Pfeiffer v. Toll

Court of Chancery of Delaware
989 A.2d 683 (2010)

ELI5:

Rule of Law:

Under Delaware law, a corporation has a valid derivative cause of action (a 'Brophy' claim) to recover for harm it suffers when its fiduciaries breach their duty of loyalty by using material, non-public corporate information to make personal profits from trading the company's stock.

Facts:

Toll Brothers, a luxury home builder, experienced significant growth during the housing boom of 2003-2004.
Beginning in late 2004 and continuing through most of 2005, Toll Brothers' senior management repeatedly issued public projections of at least 20% net income growth for fiscal years 2006 and 2007.
While making these positive projections, management was aware of negative internal trends, including declining foot traffic in its communities, a lower rate of new contract signings, and regulatory delays hindering the opening of new communities.
Between December 2004 and September 2005, eight Toll Brothers directors and officers, including Robert Toll and Bruce Toll, collectively sold approximately 14 million shares of company stock for proceeds exceeding $615 million.
On November 8, 2005, the company publicly disclosed that softening demand and a shortage of selling communities were negatively impacting its results.
On December 8, 2005, Toll Brothers formally abandoned its previous guidance, revising its projected net income growth for 2006 from 20% down to 0.5%.

Procedural Posture:

Milton Pfeiffer, a Toll Brothers stockholder, filed a shareholder derivative lawsuit on behalf of Toll Brothers, Inc. in the Delaware Court of Chancery (trial court).
The complaint named eight directors and officers as defendants, alleging breach of fiduciary duty based on insider trading.
Pfeiffer subsequently filed a Verified Amended Shareholder Derivative Complaint.
The defendants filed a motion to dismiss the amended complaint, arguing that the plaintiff failed to make a pre-suit demand on the board and that the underlying state law claim for insider trading should be rejected as outdated.

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Issue:

Does a derivative claim against corporate fiduciaries for insider trading, seeking to recover for harm to the corporation, remain a valid cause of action under Delaware law despite the existence of a comprehensive federal securities law regime?

Opinions:

Majority - Laster, Vice Chancellor

Yes. A derivative claim for insider trading under Brophy v. Cities Service Co. remains a vital part of Delaware law because it enforces the fundamental duty of loyalty and remedies harm done to the corporation itself. The court reasoned that the Brophy claim is not preempted by or duplicative of federal securities laws. In fact, the federal insider trading regime, as established in cases like Chiarella, depends on the existence of an underlying state-law fiduciary duty that is breached by such trading. Eliminating the state law claim would undermine the foundation of the federal framework. Furthermore, the harm remedied by a Brophy claim is distinct; it seeks to compensate the corporation for its own damages—such as litigation costs, fines, and reputational damage—rather than compensating contemporaneous traders for their market losses, which is the focus of federal class actions. Therefore, the state and federal regimes are complementary, and Delaware maintains a strong public policy interest in policing violations of the duty of loyalty by holding fiduciaries accountable for misusing corporate information for personal gain.

Analysis:

This decision reaffirms the vitality of the state-law derivative claim for insider trading, solidifying its place alongside the federal regulatory scheme. By clarifying that the remedy is for harm to the corporation, the court distinguishes the claim's purpose from federal class actions, thereby reducing concerns about duplicative recovery. The opinion's most significant contribution is its argument that Delaware's fiduciary duty law serves as a necessary predicate for the federal insider trading regime, strengthening Delaware's role in corporate governance. This case ensures that corporations retain a powerful tool to hold disloyal fiduciaries accountable for profiting from confidential information, thereby protecting the corporation as an entity.

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