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Question

Difficulty: MediumInsider Trading and Misuse of Material Nonpublic Information

An independent catering manager serving a private executive lunch at a publicly traded software company overhears the board of directors approving an unannounced tender offer to acquire a major competitor. The catering manager relays this information to a personal friend, who immediately purchases call options on the target company's stock prior to the public announcement. Under federal securities laws, which of the following statements accurately describes the insider trading liability in this scenario?

  1. Both the catering manager and the friend can be held liable for insider trading.Answer
  2. B
    Only the friend can be held liable because insider trading violations require an actual securities trade to occur.
  3. C
    Only the catering manager can be held liable because external tippees who are not corporate employees are exempt from federal insider trading rules.
  4. D
    Neither individual can be held liable because the information was obtained by an outside service vendor rather than a corporate officer.

Answer

Both the catering manager and the friend can be held liable for insider trading.
Under federal insider trading regulations and the misappropriation theory, liability extends to both tippers and tippees. The tipper breaches a duty of trust by revealing material nonpublic information, and the tippee assumes liability by executing trades while knowing or having reason to know that the information was improperly disclosed.

Step-by-Step Solution

1
Identify whether the overheard information constitutes material nonpublic information.
The details regarding the unannounced acquisition and tender offer are material and nonpublic.
Unannounced merger and acquisition activity would significantly impact investor decisions and stock valuation.
2
Evaluate the tipper's status and duty under insider trading laws.
The catering manager breached a duty of confidentiality owed to the host company by communicating nonpublic information.
Under the misappropriation theory, passing confidential corporate information to an outside third party constitutes an illegal tip.
3
Evaluate the tippee's liability.
The friend acted as a tippee by trading options based on material nonpublic information.
A tippee who trades while knowing or having reason to know that the information was improperly disclosed shares full insider trading liability.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
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Topics

Insider Trading and Misuse of Material Nonpublic Information