June 10, 2022

Fiduciary Duty: Del. Chancery Permits Direct “Brophy” Claim

Bringing fiduciary duty claims based on insider trading may seem somewhat incongruous given the pervasiveness of federal law in this area, but Delaware has recognized these so-called “Brophy claims” ever since the Delaware Supreme Court’s 1949 decision in Brophy v. Cities Service, (Del.;12/49). After a long period of relative dormancy, Brophy claims have become increasingly popular among plaintiffs in recent years.  Part of the reason for that is a 2011 Delaware Supreme Court decision holding that disgorgement of all gains from insider trading is a potential remedy for the breach of fiduciary duty.

Brophy claims are generally derivative in nature, but last week, in Goldstein v. Denner, (Del. Ch.; 6/22), Vice Chancellor Laster permitted a direct Brophy claim against certain target directors who traded in its securities after engaging in undisclosed discussions with a potential buyer.  In support of his argument that the Court should allow him to proceed with a direct claim, the plaintiff cited Parnes v. BaBally Entertainment, (Del.; 1/99), in which the Delaware Supreme Court held that a plaintiff can bring a direct claim challenging a merger that results, in whole or in part, from conduct that otherwise would give rise to a derivative claim. Vice Chancellor Laster agreed:

In Parnes, the Delaware Supreme Court held that a plaintiff has standing to challenge the fairness of a merger if it is reasonably conceivable that the pending derivative claim (or the conduct that otherwise would support a derivative claim) affected either the fairness of the merger price or the fairness of the process that led to the merger. Here, it is reasonably conceivable that the alleged misconduct affected the fairness of the process. As the court explained in the Sale Process Decision, it is reasonably conceivable that the sale process fell outside the range of reasonableness because Denner maneuvered to secure a near-term sale that would lock in the profits from his insider trading.

The Vice Chancellor said that because evidence about the director’s insider trading provides strong evidence of his motive and intent, it is relevant to determining whether the sale process was unreasonable, because it provides strong evidence of Denner’s motive and intent.

As previously noted, one of the reasons Brophy claims are attractive is the potential for disgorgement as a remedy. But in this case, Vice Chancellor Laster suggested that potential damages may go far beyond that. He concluded that if the plaintiff prevails, the likely remedy would be an award of class-wide damages based on the value that would have been achieved in a reasonable process “to obtain the best transaction reasonably available, either by achieving a sale at a higher price or by remaining a standalone entity and capitalizing on the Company’s business plan.”

Keith Bishop points out that California actually has a statute prohibiting insider trading – Cal. Corp. Code Sec. 25402 – which he blogged about some time ago, The statute is part of California’s blue sky law and thus isn’t limited to California corporations.

John Jenkins