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Brophy Revisited

By Robert S. Reder, David Schwartz and Roxana Azizi

A current “hot button” issue in corporate law is the extent to which federal law can ' or should ' pre-empt state corporate law regimes. Due to its prominence as the state of incorporation for so many U.S.-domiciled corporations, Delaware has frequently found itself at the epicenter of this debate. One area in which this tension recently flared is in the context of insider trading. When one thinks of insider trading actions, ' 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder naturally come to mind. However, as long ago as 1949, in “the venerable case” Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949), the Delaware Court of Chancery recognized the right of Delaware stockholders to sue corporate fiduciaries derivatively to recover profits derived from insider trading on the basis of “confidential corporate information.” According to the Brophy court, “[e]ven if the corporation did not experience actual harm, equity requires disgorgement of that profit.”

In 2010, the Court of Chancery had the opportunity to re-visit the continued viability of Brophy. In Pfeiffer v. Toll, 989 A.2d 683 (Del. Ch. 2010), the Court of Chancery rejected the argument that Brophy is a “misguided vehicle for recovering the same trading losses that are addressed by the federal securities laws.” Instead, the Court of Chancery declared, the “federal insider trading regime as currently structured rests on a foundation of state law fiduciary duties.” However, in so ruling, the Pfeiffer court limited Brophy by observing that the harm addressed is “not measured by insider trading gains or reciprocal losses,” as under the federal regime, but rather by “harm to the corporation” measured by its “ costs and expenses for regulatory proceedings and investigations, fees paid to counsel and other professionals, fines paid to regulators, and judgments in litigation.”

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