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Difficulty: HardInsider Trading and Misuse of Material Nonpublic Information

A senior research analyst at a broker-dealer receives an unsolicited phone call from a close relative who works as a clinical study coordinator at a publicly traded biopharmaceutical company. The relative reveals unreleased Phase III trial results showing that a flagship drug candidate failed to meet its primary efficacy endpoints. Knowing this information is confidential, the analyst does not trade for their personal account, but immediately communicates the negative finding to a favored institutional client, who then sells short 50,000 shares of the biopharmaceutical company prior to the public announcement. Under federal securities laws governing insider trading, which of the following statements correctly evaluates the legal liability of the analyst and the institutional client?

  1. Both the analyst and the institutional client may be held liable under insider trading regulations, as the information was material and nonpublic, a breach of duty occurred, and a trade was executed based on the tip.Answer
  2. B
    Only the institutional client can be held liable because liability under insider trading laws applies exclusively to the individual or entity that actually executes transactions and realizes financial gain.
  3. C
    Neither the analyst nor the institutional client can be held liable because the institutional client is not an insider of the biopharmaceutical company and owes no fiduciary duty to its shareholders.
  4. D
    Only the analyst can be held liable because registered representatives are subject to FINRA jurisdiction, whereas outside institutional investors are exempt from insider trading provisions.

Answer

Both the analyst (as tipper) and the institutional client (as tippee) may be held liable for insider trading because material nonpublic information was selectively disclosed in breach of duty and subsequently traded upon.
Under federal securities laws (Insider Trading Sanctions Act of 1984 and Insider Trading and Securities Fraud Enforcement Act of 1988), tipper/tippee liability applies to both parties when material nonpublic information is conveyed in breach of a duty and subsequently used to trade securities. The analyst is liable as a tipper for passing the material nonpublic clinical trial results, and the institutional client is liable as a tippee for executing short sales based on that information.

Step-by-Step Solution

1
Evaluate the nature of the information
Unreleased clinical trial results for a flagship drug candidate represent material nonpublic information (MNPI) because a reasonable investor would consider it significant in making an investment decision.
Establishing that the information is both material and nonpublic is the baseline prerequisite for an insider trading violation.
2
Analyze tipper liability for the analyst
The analyst breached a duty by communicating MNPI to a client, making them liable as a tipper.
A party who passes MNPI to others who subsequently trade is fully liable as a tipper regardless of whether the tipper personally traded or profited.
3
Analyze tippee liability for the institutional client
The institutional client traded on MNPI while knowing (or having reason to know) that the information was nonpublic and obtained improperly, establishing tippee liability.
Tippees inherit the duty not to trade or misuse MNPI when they know or should know the source breached a duty of confidentiality.

Key Concept

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

Insider Trading and Misuse of Material Nonpublic Information