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Question

Difficulty: HardInsider Trading and Misuse of Material Nonpublic Information

A graphic designer at a financial printing firm is tasked with formatting confidential acquisition documents for an unannounced corporate merger. Recognizing the target company's name, the designer mentions the upcoming transaction to a personal friend during dinner, explicitly asking the friend not to trade on the information. Despite this warning, the friend purchases call options on the target company and realizes a significant profit when the deal is publicly announced. Under federal insider trading laws, which of the following statements correctly evaluates the legal liability of the graphic designer and the friend?

  1. Both the graphic designer and the friend can be held liable, as conveying material nonpublic information breaches a duty of trust even without direct monetary compensation, and trading on known nonpublic information creates tippee liability.Answer
  2. B
    The graphic designer cannot be held liable because no direct financial compensation or kickback was received in exchange for disclosing the confidential deal details.
  3. C
    Neither individual can be held liable because the graphic designer explicitly instructed the friend not to trade on or disclose the information prior to the public announcement.
  4. D
    Only the friend can be held liable because insider trading statutory penalties attach exclusively to the party executing the actual securities trade.

Answer

Both the graphic designer and the friend can be held liable, as conveying material nonpublic information breaches a duty of trust even without direct monetary compensation, and trading on known nonpublic information creates tippee liability.
Under federal insider trading regulations and case law governing the misappropriation theory, a temporary insider (such as a financial printing employee) who discloses material nonpublic information to a friend breaches a duty of trust. The tipper receives an illegal personal benefit by gifting valuable confidential information to an acquaintance, while the tippee incurs derivative liability by knowingly trading on that nonpublic information. A verbal request not to trade does not relieve either party of liability.

Step-by-Step Solution

1
Analyze the nature of the information and the duty owed by the graphic designer.
The upcoming corporate merger information was material and nonpublic, obtained through an employment position carrying a duty of trust and confidentiality.
Employees of financial printing firms owe a duty of confidentiality regarding client documents under the misappropriation theory of insider trading.
2
Evaluate tipper liability for the graphic designer.
The designer breached a duty by sharing confidential details with a friend, satisfying the personal benefit element through a gift of confidential information to a personal acquaintance.
Under insider trading laws, passing confidential corporate information to a friend or relative constitutes an improper personal benefit, even without cash compensation.
3
Evaluate tippee liability for the friend.
The friend traded while knowing (or having reason to know) that the information was material, nonpublic, and disclosed in breach of a duty.
Tippees assume derivative liability when trading on material nonpublic information obtained from a tipper who breached a duty.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
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Topics

Insider Trading and Misuse of Material Nonpublic Information