The Delaware Supreme Court recently reversed the Court of Chancery to rule that a claim for insider trading based upon Delaware state fiduciary duty law, a so-called “Brophy” claim after the leading (Court of Chancery) case in that line, does not require proof of harm to the company. Rather, the defendant can be required to disgorge profits previously received even where the company arguably was not harmed monetarily. The Court in doing so also reaffirmed the vitality of the Brophy claim alongside federal law also dealing with insider trading claims.
In Kahn v. KKR & Co., LP, plaintiffs made a claim against KKR under Brophy v. Cities Service Co. for trading on the stock of nominal defendant Primedia, Inc. while in possession of nonpublic information (Primedia’s earnings would be better than previously forecasted). The Court of Chancery granted defendants’ motion to dismiss. The Court reasoned, among other things, that a disgorgement remedy would not be available to plaintiffs because there was no direct harm to Primedia, distinguishing the case from Brophy.
In Brophy, the defendant had acquired inside information that the corporation was about to purchase its own shares. The defendant then bought a large number of shares and resold them after the corporation’s purchases had caused the stock price to rise. The Court of Chancery in Kahn characterized Brophy itself as a case in which an insider “used confidential corporate information to compete directly with the corporation.” It held that disgorgement was also theoretically available in Brophy cases involving actual fraud.
As those whose memories still stretch back to their Corporations and/or Securities Law classes in law school will recall, one of the controversies originally surrounding the federal laws concerning insider trading is that some argued that such conduct should not be an addressed because it did not harm the corporation. While that view did not generally prevail with respect to federal securities laws, the Court of Chancery’s holding would have significantly limited the Brophy cause of action and a remedy for insider trading under Delaware state law.
The Supreme Court en Banc reversed, calling the Chancery decision “thoughtful but unduly narrow.” The Court noted that Brophy itself had stated broadly, “In equity, when the breach of confidential relation by an employee is relied on and an accounting for any resulting profit is sought, loss to the corporation need not be charged in the complaint . . . Public policy will not permit an employee occupying a position of trust and confidence toward his employer to abuse that relation to his own profit, regardless of whether his employer suffers a loss.”
The Court cited the well-known principle that “Delaware law dictates that the scope of recovery for a breach of the duty of loyalty is not to be determined narrowly.” It also cited the venerable Guth v. Loft case for its statement that the rule that a fiduciary must return profits gained in breach of his or her duty does not rest upon narrow grounds of injury to the corporation “but upon a broader foundation of a wise public policy that, for the purpose of removing all temptation, extinguishes all possibility of profit flowing from a breach of the confidence imposed by the fiduciary relation.”
Filed under: Brophy (Insider Trading) Claim, Fiduciary Duties
Delaware Corporate Law Update 