Insider trading liability extends beyond the person who actually trades. It can reach anyone in the chain of information, from the original source to the person who passes it along.
Who Can Be Liable?
| Party | Role | How Liability Arises |
|---|---|---|
| Insider | Corporate officer, director, or 10%+ shareholder who possesses material nonpublic information (MNPI) | Directly liable for trading on MNPI because they owe a fiduciary duty to the company and its shareholders |
| Tipper | Person who passes MNPI to another person | Liable even if they did NOT trade themselves, as long as the person they tipped trades on the information |
| Tippee | Person who receives MNPI from a tipper and trades on it | Liable if they knew or should have known the information was material and nonpublic |
| Controlling person | Employer, supervisor, or firm that fails to prevent insider trading | Liable under the Exchange Act's controlling-person provision for failing to maintain adequate procedures |
Think of it this way: Picture a chain of dominoes. The insider tips off a friend, who tips off another friend, who trades. Every domino in that chain can face liability, not just the one that actually fell into the trade.
Exam Tip: Gotchas
- Controlling persons (supervisors, firms) can be liable even if they personally did NOT trade. Their failure to prevent insider trading creates liability.
- A tippee who receives MNPI but does NOT trade is not liable. Liability requires actually trading on the information (or tipping someone else who trades).
The Information Barrier
- Broker-dealers must maintain information barriers (also called "ethical walls") to prevent the flow of MNPI between departments
- Example: The investment banking department learns about a pending merger. This information must NOT reach the trading desk.
- The purpose is to prevent the firm's traders from acting on information obtained through the firm's advisory relationships
Exam Tip: Gotchas
- The information barrier must separate departments that regularly handle MNPI (investment banking, mergers and acquisitions) from trading and sales departments. The barrier is about preventing information flow, not physical separation.
Key Takeaways on Liability
- Tippers are liable even if they never trade. A corporate officer who tells a friend about an upcoming merger is liable as a tipper if that friend trades on the information, even though the officer never bought or sold a single share.
- A tippee does not have to be a corporate insider. Anyone who trades on a tip, knowing or having reason to know the information is material and nonpublic, can be liable.
- Liability follows the information. Every person in the chain (insider, tipper, tippee) can face liability, and the firm and its supervisors can be liable as controlling persons if they failed to maintain procedures to prevent the misconduct.