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The Standard

Members and Candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information. 

Test your understanding of Standard II(A)


Trading or inducing others to trade on material nonpublic information erodes confidence in capital markets, institutions, and investment professionals by supporting the idea that those with inside information and special access can take unfair advantage of the general investing public. Although trading on inside information may lead to short-term profits, in the long run, individuals and the profession as a whole suffer from such trading. These actions have caused and will continue to cause investors to avoid capital markets because the markets are perceived to be “rigged” in favor of the knowledgeable insider. When the investing public avoids capital markets, the markets and capital allocation become less efficient and less supportive of strong and vibrant economies. Standard II(A) promotes and allows for a high level of confidence in market integrity, which is one of the foundations of the investment profession.

The prohibition on using this information goes beyond the direct buying and selling of individual securities or bonds. Members and candidates must not use material nonpublic information to influence their investment actions related to derivatives, mutual funds, or other alternative investments. Any trading based on material nonpublic information constitutes a violation of Standard II(A).

What Is “Material” Information?

Information is “material” if its disclosure would probably have an impact on the price of a security or if reasonable investors would want to know the information before making an investment decision. In other words, information is material if it would significantly alter the total mix of information currently available about a security in such a way that the price of the security would be affected.

The specificity of the information, the extent of its difference from public information, its nature, and its reliability are key factors in determining whether a particular piece of information fits the definition of material. For example, material information may include, but is not limited to, information on the following:

  • earnings;
  • mergers, acquisitions, tender offers, or joint ventures;
  • changes in assets or asset quality;
  • innovative products, processes, or discoveries (e.g., new product trials or research efforts);
  • new licenses, patents, registered trademarks, or regulatory approval/rejection of a product;
  • developments regarding customers or suppliers (e.g., the acquisition or loss of a contract);
  • changes in management;
  • change in auditor notification or the fact that the issuer may no longer rely on an auditor’s report or qualified opinion;
  • events regarding the issuer’s securities (e.g., defaults on senior securities, calls of securities for redemption, repurchase plans, stock splits, changes in dividends, changes to the rights of security holders, and public or private sales of additional securities);
  • bankruptcies;
  • significant legal disputes;
  • government reports of economic trends (employment, housing starts, currency information, etc.);
  • orders for large trades before they are executed; and
  • new or changing equity or debt ratings issued by a third party (e.g., sell-side recommendations and credit ratings).

In addition to the substance and specificity of the information, the source or relative reliability of the information also determines materiality. The less reliable a source, the less likely the information provided would be considered material. For example, factual information from a corporate insider regarding a significant new contract for a company is likely to be material, whereas an assumption based on speculation by a competitor about the same contract is likely to be less reliable and, therefore, not material. Additionally, information about trials of a new drug, product, or service under development from qualified personnel involved in the trials is likely to be material, whereas educated conjecture by subject experts not connected to the trials is unlikely to be material.

Also, the more ambiguous the effect of the information on price, the less material that information is considered. If it is unclear whether and to what extent the information will affect the price of a security, the information may not be considered material. The passage of time may also render information that was once important immaterial.

What Constitutes “Nonpublic” Information?

Information is “nonpublic” until it has been disseminated or is available to the marketplace in general (as opposed to a select group of investors). “Disseminated” can be defined as “made known.” For example, a company report of profits that is posted on the internet and distributed widely through a press release or accompanied by a filing has been effectively disseminated to the marketplace. Members and candidates must have a reasonable expectation that people have received the information before it can be considered public. It is not necessary, however, to wait for the slowest method of delivery. Once the information is disseminated to the market, it is public information that is no longer covered by this standard.

Members and candidates must be particularly aware of information that is selectively disclosed by corporations to a small group of investors, analysts, or other market participants. Information that is made available to analysts remains nonpublic until it is made available to investors in general. Corporations that disclose information on a limited basis create the potential for insider-trading violations.

Issues of selective disclosure may arise when a corporate insider provides material information to analysts in a briefing or conference call before that information is released to the public. Analysts must be aware that a disclosure made to a room full of analysts does not necessarily make the disclosed information “public.” Analysts should also be alert to the possibility that they are selectively receiving material nonpublic information when a company provides them with guidance or interpretation of such publicly available information as financial statements or regulatory filings.

A member or candidate may use insider information provided legitimately by the source company for the specific purpose of conducting due diligence according to the business agreement between the parties for such activities as mergers, loan underwriting, credit ratings, and offering engagements. In such instances, the investment professional would not be considered in violation of Standard II(A) by using the material information. However, the use of insider information provided by the source company for other purposes, especially to trade or entice others to trade the securities of the firm, is a violation of this standard.

