Material Nonpublic Information and Insider Trading

Before moving from company-level analysis to market-level analysis, you need to understand the rules governing how information is used. These SEC rules create boundaries that all securities professionals must follow.

SEC Rule 14e-3 - Tender Offer Trading Prohibition

Rule 14e-3 under the Securities Exchange Act of 1934 specifically addresses trading on material, nonpublic information related to tender offers.

• Prohibits any person who possesses material, nonpublic information relating to a tender offer from trading in the target company's securities
• Applies when the person knows (or has reason to know) the information:
  • Is nonpublic
  • Was acquired directly or indirectly from the offering person, the target, or their insiders
• Also prohibits insiders of the bidder and target from tipping (communicating confidential tender offer information to others)
• Creates a "disclose or abstain" obligation: you must either make the information public or refrain from trading
• Exception: The offering person itself may purchase the target's securities (the bidder can buy shares of the target)

Exam Tip: Gotchas

• Rule 14e-3 applies specifically to TENDER OFFERS, not all insider trading situations.
• The bidder (offering person) CAN buy target company shares. Everyone else who possesses material, nonpublic information about the tender offer cannot trade on it.

SEC Rule 14e-4 - Partial Tender Offers

• Prohibits tendering more shares than the person actually owns or has a net long position in
• Prevents manipulation of partial tender offers through short tendering (tendering borrowed shares)
• Protects the integrity of the tender offer process

Exam Tip: Gotchas

• Short tendering (tendering more shares than you own) is prohibited under Rule 14e-4. The rule requires a net long position in the shares being tendered.

Delivery of Annual Reports and Corporate Actions

Broker-dealers have an obligation to keep customers informed about securities they hold:

• Must deliver annual reports and other corporate communications to beneficial owners of securities held in street name
• Customers must be notified of corporate actions including:
  • Dividend declarations (cash, stock, property)
  • Stock splits (forward and reverse)
  • Odd lot tender offers
  • Mergers and acquisitions
  • Rights offerings and warrants

Exam Tip: Gotchas

• Broker-dealers must forward corporate communications to beneficial owners even when shares are held in street name. The firm holding the securities acts as a conduit for all issuer communications.