The calculation for the approximate Yield to Maturity (YTM) is performed using the following formula: \[ YTM \approx \frac{C + \frac{F – P}{n}}{\frac{F + P}{2}} \]. In this formula, C represents the annual coupon payment, F is the face or par value of the bond, P is the current market price, and n is the number of years until maturity. For the bond in question, the annual coupon payment (C) is 6% of the $1,000 par value, which equals $60. The face value (F) is $1,000, the current price (P) is $920, and the years to maturity (n) is 10. First, we calculate the annualized amortization of the discount, which is the difference between the face value and the price, divided by the years to maturity: \( \frac{\$1000 – \$920}{10} = \frac{\$80}{10} = \$8 \). This $8 represents the average annual capital gain the investor will realize by holding the bond to maturity. This amount is added to the annual coupon payment to find the total annual return: \( \$60 + \$8 = \$68 \). Next, we calculate the average value of the bond over its remaining life: \( \frac{\$1000 + \$920}{2} = \frac{\$1920}{2} = \$960 \). Finally, we divide the total annual return by the average value of the bond to find the approximate YTM: \( \frac{\$68}{\$960} \approx 0.07083 \), or 7.08%. Yield to maturity represents the total anticipated return on a bond if it is held until it matures. It takes into account not only the periodic coupon payments but also the capital gain or loss the investor will realize upon maturity. When a bond’s market price is lower than its par value, it is said to be trading at a discount. This situation typically occurs when prevailing interest rates in the market have risen above the bond’s fixed coupon rate. New bonds are being issued with higher coupons, making the older, lower-coupon bond less attractive unless its price is reduced. Therefore, a YTM that is higher than the bond’s nominal (coupon) rate is a clear indicator that the bond is trading at a discount, which in turn suggests that interest rates for comparable securities have increased since the bond was originally issued.

The initial total cost basis of the investment is calculated by multiplying the number of shares by the purchase price per share. Initial Total Cost Basis = 1,200 shares × \(\$5.00\)/share = \(\$6,000.00\) A 1-for-4 reverse stock split means that for every 4 shares an investor owns, they will receive 1 new share. The new number of shares is calculated by dividing the original number of shares by 4. New Number of Shares = 1,200 shares / 4 = 300 shares A reverse stock split is a corporate action that does not change the total value of an investor’s position at the moment of the split. Therefore, the total cost basis of \(\$6,000.00\) remains the same. This total cost must be reallocated across the new, smaller number of shares to find the new cost basis per share. New Cost Basis per Share = Total Cost Basis / New Number of Shares New Cost Basis per Share = \(\$6,000.00\) / 300 shares = \(\$20.00\) per share A reverse stock split is a corporate action in which a company reduces the total number of its outstanding shares in the open market. This is done by consolidating existing shares into a smaller number of proportionally more valuable shares. For example, in a 1-for-4 reverse split, an investor receives one new share for every four old shares they held. The primary motivation for a reverse split is often to increase the stock’s trading price per share. A higher stock price can help a company maintain its listing on a major stock exchange, which may have minimum price requirements, or it can make the stock appear more substantial and attractive to institutional investors. It is critical to understand that this action does not alter the company’s market capitalization or an investor’s total equity value in the company at the time of the split. The investor owns fewer shares, but each share is now worth more. Consequently, the investor’s total cost basis for the entire position remains unchanged. To reflect this, the cost basis per share must be adjusted upwards. This adjustment is not a taxable event for the shareholder.

The primary violation is the communication of material nonpublic information (MNPI) for personal benefit, which constitutes illegal insider trading under the Securities Exchange Act of 1934. Kenji, by selectively disclosing information about the pending merger to Anika, acted as a “tipper.” Anika, by trading on that information, acted as a “tippee.” The act of tipping is illegal if the tipper receives a personal benefit, which can be direct or indirect, financial or reputational. The substantial gift from Anika after the profitable trade serves as clear evidence of a personal benefit, solidifying the insider trading violation. While accepting a gift over the $100 limit is a violation of FINRA Rule 3220 and failing to report it is a violation of firm policy and potentially FINRA Rule 4530, these are secondary to the far more severe offense of insider trading. The penalties for insider trading, governed by the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), can include civil penalties up to three times the profit gained or loss avoided (treble damages), disgorgement of profits, and criminal penalties including fines and incarceration. Therefore, the act of tipping MNPI is the most significant regulatory breach.

