Abra, a vice-president at Mahogany, Inc., recently revealed - quite inadvertently - information about the tender offer from Mahogany to Kadabra, his friend who works for a rival firm. Kadabra, in turn, shared this information with his trading buddy, Cosmo. Cosmo immediately recognized that in light of this information, he was better off not participating in the offer. He went ahead and shorted the stock of Mahogany and reaped a tidy profit of about a hundred thousand dollars in a month's time when Mahogany tanked. In this case:
I. Cosmo can be held liable for insider trading under SEC Section 10(b) and Rule 10b-5.
II. Cosmo can be held liable for insider trading under the Misappropriation Theory.
III. Cosmo can be held liable for insider trading under SEC Rule 14e-3 which prohibits insider trading based on information about tender offers.
IV. Kadabra has breached his fiduciary duty toward Mahogany.
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A. B. C. D. E. F. G. H.C
This case is similar to the precedent set by United States vs. Chestman. According to the decision in the Chestman case, Kadabra was a "gratuitous recipient" of inside information and as such, had no responsibility to maintain its confidentiality. One party - according to this ruling - cannot unilaterallyimpose a relationship of confidence on another by simply sharing information. Thus, while Kadabra is a tippee, he has no fiduciary duty toward Mahogany. Now, the traditional theory applies only when there is a breach of a direct or inherited fiduciary duty or if the insider trading occurs in a tender offer and the trading is done by an insider or a tippee. So if an outsider - including Cosmo - received and traded based on this information, he could not be held liable under the Traditional Theory or the
Misappropriation Theory. However, if Kadabra had traded for his own account, he would be liable under both the theories as well as under Rule 14e-3.