19
Yes. The rule applies directly to the established facts because Oreamuno and Gonzalez, as chairman and president, acquired the material inside information about the sharp decline in MAI's net earnings solely by virtue of their positions with the corporation.20
They then exploited that confidential information by selling 56,500 shares of MAI stock at $28 per share before the information was made public in October 1966, realizing approximately $800,000 more than they would have after the stock price fell to $11.21
Although the complaint contains no allegation of damages to MAI, the absence of such an allegation does not defeat the cause of action.22
The purpose is to prevent the breach of fiduciary duty by requiring the defendants to account for profits derived from the exploitation of inside information that belonged to the corporation.23
The defendants' actions in selling on the basis of non-public information therefore give rise to a derivative claim by the corporation to recover those profits.24
Officers and directors may be held accountable to their corporation for gains realized by them from transactions in the company's stock as a result of their use of material inside information.25