The scenario describes a violation of FINRA Rule 5270, which prohibits front-running. Front-running occurs when a broker-dealer or an associated person trades a security based on advance knowledge of a large, non-public customer order, known as a block trade, that is reasonably expected to influence the market price of the security. In this case, Anika became aware of an impending large sell order for Innovate Corp. stock. This block sale is material information because its execution is likely to cause a decrease in the stock’s price. By advising her client to purchase put options on Innovate Corp. before the block trade was executed, she was using this privileged, non-public information about an imminent transaction to secure a potential profit for her client from the anticipated price decline. This action directly constitutes trading ahead of a customer’s block order. While it involves using non-public information, the specific violation is front-running because the information pertains to an impending market transaction rather than a fundamental corporate event like an earnings announcement or a merger, which would be more classically defined as insider trading under the Securities Exchange Act of 1934. The key distinction is the nature of the information; front-running is specifically about knowledge of an impending trade.

Logical Deduction: 1. Identify the information received by the registered representative (RR) as Material Nonpublic Information (MNPI). The information about the unannounced merger is not public and would certainly affect a reasonable investor’s decision. 2. Recognize that under the Securities Exchange Act of 1934 and the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), the RR is now considered an insider or tippee with a duty of trust and confidence. 3. The primary obligation is to not trade on the information or disseminate it. However, the RR’s professional duties (e.g., providing recommendations, managing accounts) are now in conflict with this obligation. 4. The RR cannot simply do nothing, as this fails to protect the firm from potential violations. The firm itself has an obligation to prevent the misuse of MNPI. 5. The correct procedure is to escalate the issue internally. The RR must notify their supervisor or the firm’s compliance/legal department. 6. This notification allows the firm to implement its established written supervisory procedures. A key procedure is placing the security in question (the target company’s stock) on a restricted list. This action blocks all transactions, solicitations, and recommendations regarding that security by anyone at the firm, thereby preventing inadvertent violations and managing the conflict of interest. The possession of material nonpublic information, or MNPI, by an associated person of a broker-dealer creates significant regulatory risk for both the individual and the firm. Under the provisions of the Securities Exchange Act of 1934 and the Insider Trading and Securities Fraud Enforcement Act of 1988, individuals who receive such information have a duty to not trade on it or pass it along to others who might. This duty extends to tippees, who receive information from an insider. In this scenario, the representative has become a tippee. While the most obvious prohibition is against personal trading, the representative’s professional obligations create a deeper conflict. Continuing to advise clients or make recommendations without being able to use the material information could be considered a breach of duty to the client, while using it would be illegal. To resolve this conflict and protect the firm from liability, broker-dealers must have robust written supervisory procedures. The appropriate action for the representative is to immediately report the situation to their supervisor or the firm’s compliance department. This allows the firm to take institutional-level preventative measures, the most common of which is placing the security on a restricted list. This action prohibits all employees of the firm from soliciting or executing trades in that security, effectively creating an information barrier and preventing violations.

The representative’s action constitutes a violation of FINRA Rule 2010, which requires associated persons to observe high standards of commercial honor and just and equitable principles of trade. While the situation does not meet the specific legal definition of insider trading, it represents unethical conduct. Insider trading requires that the individual acts on material, nonpublic information obtained from an insider of the company whose securities are being traded. In this scenario, the representative did not possess any information from an insider at the technology company. Instead, he made an inference based on the trading activity of his colleagues at his own firm. This information about his colleagues’ personal trading, while nonpublic, is not material information originating from the technology issuer itself. However, using observations of colleagues’ internal, private financial activities to inform client recommendations is a breach of professional ethics. It leverages his position within the firm to gain an informational advantage that is not available to the public and is not based on legitimate research. This conduct undermines the integrity of the market and the ethical standards expected of a registered professional. It falls under the broad scope of Rule 2010 because it is not a just and equitable principle of trade. The mosaic theory, which permits analysts to piece together public and non-material nonpublic information, is not applicable here as the basis for the recommendation is not diligent research but rather the exploitation of a privileged internal observation.

