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Introduction to the Law of Corporations: Cases and Materials

State-based liability

State-based insider trading liability takes the form a derivative action by stockholders against insiders. In such an action, the basic claim is that directors (or “insiders”) used confidential information of the corporation for their own benefit and not for the benefit of the corporation. As a derivative action based, state-based insider trading liability is prosecuted by stockholders and not by state regulators or the SEC. In re Oracle from earlier in the semester are examples of stockholders bringing derivative suits against board members who have allegedly engaged in insider trading in the stock of the corporation. The claim in each of those cases was, in part, that the defendant directors violated their duty of the loyalty to the corporation by using the corporation's material, nonpublic information in order to trade stock in the corporation benefiting themselves. 

State-based insider trading claims are also known as "Brophy" claims. A Brophy claim is a derivative claim against a director. Consistent with other derivative actions, the remedy, if any, is paid to the corporation in the form of disgorgement of profits. Because the state-based action is derivative, neither stockholders nor any governmental entity is entitled to receive any of the profits disgorged as a remedy. Those illicit profits are paid back to the corporation and are not paid as fines to the SEC or any other regulator. In addition, state-based insider trading liability is civil and not criminal. 

Notice that the case that follows is a ruling on a special litigation committee's Rule 56 motion to dismiss. You have come across the special litigation committee in the context of derivative litigation before. Before ruling on the Brophy claim, the court applies the two-prong test from Zapata to the special litigation committee's effort to have the litigation dismissed.