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Question

Difficulty: MediumInsider Trading and Misuse of Material Nonpublic Information

A commercial real estate appraiser is retained by a publicly traded retail corporation to value several warehouse distribution centers ahead of an unannounced corporate acquisition. During a social event, the appraiser discloses details of the confidential pending acquisition to a friend, who subsequently purchases call options on the retail corporation's stock prior to the public announcement. Which of the following best describes the regulatory liability under federal securities insider trading rules?

  1. Both the appraiser and the friend can be held liable for insider trading violations.Answer
  2. B
    Only the friend can be held liable because the appraiser did not personally execute any securities transactions.
  3. C
    Neither party can be held liable because the appraiser is an independent contractor rather than an employee of the retail corporation.
  4. D
    Only the appraiser can be held liable because the friend owes no direct fiduciary duty to the retail corporation's shareholders.

Answer

Both the real estate appraiser (tipper) and the friend (tippee) can be held liable for insider trading under federal securities laws.
Both the tipper (the real estate appraiser) and the tippee (the friend) can be held liable under federal securities regulations. The appraiser breached a duty of trust and confidence owed to the client company by disclosing material nonpublic information. The friend is liable as a tippee for acting on that information while knowing or having reason to know it was improperly obtained.

Step-by-Step Solution

1
Identify the nature of the information
The details regarding the unannounced corporate acquisition constitute material nonpublic information.
Information is material if a reasonable investor would consider it important in making an investment decision, and nonpublic if it has not been broadly disseminated to the public market.
2
Evaluate tipper liability
The real estate appraiser acts as a temporary insider owing a duty of confidentiality to the retail corporation.
Breaching confidentiality by conveying material nonpublic information to an acquaintance creates tipper liability under SEC Rule 10b-5, regardless of whether the tipper personally trades.
3
Evaluate tippee liability
The friend who received the tip and executed options trades is liable as a tippee.
A tippee who trades while knowing or having reason to know that the information was material, nonpublic, and improperly disclosed assumes derivative liability.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
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Topics

Insider Trading and Misuse of Material Nonpublic Information