Leo’s actions constitute a serious regulatory violation. The core issue is the communication of Material Nonpublic Information (MNPI). While the raw data Leo analyzed was technically in the public domain, his synthesized analysis, the conclusions drawn in the research report, and most importantly, the imminent publication of that report by his firm, are all considered MNPI until the report is widely disseminated. The information is material because it is reasonably certain to affect the stock’s price and influence an investor’s decision. It is nonpublic because it was known only to Leo and his firm prior to the official release. By hinting to Maya about the “troubling data” and the forthcoming negative news, Leo engaged in “tipping.” This is a form of insider trading where a person with MNPI (the tipper) discloses it to another person (the tippee) who then trades on that information. The tipper is liable, as is the tippee if they knew or should have known the information was MNPI. The violation occurs regardless of whether Leo personally profited from the trade. The act of providing the tip for a personal benefit, which can be as intangible as enhancing a friendship, is sufficient to establish liability. This conduct is a breach of the Securities Exchange Act of 1934, specifically Rule 10b-5, which prohibits manipulative and deceptive devices. It also violates FINRA Rule 2010, which requires associated persons to observe high standards of commercial honor and just and equitable principles of trade, and potentially FINRA Rule 5280, which prohibits trading ahead of research reports.

This scenario is governed by FINRA Rule 3240, which addresses borrowing from and lending to customers. The rule generally prohibits registered persons from entering into such arrangements. However, the rule provides five specific exceptions where lending may be permissible, but only if the member firm has established written procedures allowing for it. These exceptions include arrangements with a customer who is a member of the representative’s immediate family; a customer that is a financial institution regularly engaged in the business of lending; a customer who is also a registered person at the same firm; a lending arrangement based on a personal relationship with the customer outside of the broker-customer relationship; or a lending arrangement based on a business relationship outside of the broker-customer relationship. In the situation described, the relationship between the representative and the client is purely professional, based on their broker-customer history. A long-standing professional relationship does not qualify as a personal relationship outside of the broker-customer context under the rule. Therefore, the proposed loan does not meet any of the specified exceptions. The action would be a violation of FINRA Rule 3240, regardless of the representative’s good intentions or the client’s need. The rules regarding gifts and the improper use of a customer’s own funds are distinct and do not apply directly to this situation of a representative lending their personal funds to a client.

FINRA Rule 3240 generally prohibits registered representatives from borrowing money from or lending money to their customers to prevent potential conflicts of interest and exploitation. However, the rule provides for specific exceptions if the member firm has established written procedures permitting such arrangements. The five permissible arrangements are: 1) the customer is a member of the representative’s immediate family; 2) the customer is a financial institution regularly engaged in the business of lending; 3) the customer and the representative are both registered with the same firm; 4) the loan is based on a personal relationship with the customer that exists outside of the broker-customer relationship; 5) the loan is based on a business relationship that is independent of the broker-customer relationship. In the scenario presented, the arrangement falls under the fourth exception, as it is based on a pre-existing personal relationship. For arrangements based on a personal or independent business relationship, the rule imposes a specific supervisory requirement. The registered representative must provide prior written notice of the proposed lending arrangement to the member firm and must receive written approval from the firm before the loan can be made. The firm’s pre-approval is a critical step to ensure proper supervision and to assess whether the arrangement could compromise the representative’s duties to the customer or the firm. Simply having a personal relationship does not negate this requirement for firm notification and pre-approval.

The core issue revolves around the use of material nonpublic information (MNPI) and the specific regulations governing research reports. Ben, the proprietary trader, directly overheard information about an impending “buy” rating upgrade. This information is material because its release is likely to affect the stock’s price, and it is nonpublic because it has not been disseminated to the public. By trading in the firm’s proprietary account based on this advance knowledge, Ben is engaging in a prohibited practice known as trading ahead of a research report, a violation of FINRA Rule 5280. This rule is designed to prevent firms and their employees from profiting from their own research before clients have an opportunity to act on it. Chloe’s situation is fundamentally different due to the presence of an effective information barrier, often called a Chinese Wall. These are policies and procedures that prevent the flow of MNPI between a firm’s departments, such as research and trading. Chloe’s decision to purchase the stock was based on her own independent analysis and her observation of public market data, such as pre-market trading volume and price movement. Since she did not possess the MNPI from the research department and her decision-making process was separate and documented, her trades for institutional client accounts are permissible. The regulations recognize that large, multi-service firms can continue to trade for clients as long as effective information barriers are in place and the trading decision is not based on inside information.

