Stock Lawyer Insider Trading Laws 1 — Questions and Answers
Question 1: What is the legal basis for prohibiting insider trading under federal securities law?
- Section 11 of the Securities Act of 1933
- Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 (Correct answer)
- Section 16(b) of the Securities Exchange Act of 1934
- Section 5 of the FTC Act
Correct answer: Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
Insider trading is primarily prosecuted under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which broadly prohibit fraud and deception in securities transactions.
Question 2: Under the 'classical theory' of insider trading, who owes a duty that prohibits trading on material nonpublic information?
- Any person who possesses material nonpublic information
- Only company officers and directors
- Corporate insiders who owe a fiduciary duty to shareholders (Correct answer)
- Only registered broker-dealers
Correct answer: Corporate insiders who owe a fiduciary duty to shareholders
The classical theory holds that corporate insiders (officers, directors, and employees) breach their fiduciary duty to shareholders when they trade on material nonpublic information about their company.
Question 3: What is the 'misappropriation theory' of insider trading liability?
- Liability for stealing physical stock certificates
- Liability for trading on information misappropriated from a source to whom a duty of trust or confidence is owed (Correct answer)
- Liability for misrepresenting stock prices
- Liability for front-running client orders
Correct answer: Liability for trading on information misappropriated from a source to whom a duty of trust or confidence is owed
The misappropriation theory, upheld in United States v. O'Hagan, holds that a person commits fraud when they trade on material nonpublic information misappropriated from an outside source to whom they owe a duty.
Question 4: What must the government prove to establish 'tipping' liability against a tipper in an insider trading case?
- That the tipper received monetary payment for the tip
- That the tipper received a personal benefit from disclosing material nonpublic information (Correct answer)
- That the tippee actually traded on the information
- That the tipper intended to defraud the company
Correct answer: That the tipper received a personal benefit from disclosing material nonpublic information
Under Dirks v. SEC, a tipper is liable only if they received a personal benefit — direct or indirect — from disclosing material nonpublic information to the tippee.
Question 5: What civil penalty can the SEC impose on a person found liable for insider trading?
- Up to $1 million or twice profits gained
- Up to three times the profit gained or loss avoided (Correct answer)
- Disgorgement of profits only
- No more than $500,000 per violation
Correct answer: Up to three times the profit gained or loss avoided
Under the Insider Trading Sanctions Act, the SEC may seek civil penalties of up to three times the profit gained or loss avoided as a result of the unlawful insider trading.
Question 6: Which SEC rule defines 'material nonpublic information' for purposes of insider trading enforcement?
- Rule 10b-5
- Rule 14e-3
- There is no single rule — materiality is a facts-and-circumstances test (Correct answer)
- Rule 144
Correct answer: There is no single rule — materiality is a facts-and-circumstances test
Materiality is determined by a facts-and-circumstances test: information is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision.
Stock Lawyer Insider Trading Laws 1
What is the legal basis for prohibiting insider trading under federal securities law?