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Difficulty: HardInsider Trading and Misuse of Material Nonpublic Information

A graphic designer employed by a commercial printing firm is tasked with typesetting confidential prospectus documents for an unannounced corporate acquisition. During a private lunch, the designer reveals details of the pending transaction to a personal friend. The friend, who has no employment relationship or contractual obligation to either corporate entity, immediately purchases call options on the target company and realizes a significant profit once the acquisition is publicly announced. Under federal securities laws, which of the following statements correctly describes the legal liability of the involved parties?

  1. Both the graphic designer and the friend are liable for insider trading, because tippee liability applies when an individual trades on material nonpublic information knowing it was disclosed in breach of a duty, regardless of employment status.Answer
  2. B
    Only the graphic designer is liable for insider trading, because an outside third party who is not an officer, director, or employee of the subject firm cannot be prosecuted under federal insider trading rules.
  3. C
    Neither party is liable for insider trading, because the graphic designer received no monetary payment or tangible financial consideration from the friend in exchange for sharing the acquisition details.
  4. D
    Only the friend is liable for insider trading, because a tipper cannot be held legally accountable for securities fraud unless they personally execute a transaction in their own account.

Answer

Both the graphic designer and the friend are liable for insider trading, because tippee liability applies when an individual trades on material nonpublic information knowing it was disclosed in breach of a duty, regardless of employment status.
The correct position states that both the graphic designer and the friend are liable for insider trading. Under federal securities laws (including Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5), tipper liability is triggered when an individual discloses material nonpublic information in breach of a duty of trust or confidence. Tippee liability attaches when the recipient knows or should know that the information was confidential and wrongfully disclosed, and subsequently trades on it. Employment status at the target firm is not a prerequisite for tippee prosecution.

Step-by-Step Solution

1
Evaluate the tipper's conduct and duty of confidentiality.
The graphic designer owed a duty of trust and confidence to the printing firm and its client. Communicating unannounced acquisition details to a friend breached this duty.
Improperly conveying material nonpublic information to an outside party constitutes an unlawful 'tip'.
2
Evaluate the tippee's legal standing and liability requirements.
The friend acted upon confidential information knowing (or having reason to know) that it originated from an insider breach.
Tippee liability does not require employment at the subject firm; trading on improperly disclosed nonpublic material information creates direct liability.
3
Synthesize joint liability under federal insider trading regulations.
Both the tipper (designer) and the tippee (friend) face joint civil and potential criminal liability.
The tipper is liable for making the illicit disclosure, and the tippee is liable for executing trades based on that disclosure.

Key Concept

Tipper and Tippee Liability Elements under Insider Trading Regulations
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Topics

Insider Trading and Misuse of Material Nonpublic Information