Under SEC Rule 144, an affiliate of a reporting company who wishes to sell shares must comply with specific conditions, including volume limitations. An affiliate, or control person, is an individual in a position of power, such as an officer, director, or major shareholder. The shares they own are considered control stock, and any sales are subject to Rule 144’s volume limits, regardless of how the shares were acquired. The rule also governs the sale of restricted securities, which are those acquired in a private, unregistered transaction. For a reporting company, restricted securities have a six-month holding period before they can be sold. In this scenario, the individual is an executive vice president, making him an affiliate. His restricted shares have been held for eight months, satisfying the six-month holding period. Therefore, he can sell both his restricted and control shares, but the total amount sold in any 90-day period is subject to a volume limitation. This limit is the greater of 1% of the total outstanding shares of the company or the average weekly trading volume over the preceding four calendar weeks. First, calculate 1% of the outstanding shares: \[0.01 \times 50,000,000 \text{ shares} = 500,000 \text{ shares}\] Next, identify the average weekly trading volume over the last four weeks, which is given as 480,000 shares. Finally, compare the two figures and take the greater value. \[\text{Greater of } (500,000 \text{ shares}, 480,000 \text{ shares}) = 500,000 \text{ shares}\] Therefore, the maximum number of shares the affiliate can sell during any 90-day period is 500,000.

Kenji is liable for insider trading under the misappropriation theory, which is codified in part by SEC Rule 10b5-2. This rule addresses situations where a duty of trust or confidence exists outside of a traditional business or fiduciary relationship. The rule specifies that such a duty is established when the person receiving the information has a history, pattern, or practice of sharing confidences with the person communicating the information, leading to a reasonable expectation of confidentiality. In this scenario, Anika and Kenji have such a history. Furthermore, the rule explicitly states that a duty of trust or confidence is presumed when material nonpublic information is obtained from a sibling. Anika, the corporate insider, shared material nonpublic information about the impending FDA rejection with her brother, Kenji. She also explicitly requested that he keep the information confidential. By trading on this information for his own benefit, Kenji breached the duty of trust and confidence he owed to his sister. This act of misappropriating confidential information for personal gain constitutes a violation of insider trading laws, regardless of the fact that he is not an employee of PharmaCorp or that his sister did not receive a direct financial benefit for the tip.

The core of this issue revolves around FINRA Rule 2150, which governs the sharing of profits and losses in a customer’s account by an associated person. The general principle is that registered representatives are prohibited from sharing directly or indirectly in the profits or losses of a customer’s account. However, the rule provides a specific exception. An associated person may share in a customer’s account if two critical conditions are met. First, the associated person must receive prior written authorization from their employing member firm. Second, the sharing of gains and losses must be in direct proportion to the financial contribution made by the associated person to the account. For instance, if the representative contributes 25% of the capital to the joint account, they may only share in 25% of the profits and must also bear 25% of the losses. Any arrangement that deviates from this proportionality, such as sharing only in profits, is prohibited. Furthermore, the rule explicitly forbids any associated person from guaranteeing a customer’s account against loss. Separately, FINRA Rule 3240 addresses lending arrangements. While it permits lending to a customer with whom the representative has a pre-existing personal relationship, this is not an automatic right; it is still subject to the member firm’s written procedures and requires pre-approval from the firm. An exemption from firm approval does not exist for this type of relationship.

Maria’s actions constitute two significant and distinct regulatory violations. First, she engaged in front running, which is prohibited under FINRA Rule 5270. Front running occurs when a broker-dealer or its representative trades a security for their own account with advance knowledge of a pending large customer order (a block trade) or a soon-to-be-issued research report that is expected to influence the stock’s price. By purchasing shares for her discretionary account and advising her institutional client to do so before the research report’s public release, she was trading ahead of information that would foreseeably move the market. Second, her actions fall under the definition of insider trading, as prohibited by the Securities Exchange Act of 1934. The unreleased research report with its “strong buy” rating is considered material nonpublic information (MNPI). The analyst, Leo, had a fiduciary duty not to selectively disclose this information. By receiving this information as a “tippee” and subsequently trading on it for personal gain and tipping her client to trade, Maria breached the duty of trust and confidence. The information was material because a reasonable investor would consider it important in making an investment decision, and it was nonpublic because it had not been disseminated to the market at large. Both trading for her own account and causing her client to trade based on this MNPI are violations.

