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.

What Does the Tender-Offer Insider Trading Prohibition Cover?

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.

The prohibition is not absolute. It does not reach information that was already public, or information the trader can show did not come from the offering person, the issuer, or their insiders.

Why Is the Tender-Offer Rule 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.

How Do the Tender-Offer Insider Trading Rule and General Anti-Fraud Regime Compare?

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 financial-printer employee who pieces together a pending offer from confidential documents and trades on it has no fiduciary duty to 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 prohibition is not absolute. Already-public information and information a trader can show did not come from the deal chain fall outside it.

What Does the Net-Long Rule Require in 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, and net-long violations remain an active enforcement area.

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.

What Does the Outside-Purchase Prohibition Bar?

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 applies to equity-security tender offers and does not bar purchases made during a subsequent offering period at the same form and amount of consideration as 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.

An issuer self-tender carries its own additional tail: the issuer or affiliate may not purchase the security outside the offer, other than pursuant to the tender offer, until 10 business days after termination of the issuer tender offer. This is on top of, not a substitute for, the general outside-purchase prohibition that runs from public announcement through expiration.

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.
• An issuer self-tender's outside-purchase ban does not end at expiration. It extends 10 business days past termination of the issuer tender offer, a narrower fact pattern than the general rule's public-announcement-to-expiration window.

What Should You Check on Exam Day?

• Confirm whether a fact pattern needs a fiduciary breach (general anti-fraud insider trading regime) or not (tender-offer insider trading rule, parity-of-information).
• Trigger the tender-offer insider trading rule once substantial steps toward commencing the offer have occurred, not only after public announcement.
• Recalculate net long position as long positions minus short positions before checking whether a tender amount is permitted.
• Check whether a purchaser outside the offer is a covered person (bidder, dealer-manager, contingent-fee advisor, or person acting in concert) before applying the outside-purchase prohibition.
• For an issuer self-tender fact pattern, extend the outside-purchase analysis 10 business days past termination, not just to expiration.