June 2011

Although the case at issue involves insider trading, the limitations involving disgorgement as a monetary remedy could be applied to other circumstances. The Delaware Supreme Court took little time in reversing a lower court decision that could have had widespread effects. The case is important because of the large number of companies that are incorporated in Delaware.

The case involves a defendant (a 60% shareholder) who traded on inside information. However, before doing so, the Board of Directors indicated that the trading was not a corporate opportunity. The issue before the Delaware Supreme Court was whether disgorgement of the insider trading profits was a viable monetary remedy since the corporation did not suffer any harm.

Most damage analysts would almost automatically state that disgorgement would be an available remedy in this situation. But this somewhat intuitive result was altered with a 2010 decision by the Delaware Chancery Court in re: Pfeiffer v. Toll et al., 989 A. 2d 683 (Del.Ch. 2010). The Chancery Court in the Pfeiffer case decided that, while corporate fiduciaries could still be sued for trading on inside information, the corporation (i) could only recover upon proof of actual damage, and (ii) was not necessarily entitled to recover the insider’s ill-gotten gains. This decision was based on a 60-year old case named Brophy.

The Delaware Supreme Court reversed the Chancery court, thus allowing a disgorgement damage claim to proceed. The Supreme Court reasoned:

“…the Vice Chancellor concluded that in the context of a Brophy claim, disgorgement is “theoretically available” in two circumstances: (1) “when a fiduciary engages directly in actual fraud and benefits from trading on the basis of the fraudulent information;” and (2) “if the insider used confidential corporate information to compete directly with the corporation. Brophy, in the Vice Chancellor’s view, was an example of the second circumstance where disgorgement is an appropriate remedy But, in most circumstances a corporation would only be able to recover for “actual harm causally related (in both the actual and proximate sense) to the breach of the duty of loyalty”—for example “costs and expenses for regulatory proceedings and internal investigations, fees paid to counsel and other professionals, fines paid to regulators, and judgments in litigation.

… We decline to adopt Pfeiffer’s interpretation that would limit the disgorgement remedy to a usurpation of corporate opportunity or cases where the insider used confidential corporate information to compete directly with the corporation.”

Thus, Delaware law on this point returns to a classic election of remedies by the plaintiff.

Fulcrum Inquiry performs damages analysis and related expert testimony.