This scenario illustrates the concept of insider trading, specifically focusing on tipper and tippee liability under the misappropriation theory. Insider trading is the illegal practice of trading on the stock exchange to one’s own advantage through having access to confidential, or material nonpublic, information. Material nonpublic information is any information that has not been disseminated to the public and that a reasonable investor would likely consider important in making an investment decision. Examples include pending mergers, acquisitions, or significant earnings announcements. Under the Securities Exchange Act of 1934, liability extends beyond traditional corporate insiders like officers and directors. The misappropriation theory holds that a person commits fraud in connection with a securities transaction when they misappropriate confidential information for securities trading purposes, in breach of a duty owed to the source of the information. In this case, Kenji, the paralegal, owes a duty of confidentiality to his employer, the law firm. By sharing the confidential information about the acquisition with his cousin, he breaches this duty and becomes a tipper. For a tippee to be liable, they must know or have reason to know that the information was confidential and obtained through a breach of duty, and they must trade on that information. When Maya uses this specific, nonpublic information to purchase shares of the target company, she becomes a liable tippee. Both the tipper (Kenji) and the tippee (Maya) have committed a violation. The act of trading on the information is the culminating prohibited activity. The law firm’s internal policies are a compliance matter but do not define the securities law violation itself. Simply possessing the information without a breach of duty or subsequent trade is not a violation.

The scenario describes a violation known as trading ahead of a research report, which is prohibited under FINRA Rule 5280. This rule specifically forbids a member firm from establishing, increasing, decreasing, or liquidating an inventory position in a security or a related derivative based on nonpublic advance knowledge of the content and timing of a research report in that security. The trader, upon learning from the analyst about the imminent release of a “strong buy” recommendation, used this privileged, nonpublic information to purchase shares for the firm’s proprietary account. The intent was to profit from the anticipated price increase that would follow the public dissemination of the report. This action is a breach of regulatory standards because it leverages nonpublic information generated by the firm for its own benefit before clients and the public have an opportunity to react to the same information. It is distinct from classic insider trading, which typically involves material nonpublic information obtained directly from the issuer. It is also different from front-running, which involves trading ahead of a large customer block order rather than a research report. The core of the violation is the misuse of advance knowledge of the firm’s own research for proprietary gain.

The core issue revolves around the application of SEC Rule 10b5-1, which provides an affirmative defense against allegations of insider trading. Insider trading is the act of trading a security based on material nonpublic information, or MNPI. In this scenario, the negative news about losing a major government contract is clearly MNPI. The executive, Anika, was in possession of this MNPI at the time her stock sale was executed on April 1st. However, the trade was not a spontaneous decision made after learning the bad news. Instead, it was executed automatically as part of a pre-arranged trading plan established on January 15th. For a Rule 10b5-1 plan to provide a valid defense, it must be entered into in good faith at a time when the individual is not aware of any MNPI. The plan must specify the amount, price, and date of the transactions, or provide a clear formula for determining them, and the individual cannot exercise any subsequent influence over the trades. Since Anika established her written plan before she came into possession of the MNPI, and the trade was executed pursuant to that pre-existing, un-altered plan, she can assert an affirmative defense. The rule is designed to allow corporate insiders to liquidate their holdings in an orderly manner without being accused of insider trading every time a transaction occurs while they possess some form of MNPI.

The primary violation committed by the registered representative, Anya, is the act of illegally tipping material nonpublic information. Material nonpublic information, or MNPI, is any information that has not been disseminated to the general public and that a reasonable investor would likely consider important when making an investment decision. The news of a failed drug trial for a pharmaceutical company is a classic example of MNPI. Under the Securities Exchange Act of 1934, it is illegal to trade securities based on MNPI or to pass such information to others who may trade on it. The person who passes the information is known as the “tipper,” and the person who receives the information and acts on it is the “tippee.” In this scenario, Anya is the tipper and her colleague, Ben, is the tippee. Both the tipper and the tippee can be held liable for the insider trading violation. Anya’s liability exists even though she did not personally profit from the information or trade in her own account. Her act of conveying the MNPI to a person who subsequently traded constitutes the violation. This liability often stems from a breach of a duty of trust and confidence, which can be established through relationships like close friendships where there is a reasonable expectation of confidentiality, as described in SEC Rule 10b5-2. The key takeaway is that liability for insider trading extends beyond just the person who executes the trade to those who improperly disseminate the information.

