In Pfeiffer v. Toll, the Delaware Court of Chancery recently refused to dismiss a lawsuit claiming breach of fiduciary duty on the part of members of the board of directors of Toll Brothers who allegedly engaged in insider trading. In so ruling, the court affirmed Brophy v. Cities Service Co., a 1949 case which “recognized the right of a Delaware corporation to recover from its fiduciaries for harm caused [to the corporation] by insider trading” in the corporation’s stock. Rejecting the defendant directors’ argument that the federal securities laws pre-empt a state law claim under Brophy, the court found that the “federal insider trading regime as currently structured rests on a foundation of state law fiduciary duties.”
The Toll decision preserves a state law claim for stockholders of Delaware corporations whose fiduciaries may have engaged in the trading of the corporation’s securities on the basis of material, nonpublic information. As a result, corporate directors and officers engaging in insider trading may face a derivative action under Brophy as well as federal securities law claims. More important, this decision illustrates that Delaware courts will not lightly accept an argument that state corporate law is pre-empted by federal law and regulation. It will be interesting to see how this view factors into future debates over whether pending federal financial reform legislation, insofar as it purports to address corporate governance issues, supersedes Delaware corporate law.
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Robert Reder is co-practice group leader of Milbank, Tweed, Hadley & McCloy’s Global Corporate Group.