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Question

Difficulty: MediumInsider Trading and Misuse of Material Nonpublic Information

A server at a private dining club overhears two corporate executives discussing an upcoming unannounced acquisition of a publicly traded company. The server communicates this nonpublic details to a friend, who subsequently purchases shares of the target firm prior to the public announcement and sells them for a significant profit. Neither the server nor the friend is an officer, director, or employee of either company. Under federal securities laws governing insider trading, which of the following statements correctly describes their potential liability?

  1. Both the server and the friend can be held liable under insider trading regulations because material nonpublic information was wrongfully disclosed and subsequently traded upon.Answer
  2. B
    Only the server can be held liable as the tipper, while the friend is fully exempt from liability because the friend is not an insider or employee of the target company.
  3. C
    Only the friend can be held liable because liability attaches strictly to the individual who executes the transaction, provided the tipper did not receive direct financial compensation.
  4. D
    Neither individual can be held liable because overhearing a conversation in a public or hospitality setting automatically places the information into the public domain.

Answer

Both the server (tipper) and the friend (tippee) can be held liable under insider trading rules because confidential material information was improperly passed and acted upon in the securities market.
Under the Insider Trading and Securities Fraud Enforcement Act and federal securities regulations, both the person who passes along material nonpublic information (the tipper) and the person who receives and trades on that information (the tippee) can be held liable. Corporate employment or insider status is not required for liability to attach to either party.

Step-by-Step Solution

1
Evaluate the nature of the information
The overheard acquisition details represent material nonpublic information because a reasonable investor would consider it significant in making an investment decision and it has not been released to the general public.
Insider trading prohibitions cover any material nonpublic information regardless of how it was obtained.
2
Analyze tipper liability for the server
The server acted as a tipper by communicating material nonpublic information to another person who then executed trades based on that information.
Tippers are liable for passing confidential material information even if they do not execute trades themselves.
3
Analyze tippee liability for the friend
The friend acted as a tippee by trading securities while in possession of material nonpublic information obtained from a tipper.
Tippees inherit the duty not to trade on nonpublic material information and can be held fully liable regardless of employment status with the subject company.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
Estimated Time:1m 15s
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Topics

Insider Trading and Misuse of Material Nonpublic Information