The calculation to determine the capital gain is as follows. First, determine the initial total cost of the investment: \[1,200 \text{ shares} \times \$5.00/\text{share} = \$6,000\] Next, calculate the impact of the 1-for-4 reverse stock split on the number of shares and the cost basis per share. The total cost of the position remains unchanged. New number of shares: \[1,200 \text{ shares} \div 4 = 300 \text{ shares}\] New cost basis per share: \[\$6,000 \text{ total cost} \div 300 \text{ new shares} = \$20.00/\text{share}\] Then, calculate the proceeds from the sale of 100 shares: \[100 \text{ shares} \times \$25.00/\text{share} = \$2,500\] Next, calculate the cost basis of the shares that were sold using the new, adjusted cost basis per share: \[100 \text{ shares} \times \$20.00/\text{share} = \$2,000\] Finally, calculate the capital gain by subtracting the cost basis of the sold shares from the sale proceeds: \[\$2,500 \text{ (Proceeds)} – \$2,000 \text{ (Cost Basis)} = \$500 \text{ (Capital Gain)}\] A reverse stock split is a corporate action where a company reduces the number of its outstanding shares, which proportionally increases the market price per share. For an investor, the total value of their holding remains the same immediately after the split. A critical concept for tax purposes is the adjustment of the cost basis. While the total cost basis of the entire position does not change, the cost basis per share must be recalculated. This is done by dividing the original total cost of the investment by the new, lower number of shares. This new per-share cost basis is then used to determine the capital gain or loss when any of the shares are subsequently sold. The sale of a security is a taxable event where a capital gain or loss is realized. The gain or loss is the difference between the net proceeds from the sale and the adjusted cost basis of the securities sold. It is a common misconception that the original per-share cost basis is used or that no gain or loss is recognized until the entire position is liquidated. Each sale of shares is a separate event for tax reporting purposes.

The transaction described occurs in the fourth market. The defining characteristic of the fourth market is the direct trading of securities between two institutional investors without the intermediation of a broker-dealer. In this scenario, the pension fund and the mutual fund, both being large institutional investors, are executing a large block trade directly with one another. The use of an Electronic Communication Network (ECN) is a common feature of the fourth market, as these systems facilitate direct matching of buyers and sellers. This market exists to allow institutions to trade large quantities of stock without causing significant price fluctuations that might occur if the order were placed on a public exchange. It is distinct from the primary market, where new securities are issued. It is also different from the standard secondary market, which involves trading on a centralized exchange like the NYSE. Finally, it is not the third market, because the third market involves a broker-dealer trading exchange-listed securities in the over-the-counter (OTC) space for its clients; the key here is the absence of a broker-dealer intermediary in the transaction between the two institutions.

The situation involves a “specified adult,” defined by FINRA as a person age 65 or older, or a person age 18 or older who the member firm reasonably believes has a mental or physical impairment that makes them unable to protect their own interests. In this case, the 82-year-old client clearly meets this definition. The registered representative has a reasonable belief that the client may be subject to financial exploitation or is making a decision inconsistent with her historical investment profile due to potential cognitive decline. Under FINRA Rule 2165, Financial Exploitation of Specified Adults, a member firm is permitted to place a temporary hold on the disbursement of funds or securities from the account of a specified adult. This hold is intended to give the firm time to investigate the situation. It is critical to understand that this rule allows a hold on disbursements out of the account, not a block on trading activity within the account. Furthermore, the rule authorizes, but does not require, the firm to contact the trusted contact person designated on the account to discuss the situation and the firm’s concerns. Contacting the trusted contact is a key step in fulfilling the firm’s duty to protect the client. Simply executing the trade without further action ignores the protective measures available, while refusing the trade or demanding authorization from the trusted contact person oversteps the firm’s authority in a non-discretionary account and misinterprets the role of a trusted contact. The most appropriate course of action combines the specific powers granted by the rule: placing a hold on disbursements and communicating with the trusted contact person to gather more information and express concern.

The initial position consists of 100,000 shares acquired at a cost of \( \$2.00 \) per share, resulting in a total cost basis of \(100,000 \times \$2.00 = \$200,000\). A 1-for-5 reverse stock split means that for every 5 shares an investor owns, they will receive 1 new share. The number of shares held after the split is calculated by dividing the original number of shares by 5, which is \(100,000 \div 5 = 20,000\) new shares. The total value or aggregate cost basis of the position does not change due to a stock split or reverse split. The total cost basis remains \( \$200,000 \). To find the new cost basis per share, the total cost basis is divided by the new number of shares: \(\$200,000 \div 20,000 \text{ shares} = \$10.00\) per share. Crucially, under SEC Rule 144, the holding period for restricted securities is not affected by a stock split, reverse stock split, or reclassification of securities. The holding period for the new shares is considered to have begun on the same date the original shares were acquired. For a non-reporting issuer, the required holding period under Rule 144 is one year. Since the executive has already held the shares for eight months, the original holding period continues to run. Therefore, she must wait for the remainder of the one-year period, which is four more months, before she is eligible to sell the shares in the public market, subject to other Rule 144 conditions.

