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Question

Difficulty: MediumInsider Trading and Misuse of Material Nonpublic Information

A registered representative receives a confidential phone call from a close friend who serves as an executive officer at a publicly traded biotechnology firm. The officer discloses that the company's flagship drug candidate failed its primary clinical trial—a result that will not be publicly disclosed until next week. Prompted by this news, the registered representative immediately sells all personal shares of the company to prevent impending financial losses. Under federal securities law, which of the following statements correctly identifies the insider trading liability of the parties involved?

  1. Both the executive officer and the registered representative are subject to insider trading liability, as material nonpublic information was communicated in breach of duty and subsequently traded upon.Answer
  2. B
    Only the registered representative is liable, because tippers incur no financial or legal liability unless they personally execute trades in the subject security.
  3. C
    Only the executive officer is liable, because tippees who are not officers, directors, or employees of the issuing corporation are legally exempt from insider trading rules.
  4. D
    Neither party is liable, because selling securities to avoid a loss does not satisfy the legal definition of trading for financial gain under federal securities laws.

Answer

Both the executive officer (tipper) and the registered representative (tippee) are liable under federal insider trading regulations because material nonpublic information was improperly communicated in breach of a duty and acted upon to execute a transaction.
Under federal insider trading regulations (including the Insider Trading and Securities Fraud Enforcement Act), both the tipper (the executive officer) and the tippee (the registered representative) can be held liable. The executive officer breached a fiduciary duty by conveying material nonpublic information, and the registered representative violated securities laws by acting on that information to execute a trade.

Step-by-Step Solution

1
Analyze the nature of the information communicated.
The failed clinical trial result is both material (would affect an investor's decision) and nonpublic (not yet announced to the market).
Trading while in possession of material nonpublic information forms the foundation of insider trading violations.
2
Determine the liability of the insider disclosing the information (the tipper).
The executive officer breached a fiduciary duty of trust by sharing confidential corporate news with a friend.
Passing material nonpublic information to an outside party without a valid corporate purpose establishes tipper liability under the Insider Trading Act.
3
Determine the liability of the recipient who executed the trade (the tippee).
The registered representative is liable as a tippee for executing a sell order based on the confidential tip.
A tippee assumes a derivative duty not to trade when they know or should know that the information was communicated in breach of a fiduciary duty.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
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Topics

Insider Trading and Misuse of Material Nonpublic Information