Examkin

Question

Difficulty: MediumInsider Trading and Misuse of Material Nonpublic Information

A supply chain auditor working for a third-party consulting firm uncovers confidential manufacturing data indicating that a publicly traded pharmaceutical company's flagship drug failed its final trial. Prior to any public announcement, the auditor passes this information to a close personal friend, who immediately purchases put options on the pharmaceutical company's stock. Under federal insider trading regulations, which of the following statements correctly describes the legal liability of the friend (the tippee)?

  1. The friend is subject to insider trading liability because trading on material nonpublic information obtained through a breach of duty constitutes a violation, regardless of employment status with the target company.Answer
  2. B
    The friend cannot be held legally liable because tippee liability applies exclusively to direct employees, directors, and officers of the issuing corporation.
  3. C
    The friend is exempt from insider trading violations because the tip originated from an independent third-party consultant rather than an officer of the company.
  4. D
    The friend can only be held liable if the supply chain auditor received explicit cash compensation in exchange for providing the confidential information.

Answer

The friend is subject to insider trading liability because trading on material nonpublic information obtained through a breach of duty constitutes a violation, regardless of employment status with the target company.
The correct option correctly reflects federal securities law regarding tipper and tippee liability. Under the Insider Trading and Securities Fraud Enforcement Act, a tippee (the person receiving nonpublic material information) who knows or should know that the information was shared in breach of a duty of confidentiality assumes a derivative duty not to trade. Tippees can face severe civil fines (up to 3x the profit gained or loss avoided) and criminal penalties regardless of whether they are employed by the issuer.

Step-by-Step Solution

1
Analyze the nature of the information.
The unannounced failure of a flagship drug trial is material nonpublic information.
Information is material if a reasonable investor would consider it important when making an investment decision, and nonpublic if it has not been broadly disseminated to the marketplace.
2
Determine duty of confidentiality and breach.
The third-party auditor breached a duty of trust and confidentiality by leaking the information.
Independent consultants and contractors are temporary insiders bound by confidentiality obligations.
3
Evaluate tippee liability.
The friend (tippee) is liable for trading options based on this information.
Under the Insider Trading Sanctions Act and SEC rules, anyone who trades while in possession of material nonpublic information derived from a breach of duty is liable.

Key Concept

Tippee Liability under Insider Trading Law
Estimated Time:1m 0s
Rate this question

Topics

Insider Trading and Misuse of Material Nonpublic Information