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← Series 79: Section 4
Series 79 practice questionhardMNPI and Insider Trading

A senior investment banker at Firm X tells his college roommate about a pending merger involving one of Firm X's clients. The roommate then tips his brother, who purchases shares in the target company. Under the misappropriation theory of insider trading, who may face liability?

  1. AOnly the brother who purchased the shares, since he is the one who profited from the trade
  2. BOnly the investment banker, since he was the original source of the information
  3. CThe investment banker, the college roommate, and the brother may all face liability as tipper and tippees in the chain✓ Correct answer
  4. DNo one faces liability because the roommate and brother had no fiduciary duty to the issuer
Explanation

Why C — The investment banker, the college roommate, and the brother may all face liability as tipper and tippees in the chain

Under the misappropriation theory established in United States v. O'Hagan, all participants in a tipping chain may face liability for insider trading. The investment banker is liable as the original tipper who breached his duty of confidence. The roommate is liable as both a tippee and a secondary tipper, and the brother is liable as the downstream tippee who traded on the information. The SEC can pursue civil enforcement against all parties, and criminal charges may also apply under Section 10(b) and Rule 10b-5.

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