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Question

Difficulty: MediumInsider Trading and Misuse of Material Nonpublic Information

During a charity golf tournament, a registered representative learns from a senior executive of a publicly traded biotechnology firm that an unannounced, positive drug trial result will be released next week. The representative does not trade on the information, but passes the tip to a key client who buys 5,000 shares of the stock prior to the public announcement. Which of the following statements correctly describes the liability under federal insider trading regulations?

  1. Both the registered representative and the client can be held liable under insider trading regulations.Answer
  2. B
    Only the client can be held liable because the registered representative did not execute any trades or personally profit.
  3. C
    Neither party can be held liable because the information was disclosed in an informal setting rather than a formal business meeting.
  4. D
    Only the corporate executive who originally disclosed the information can be held liable for a breach of fiduciary duty.

Answer

Both the registered representative and the client can be held liable under federal insider trading regulations.
Under federal insider trading laws, liability applies to both the individual who discloses material nonpublic information (the tipper) and the individual who trades on it (the tippee). The registered representative is liable as a tipper despite not trading or profiting, and the client is liable as a tippee for acting on the nonpublic tip.

Step-by-Step Solution

1
Determine whether the shared information constitutes material nonpublic information.
The unannounced positive trial result is material because it would influence an investor's decision, and it is nonpublic.
Trading or relaying material nonpublic information violates federal securities laws under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.
2
Analyze the registered representative's liability as a tipper.
Passing the information to a client constitutes illegal tipping.
Tipper liability arises when an individual passes material nonpublic information in breach of a duty, even if the tipper does not trade or profit personally.
3
Analyze the client's liability as a tippee.
Executing trades based on the tip makes the client liable as a tippee.
Tippee liability attaches when an individual trades on information they know or should know was derived from a breach of duty.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
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Topics

Insider Trading and Misuse of Material Nonpublic Information