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Difficulty: HardInsider Trading and Misuse of Material Nonpublic Information

An IT systems administrator at a publicly traded biopharmaceutical firm inadvertently gains access to confidential data showing the failure of a key Phase 3 clinical trial. Before the news is publicly disclosed, the administrator informs a personal friend who is not employed by the company. The friend subsequently purchases put options on the firm's stock and realizes significant profits. The administrator did not execute any trades and received no direct financial compensation. Which of the following statements regarding insider trading liability under federal securities regulations are correct?

  1. The IT administrator can be held liable as a tipper for breaching a duty of confidentiality by passing material nonpublic information, regardless of whether they executed trades directly.Answer
  2. The friend can be held liable as a tippee because trading on material nonpublic information while knowing (or having reason to know) that it was improperly disclosed constitutes a violation.Answer
  3. C
    The friend is immune from tippee liability because insider trading regulations apply exclusively to registered corporate insiders, officers, and employees of the issuer.
  4. D
    Neither party can be held liable because federal insider trading law requires a direct exchange of cash or tangible assets between the tipper and tippee to establish a violation.

Answer

Both the IT administrator (as tipper) and the friend (as tippee) can be held liable for insider trading violations. Liability does not require the tipper to trade or receive financial payment, nor does it exempt tippees who are not company employees.
Under federal insider trading regulations, tipper liability arises when an individual in possession of material nonpublic information breaches a duty of trust by disclosing it to another person. The tippee assumes derivative liability when trading on that information while knowing (or having reason to know) that it was improperly disclosed. Neither employment status with the subject firm nor direct monetary payment between the parties is required to establish liability.

Step-by-Step Solution

1
Analyze tipper liability criteria under Section 10(b) and Rule 10b-5.
The IT administrator possessed material nonpublic information, owed a duty of confidentiality to the biopharmaceutical firm, and breached that duty by passing the information to an outsider.
Passing material nonpublic information in breach of a duty constitutes tipper liability regardless of whether the tipper personally trades or receives money.
2
Analyze tippee liability criteria.
The friend knew or should have known the clinical trial data was confidential and disclosed in breach of duty, yet used it to trade put options.
Tippees who trade on material nonpublic information derived from a breach of duty assume derivative liability under federal securities laws.
3
Evaluate legal defenses regarding employee status and financial compensation.
Neither non-employee status nor the absence of cash compensation shields the parties from civil or criminal liability.
Federal regulations do not limit tippee liability to corporate officers, nor do they require monetary kickbacks to prove a tipper benefit.

Key Concept

Elements of Tipper and Tippee Liability under Insider Trading Rules
Estimated Time:2m 0s
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Topics

Insider Trading and Misuse of Material Nonpublic Information