Insider Trading and Trading Restrictions

The tender-offer insider trading rule is conceptually the most important rule in this unit because it differs from the general anti-fraud insider trading regime in a way the exam tests directly. The net-long rule and the outside-purchase prohibition are smaller but well-tested companion rules.

The Tender-Offer Insider Trading Prohibition

The tender-offer insider trading rule, adopted by the SEC in 1980, applies once substantial steps have been taken toward commencing a tender offer (or after the offer has commenced).

It is unlawful for any person who possesses material nonpublic information relating to the offer to:

• Trade in the target's securities (or related derivatives), OR
• Tip that information to others who may trade

The information must have been acquired from:

• The offering person (bidder)
• The issuer of the subject securities (target)
• Any officer, director, partner, or employee acting on behalf of either

The rule reaches not just classic insiders but also financial printers, lawyers, bankers, dealer-managers, information agents, secretaries, and anyone else who picks up the information through a path that traces back to the bidder or target.

Why the Tender-Offer Rule Is Broader Than the General Anti-Fraud Insider Trading Regime

The conceptual difference between the tender-offer rule and the general anti-fraud insider trading regime is the most important fact in this unit.

• The tender-offer rule does NOT require a breach of fiduciary duty. It operates on the parity-of-information principle: if you have material nonpublic information about a tender offer that you got from the bidder or target chain, you must abstain.
• The general anti-fraud insider trading regime (after the Chiarella and O'Hagan cases) requires either a classical-theory fiduciary duty to shareholders OR a misappropriation breach of duty to the source of the information.

The SEC adopted the tender-offer rule in 1980 specifically to fill the gap left by Chiarella v. United States (1980), which had held that a financial-printer employee who traded on confidential takeover documents did not violate the general anti-fraud insider trading regime because he owed no fiduciary duty to the target shareholders.

Side-by-Side: Tender-Offer Insider Trading Rule vs General Anti-Fraud Regime

Think of it this way: The tender-offer rule says "if you got this from the deal chain, you can't trade." It doesn't care whether you had a fiduciary duty. The general anti-fraud regime needs the duty. The 1980 SEC rule was specifically drafted to catch Chiarella-style printer-employee fact patterns the general regime could not reach.

Exam Tip: Gotchas

• The tender-offer insider trading rule does NOT require a fiduciary breach. This is the single most important conceptual difference from the general anti-fraud insider trading regime. A printer at a financial-printer firm who pieces together a pending offer from confidential documents and trades on it has no fiduciary duty to the target shareholders, so general-regime classical-theory liability was historically uncertain. The tender-offer rule catches that case directly.
• The rule is triggered by SUBSTANTIAL STEPS toward a tender offer, not just by an announced offer. If a bidder has begun talking to its board, hired bankers, and drafted offer documents, substantial steps have likely been taken.

The Net-Long Rule for Partial Tender Offers

In a partial tender offer (offer for less than all outstanding shares of the class), the net-long rule prevents a market participant from tendering more shares than they actually own.

• A person may tender only up to their net long position at both the time of tender and at the end of the proration period
• Net long position = excess of long positions over short positions in the subject security
• Designed to stop double-counting in proration: tendering more shares than you actually own to game the partial-tender proration formula
• Applies to broker-dealers as well as customer accounts

Example: A trader who is long 10,000 shares and short 4,000 shares has a net long position of 6,000 shares. The trader can tender 6,000 shares; tendering 10,000 violates the net-long rule.

The rule has been the subject of continuing SEC enforcement. FY 2019 enforcement actions confirmed the SEC's continuing focus on net-long violations.

Exam Tip: Gotchas

• The net-long rule prohibits tendering more shares than your NET LONG position. A market participant who is short the stock cannot count those short shares against the tender. Long 10,000 / short 4,000 = net long 6,000; that is the maximum you can tender.
• The rule applies to broker-dealers AND customer accounts. A broker-dealer cannot facilitate a customer's over-tender any more than it can over-tender on its own behalf.

The Outside-Purchase Prohibition

The outside-purchase rule prohibits the bidder and other covered persons from buying the subject security outside the tender offer during the offer window.

• From the public announcement of the offer until expiration, a "covered person" may not directly or indirectly purchase or arrange to purchase the subject securities or related securities, except as part of the tender offer
• The rule closes an end-run where the bidder runs a low-price tender and then mops up additional shares in the open market for less

Who Is a Covered Person?

Covered persons include:

• The bidder and its affiliates
• The dealer-manager and its affiliates
• Advisors paid contingent on completion of the offer
• Any person acting in concert with the foregoing

Limited exceptions exist for certain dealer-manager hedging and basket transactions, and there is class relief for cross-border offers where US holders are 10% or less of the class.

Exam Tip: Gotchas

• The outside-purchase rule prohibits the bidder (AND dealer-managers, advisors, and persons acting in concert with them) from buying the subject security OUTSIDE the offer during the offer window. This forecloses the end-run where the bidder runs a low-price tender and then mops up additional shares in the open market for less.
• The covered-persons definition is broad. It captures the bidder's advisors and anyone acting in concert with the bidder, not just the bidder itself.