An analyst hears at a private dinner that a CEO's resignation will be announced Monday. By Sunday night, the analyst's clients are out of the stock. The trade was profitable. It was also a career-ending violation of Standard II(A).
Standard II is the smallest section of the Standards by sub-standard count, only two pieces, but among the most heavily tested because the fact patterns are subtle. The integrity of capital markets depends on a level playing field of information and on prices that reflect real supply and demand. Both sub-standards exist to protect that level field.
Members and candidates who possess MNPI that could affect the value of an investment must not act on it or cause others to act on it. The standard has two prongs joined by AND. Both must be satisfied for the prohibition to apply.
KEY: Material means a reasonable investor would want to know the information before making an investment decision, or the information would likely affect price upon release.
Common mistakes
- Treating "I did not work there" as a defense. Standard II(A) applies to anyone who trades on MNPI, regardless of whether they are an insider. The tippee with knowledge of the breach is liable. Trap: assuming only employees of the issuer are bound.
- Calling selective disclosure "public." If an issuer tells 20 analysts on a private call, the information remains nonpublic until broadly disseminated. Trap: treating a closed conference call or analyst day as public release.
- Misapplying the mosaic theory to MNPI inputs. The theory permits combining public information with non-material nonpublic pieces. It does not launder MNPI through the analytical process. Trap: assuming any combination of inputs produces a clean conclusion.
Bottom line
- Standard II(A) prohibits acting, or causing others to act, on material nonpublic information. Both prongs (material AND nonpublic) must be present for it to apply.
- Mosaic theory permits combining public information with non-material nonpublic items to reach a material conclusion. The conclusion is the analyst's work product, not insider information.
- Standard II(B) prohibits practices that distort prices or artificially inflate trading volume to mislead participants. Intent to deceive is the trigger, not the price effect.
- The four standard II(A) prevention tools are information barriers (firewalls), restricted lists, watch lists, and personal trading reviews (wall-crossing procedures).
Exam shortcut
For Standard II(A), apply the AND test: material AND nonpublic. If either is missing, the prohibition does not apply, and mosaic or normal research is allowed. For Standard II(B), apply the intent test: is the trading designed to mislead, or designed to capture genuine economic value? Legitimate large trades, hedges, and arbitrage move prices without violating II(B).
The full lesson (about 2,726 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- standard II integrity of capital markets
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