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Difficulty: HardInsider Trading and Misuse of Material Nonpublic Information

An independent IT consultant working overnight at a law firm reads a confidential draft acquisition agreement between two publicly traded energy corporations. The consultant calls a relative and discloses the pending buyout details as a tip. The relative does not trade on the information, but subsequently passes the exact merger details to a business associate, who executes a purchase of 5,0005,000 shares prior to the public announcement. Under federal securities laws governing insider trading, which of the following statements correctly describes the potential legal liability of the parties involved?

  1. Both the IT consultant and the business associate can be held liable for insider trading, even though the IT consultant did not personally trade or execute securities transactions.Answer
  2. B
    Only the business associate who executed the trade can be held liable, because tipper liability requires the tipper to have personally bought or sold securities.
  3. C
    The business associate cannot be held liable because tipper/tippee liability applies only to direct tips from corporate insiders and does not extend to secondary tippees.
  4. D
    Neither party can be held liable because the IT consultant was an independent contractor rather than a corporate officer or full-time employee of either corporation.

Answer

Both the IT consultant and the business associate can be held liable for insider trading, even though the IT consultant did not personally trade or execute securities transactions.
The correct option correctly states that both the IT consultant (tipper) and the business associate (remote tippee) can be prosecuted under federal insider trading rules. The IT consultant breached a duty of confidentiality by disclosing material nonpublic information, and the business associate executed trades based on that improperly disclosed information.

Step-by-Step Solution

1
Analyze the nature of the information and the IT consultant's duty.
The IT consultant obtained material nonpublic information regarding a pending corporate buyout while bound by a duty of trust and confidentiality to the law firm and its client.
Contractors and temporary insiders who access confidential documents owe a legal duty not to misuse or disclose that material nonpublic information.
2
Evaluate the tipper's liability.
The IT consultant committed a insider trading violation (tipper liability) by intentionally passing confidential merger information to a relative.
Personal trading by the tipper is not a prerequisite for insider trading liability; providing a gift of confidential information to a relative or friend satisfies the personal benefit element.
3
Evaluate the tippee and remote tippee's liability.
The business associate who traded on the tip is liable as a remote tippee.
Tippees who receive material nonpublic information and trade on it are liable if they knew or should have known that the information was communicated in breach of a duty, regardless of how many links exist in the communication chain.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
Estimated Time:1m 45s
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Topics

Insider Trading and Misuse of Material Nonpublic Information