Also known as: secret profit · undisclosed profits
Written by attorneys · grounded in primary & secondary sources — see below
A gain realized by a fiduciary through a transaction conducted for the principal or the entity to be formed. The fiduciary must account for the gain to the principal unless the fiduciary made full disclosure of all material facts and obtained informed approval from every person contemplated as part of the original financing scheme who becomes an initial stakeholder.
Samuel Soto and Santiago Sanchez formed a side partnership that acquired a parcel at a low basis. They caused the newly formed Sentinel Security to purchase the parcel at a substantial markup. They disclosed the profit only to two wealthy backers who later sat on the board. The corporation later sued to recover the markup after discovering that trade investors invited into the original equity group had received no information.
Seth Shapiro and a co-promoter acquired technology rights at low cost while organizing Summit Bank. They caused the new corporation to purchase the rights at a substantial markup. They disclosed the profit only to two early backers. The corporation later sued to recover the secret profit after discovering that other contemplated initial investors had received no information.
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Sasha Stone and Samantha Stone, while promoting Solstice Ventures, acquired land at a low basis. They caused the new corporation to purchase the land at a substantial markup. They disclosed the profit only to insider investors. The corporation later sued seeking an accounting of the secret profit after discovering that other contemplated initial shareholders had received no information.
Sylvia Santos, an agent for Sterling Manufacturing, steered a large supply contract to a vendor that paid her a secret commission. She deposited the payment into a personal account without informing the principal. Sterling Manufacturing later discovered the payment and demanded that Santos disgorge the amount to the company.
Yes. Disclosure limited to some initial subscribers is insufficient. The promoter must obtain informed approval from all persons contemplated as part of the original financing scheme who become initial shareholders.
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The corporation itself may sue. The rule protects both the entity and its contemplated initial shareholders, so the corporation is a proper plaintiff entitled to recover the profit or rescind the transaction.
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No. Ratification by only a subset of the original financing group leaves the profit secret as to the remaining contemplated investors. Full disclosure to every person included in the promotion plan is required.
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The duties attach during the promotion phase while the promoter is organizing the corporation and recruiting initial investors, well before formal incorporation.
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…10b-5 for inside trading only where he fails to disclose material nonpublic information before trading on it and thus makes "secret profits." Cady, Roberts, supra , at 916, n. 31. III We were explicit in Chiarella in saying that there can be no duty to disclose where the person who has traded on inside information "was not…