Diamond v. Oreamuno
248 N.E.2d 910, 24 N.Y.2d 494, 301 N.Y.S.2d 78 (1969)
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Rule of Law:
Corporate officers and directors who use material, non-public information acquired in their official capacity to make personal profits from trading the corporation's stock have breached their fiduciary duty. The corporation may bring a derivative action to recover these profits, even if it cannot prove it suffered direct financial damage.
Facts:
- Management Assistance, Inc. (MAI) was a business that financed and arranged for the servicing of computer installations.
- MAI's ability to service the computers depended on International Business Machines (IBM).
- IBM sharply increased its charges for servicing the machines, which the leaders of MAI knew would cause a dramatic decrease in MAI's earnings.
- MAI's net earnings for August 1966 fell by approximately 75% compared to the previous month.
- Oreamuno, MAI's chairman of the board, and Gonzalez, its president, learned of this steep decline in earnings before the information was made public.
- Prior to the public announcement of the earnings drop, Oreamuno and Gonzalez sold a combined 56,500 shares of their MAI stock at the prevailing market price of $28 per share.
- After MAI publicly disclosed the sharp drop in earnings, the market price of its stock fell to $11 per share.
Procedural Posture:
- A shareholder of Management Assistance, Inc. (MAI) filed a derivative action against officers Oreamuno and Gonzalez in a New York state trial court (Special Term).
- The defendants filed a motion to dismiss the complaint for failure to state a cause of action.
- The trial court granted the defendants' motion and dismissed the complaint.
- The plaintiff shareholder appealed to the New York intermediate appellate court (the Appellate Division).
- The Appellate Division modified the trial court's order, reinstating the complaint as to defendants Oreamuno and Gonzalez.
- The defendants appealed that decision to the highest court of New York, the Court of Appeals.
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Issue:
Does a corporation have a valid cause of action against its officers and directors for profits they realized by trading the corporation's stock using confidential information obtained through their positions, even when the corporation itself did not suffer direct harm from the transactions?
Opinions:
Majority - Chief Judge Fuld
Yes. A corporation has a valid cause of action against its fiduciaries for profits realized from their use of inside information because such conduct constitutes a breach of their fiduciary duty. The function of an action for breach of fiduciary duty is not merely to compensate for damages but to prevent fiduciaries from yielding to the temptation of self-dealing. Confidential information acquired by virtue of one's corporate office is a corporate asset, and any profits derived from its exploitation belong to the corporation. Even absent a specific allegation of monetary damage, the corporation is harmed by the injury to its reputation and public goodwill when its officers engage in such conduct. This state common law remedy is necessary to fill gaps where federal securities laws may not provide an effective remedy and is not preempted by them.
Analysis:
This landmark decision established that a corporation, through a derivative suit, can recover profits from insiders who trade on confidential corporate information, a cause of action distinct from federal securities laws. It significantly broadened the scope of fiduciary duty by treating confidential information as a corporate asset and focusing on the unjust enrichment of the fiduciary rather than on proof of direct harm to the corporation. This ruling, sometimes called the "New York Rule," provides a powerful tool for shareholders to police insider trading, especially in situations where federal remedies under SEC Rule 10b-5 or Section 16(b) may be unavailable or impractical for private litigants to pursue.