Kenji’s action of communicating information about an upcoming, unreleased research report constitutes a violation of insider trading regulations. The core of the issue rests on the definition of Material Nonpublic Information (MNPI). Information is considered material if a reasonable investor would find it important in making an investment decision. An upcoming, highly positive research report from a broker-dealer certainly meets this criterion. The information is nonpublic because it has not been disseminated in a way that gives the general public an opportunity to act on it. Under the Securities Exchange Act of 1934 and the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), individuals with a fiduciary duty, such as employees of a broker-dealer, are prohibited from using MNPI for improper purposes. When Kenji disclosed this information to Maria, he became a “tipper.” He breached his duty of confidentiality to his employer. Maria, who then traded based on this information, is the “tippee.” The fact that Kenji did not explicitly name the company does not absolve him of liability. He provided enough specific detail—a “very bullish report” on a “niche robotics company specializing in automated warehouse solutions”—for Maria to deduce the company’s identity. This is often referred to as the “mosaic theory,” where even providing a key piece of a puzzle of nonpublic information can be a violation. The personal benefit for the tipper does not need to be financial; it can be reputational or simply the act of making a gift of confidential information to a friend or relative. Therefore, Kenji’s selective disclosure was an illegal tip of MNPI.

The situation described involves an insider, a director of a public company, who wishes to sell company stock but is frequently in possession of material nonpublic information (MNPI). Trading while in possession of such information constitutes illegal insider trading. The Securities and Exchange Commission (SEC) provides a specific safe harbor through Rule 10b5-1 to allow insiders to trade their company’s securities in a compliant manner. This rule establishes an affirmative defense against insider trading allegations. To utilize this defense, the insider must establish a written trading plan at a time when they are not aware of any MNPI. This plan must be entered into in good faith and not as part of a scheme to evade insider trading prohibitions. The plan must specify the amount of securities to be sold, the price at which to sell, and the date on which to sell. Alternatively, it can provide a written formula or algorithm for determining these factors. Once this binding plan is in place, the trades are executed automatically according to its terms, even if the insider later comes into possession of new MNPI. This structure effectively separates the trading decision from the subsequent possession of inside information, demonstrating that the trades were not made on the basis of that information.

The core of this issue revolves around the distinction between an Outside Business Activity (OBA) under FINRA Rule 3270 and a Private Securities Transaction (PST) under FINRA Rule 3280. An OBA is any business activity conducted by a registered person outside the scope of their relationship with their member firm. FINRA Rule 3270 requires the registered person to provide prior written notice to the member firm before engaging in the OBA. The rule applies regardless of whether the activity is investment-related. Compensation is defined broadly and includes any economic benefit, not just immediate cash payment. A reasonable expectation of future compensation, such as receiving equity, triggers the notification requirement. A PST, often called “selling away,” is any securities transaction outside the regular course or scope of an associated person’s employment with a member firm. If the representative is to receive any compensation for the transaction, FINRA Rule 3280 requires them to obtain prior written approval from their firm, and the firm must record the transaction on its books and records and supervise the transaction as if it were its own. If no compensation is involved, only prior written notice is required. In this scenario, the representative’s active involvement in advising the startup on its business plan and financial projections, coupled with the promise of future equity, squarely defines the activity as an OBA. The expectation of compensation exists, even if it is not immediate. Therefore, the primary and immediate obligation is to provide prior written notice to the firm as required by Rule 3270. While the conversations with clients are a significant concern and are moving toward a potential PST, the OBA itself is a distinct, reportable event that has already been established and requires action.

SEC Rule 10b5-1 provides a crucial affirmative defense for individuals, such as corporate insiders, against allegations of insider trading. This defense allows individuals to trade in their company’s securities, even if they later come into possession of material nonpublic information (MNPI), provided the trades are executed under a pre-established plan. For this defense to be valid, the trading plan must be entered into in good faith at a time when the individual was not aware of any MNPI. The plan must specify the amount of securities to be traded, the price, and the date of the transactions, or it must include a written formula or algorithm for determining these elements. Once the plan is established, the individual cannot exercise any subsequent influence over how, when, or whether the trades are made. In the described scenario, the executive established the plan before learning the adverse news. The subsequent trade was executed automatically according to the plan’s predetermined instructions. Therefore, the trade is generally protected by the affirmative defense provided by Rule 10b5-1, as the decision to sell was made before the executive possessed the MNPI. Attempting to alter or cancel the plan after receiving MNPI could itself be viewed as an action based on that information, potentially negating the plan’s protections.

