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Question

Difficulty: MediumInsider Trading and Misuse of Material Nonpublic Information

A freelance graphic designer contracted to format confidential financial statements for a publicly traded pharmaceutical company learns of an unannounced positive FDA drug approval. Prior to public dissemination, the designer shares this information with a close friend, who subsequently purchases call options on the pharmaceutical company's stock. The designer executes no personal trades. Which of the following statements regarding potential insider trading liability under federal securities laws are correct?

  1. The graphic designer can be held liable for insider trading as a tipper even though the designer did not personally execute any stock trades.Answer
  2. The friend can be held liable for insider trading as a tippee if the friend knew or should have known that the information was material and nonpublic.Answer
  3. C
    The graphic designer is fully exempt from insider trading laws because independent contractors are not considered corporate insiders or fiduciaries.
  4. D
    Tippee liability cannot be established unless the tippee pays direct financial compensation or a cash fee to the tipper in exchange for the confidential tip.

Answer

The graphic designer can be held liable as a tipper despite not trading personally, and the friend can be held liable as a tippee for trading while knowing the information was material and nonpublic.
Both tipper and tippee liability can be established under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. A contractor who misuses confidential information acts as a temporary insider and incurs tipper liability by passing material nonpublic information to a friend. The tippee incurs liability by acting on that information while knowing or having reason to know of the breach.

Step-by-Step Solution

1
Evaluate the status and duty of the contractor (graphic designer).
As an independent contractor given access to confidential files, the designer becomes a temporary insider with a duty of trust not to disclose or misuse material nonpublic information.
Temporary insiders owe the same duty of confidentiality as full-time corporate officers and directors.
2
Assess tipper liability for passing material nonpublic information.
The designer is liable as a tipper for disclosing unannounced FDA approval details to a friend.
Tipper liability applies when insider information is disclosed in breach of duty, even if the tipper places no trades.
3
Assess tippee liability for trading on the received information.
The friend is liable as a tippee after purchasing call options based on the tipped information.
Tippees incur liability when they trade on material nonpublic information knowing or having reason to know it derived from a breach of duty.

Key Concept

Tipper and Tippee Liability under Insider Trading Regulations
Estimated Time:1m 15s
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Topics

Insider Trading and Misuse of Material Nonpublic Information