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Difficulty: HardInsider Trading and Misuse of Material Nonpublic Information

A commercial real estate consultant retained by a publicly traded retail chain learns during a confidential site evaluation that the company plans to file for Chapter 11 bankruptcy restructuring later that week. The consultant does not trade any securities but urges an adult sibling to sell all holdings of the retailer's stock immediately. Acting on this advice, the sibling liquidates their entire position prior to the public announcement, avoiding a significant financial loss. Under federal securities laws governing insider trading, which of the following statements correctly describes the liability of the parties involved?

  1. Both the real estate consultant and the sibling have violated insider trading laws because the consultant breached a duty of trust by passing material nonpublic information and the sibling traded on that information.Answer
  2. B
    Only the sibling has violated insider trading laws because liability requires an actual trade to occur, exempting the consultant who did not personally execute any transactions.
  3. C
    Neither party has violated insider trading laws because the real estate consultant was an independent contractor rather than a corporate officer, director, or employee of the retailer.
  4. D
    Only the real estate consultant has violated insider trading laws because tippee liability applies exclusively to registered representatives and securities industry professionals.

Answer

Both the real estate consultant (as tipper) and the sibling (as tippee) are liable for insider trading violations under federal securities laws.
The correct answer identifies that both parties are legally liable under federal securities laws. Third-party contractors act as temporary insiders; disclosing unannounced bankruptcy details breaches a fiduciary-like duty of confidentiality. When the recipient (tippee) trades based on that material nonpublic information, both the tipper and the tippee commit an insider trading violation.

Step-by-Step Solution

1
Determine if the information communicated is material and nonpublic.
The unannounced bankruptcy filing is material (likely to affect stock price) and nonpublic.
Insider trading rules cover any nonpublic information that a reasonable investor would consider important when making an investment decision.
2
Evaluate the status and duties of the tipper (the consultant).
The consultant is a temporary insider who breached a duty of confidentiality owed to the client by conveying the information to a family member.
Under the Insider Trading Sanctions Act and broader federal securities jurisprudence (including the misappropriation theory), third-party consultants owe a duty of trust to their clients and cannot convey material nonpublic information for non-business purposes.
3
Evaluate the liability of the tippee (the sibling).
The sibling is liable as a tippee because they knew or should have known that the information was material and nonpublic and derived from a breach of duty.
A tippee inherits the insider's duty and incurs full legal liability upon executing trades based on the material nonpublic tip.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
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Topics

Insider Trading and Misuse of Material Nonpublic Information