The situation described constitutes a violation of FINRA Rule 5280, Trading Ahead of Research Reports. This rule prohibits a member firm from purposefully establishing, increasing, decreasing, or liquidating an inventory position in a security or a related derivative in anticipation of the issuance of a research report on that security by the member firm. The trader, by observing the analyst’s activities and deducing the nature of the forthcoming report, acted on this nonpublic information about the firm’s own research to trade for the firm’s benefit before the report was disseminated to clients and the public. This action leverages the firm’s own research for proprietary gain before clients have an opportunity to act on it, which is a prohibited manipulative practice. This is distinct from classic insider trading under Rule 10b-5, which typically involves trading on material nonpublic information obtained from an insider of the issuer. Here, the information pertains to the broker-dealer’s own research report, not confidential information from the tech company itself. It is also different from front running under FINRA Rule 5270, which specifically involves trading ahead of a large customer block order. The trigger in this scenario is the impending research report, not a customer’s trade. The core issue is the misuse of information about the firm’s own market-moving analysis for its own account before that analysis is made public.

The action described constitutes front-running. Front-running, as defined under FINRA Rule 5270, is a prohibited activity where a broker-dealer or an associated person trades a security for their own account with advance knowledge of a large, pending customer order, known as a block trade. The intent is to profit from the market movement that the block trade is expected to cause. In this scenario, the representative became aware of a significant institutional sell order that had not yet been executed. Knowing that such a large sell order would likely exert downward pressure on the stock’s price, she executed a short sale in her personal account to capitalize on the anticipated price decline. This action places her personal financial interests ahead of the client’s and exploits non-public information about a pending transaction. This is distinct from insider trading, which typically involves using material non-public information obtained from the issuer of the security, such as knowledge of an unannounced merger or earnings report. Front-running specifically pertains to knowledge of an impending large trade and trading ahead of it. The representative’s action is a direct violation of fair dealing principles and specific SRO rules designed to prevent such manipulative practices.

The governing regulation in this scenario is FINRA Rule 3240, which addresses borrowing from and lending to customers by registered persons. The general principle of this rule is that such arrangements are prohibited to avoid conflicts of interest and potential exploitation of clients. However, the rule provides for specific exceptions where the conflict of interest is deemed to be minimal. These exceptions are permissible only if the member firm has established written procedures allowing them. The five permitted arrangements include those between the registered person and a customer who is an immediate family member; a customer who is a financial institution regularly engaged in the business of extending credit; a customer who is also a registered person at the same firm; a customer with whom the registered person has a personal relationship outside the broker-customer relationship; and a customer with whom the registered person has a business relationship outside the broker-customer relationship. For the exceptions involving personal and business relationships, the rule imposes an additional requirement. The registered person must provide prior written notice of the proposed lending arrangement to the member firm and must receive written approval from the firm before the loan can be made or received. Therefore, even if a legitimate personal relationship exists, the representative cannot proceed without firm notification and approval.

The core issue revolves around a registered representative’s obligations when in possession of material nonpublic information (MNPI) and receiving a client order that appears to be based on that same information. Anya possesses MNPI due to the confidential information shared by her spouse, to whom she owes a duty of trust and confidence under SEC Rule 10b5-2. While she did not personally trade or tip another individual, which would be a direct violation of insider trading rules, her professional responsibilities under SRO rules are still paramount. The client’s large, unsolicited short sale order immediately preceding the negative news is a significant red flag for potential insider trading by the client. Under FINRA Rule 2010, which requires members to observe high standards of commercial honor and just and equitable principles of trade, a representative cannot ignore such a glaring coincidence. Executing a trade that she has strong reason to believe is based on illegal insider activity could be seen as facilitating that activity. Her primary duty in this situation is not to the client’s request to trade, but to the integrity of the market and her firm’s compliance procedures. Therefore, she must escalate the matter to her supervisor or compliance department before proceeding with the order. This allows the firm to review the suspicious activity and determine the appropriate course of action, which may include refusing the trade and filing a Suspicious Activity Report (SAR). Simply executing the unsolicited order ignores her gatekeeper role in preventing market manipulation.