Mosaic Theory

A financial analyst gathers and interprets large quantities of information from many sources. The analyst may use significant conclusions derived from the analysis of public and nonmaterial nonpublic information as the basis for investment recommendations and decisions even if those conclusions would have been material inside information had they been communicated directly to the analyst by a company. Under the “mosaic theory,” financial analysts are free to act on this collection, or mosaic, of information without risking violation.

The practice of financial analysis depends on the free flow of information. For the fair and efficient operation of the capital markets, analysts and investors must have the greatest amount of information possible to facilitate making well-informed investment decisions about how and where to invest capital. Accurate, timely, and intelligible communication is essential if analysts and investors are to obtain the data needed to make informed decisions about how and where to invest capital. These disclosures must go beyond the information mandated by the reporting requirements of the securities laws and should include specific business information about items used to guide a company’s future growth, such as new products, capital projects, and the competitive environment. Analysts seek and use such information to compare investment alternatives.

Much of the information used by analysts comes directly from companies. Analysts often receive such information through contacts with corporate insiders, especially investor relations staff and financial officers. Information may be disseminated in the form of press releases, through oral presentations by company executives in analysts’ meetings or conference calls, or during analysts’ visits to company premises. In seeking to develop the most accurate and complete picture of a company, analysts reach beyond contacts with companies themselves and collect information from other sources, such as customers, contractors, suppliers, and the companies’ competitors.

Analysts formulate opinions and insights that are not obvious to the general investing public about the attractiveness of particular securities. In the course of their work, analysts actively seek out corporate information not generally known to the market for the express purpose of analyzing that information, forming an opinion on its significance, and informing their clients, who can be expected to trade based on the recommendation. Analysts’ initiatives to discover and analyze information and communicate their findings to their clients significantly enhance market efficiency, thus benefiting all investors. Accordingly, violations of Standard II(A) will not result when a perceptive analyst reaches a conclusion about a corporate action or event through an analysis of public information and items of nonmaterial nonpublic information.

Investment professionals should note, however, that although analysts are free to use mosaic information in their research reports, they should save and document all their research. Evidence of the analyst’s knowledge of public and nonmaterial nonpublic information about a corporation strengthens the assertion that the analyst reached his or her conclusions solely through appropriate methods rather than through using material nonpublic information.

Social Media

The continuous advancement in technology allows members, candidates, and the industry at large to exchange information with increasing speed and efficiency. Members and candidates may use social media platforms to communicate with clients or investors without conflicting with this standard. If the information reaches all clients or is available to the investing public, the use of social media is comparable to other forms of communication.

However, it is important for investment professionals to understand the implications of using information from the internet and social media platforms because all such information may not actually be considered public. Some social media platforms require membership in specific groups to access the published content. Members and candidates participating in groups with membership limitations should verify that material information obtained from these sources can also be accessed from a source that would be considered available to the public before using that information.

Using Industry Experts

Members and candidates may engage with outside experts for insights into the complexities of some industries. Businesses have formed to connect analysts and investors with individuals who have specialized knowledge of their industry (e.g., technology or pharmaceuticals). These networks offer investors the opportunity to reach beyond their usual business circles to speak with experts regarding economic conditions, industry trends, and technical issues relating to specific products and services.

Members and candidates may provide compensation to individuals for their insights without violating this standard. However, members and candidates are ultimately responsible for ensuring that they are not requesting or acting on confidential information received from external experts, which may violate security regulations and would violate this standard.

Firms connecting experts with members or candidates often require both parties to sign agreements concerning the disclosure of material nonpublic information. Even with the protections from such compliance practices, if an expert provides material nonpublic information, members and candidates are prohibited from taking investment actions using this information until the information becomes publicly known to the market.

Investment Research Reports

When a particularly well-known or respected analyst issues a report or makes changes to his or her recommendation, that information alone may influence the market and thus may be considered material. The analyst is not a company insider, however, and does not have access to inside information. Presumably, the analyst created the report from information available to the public (mosaic theory) and by using his or her expertise to interpret the information. The analyst’s hard work, paid for by the client, generated the conclusions.

Simply because the public in general would find the conclusions material does not require that the analyst make his or her work public. Investors who are not clients of the analyst can either do the work themselves or become clients of the analyst to gain access to the analyst’s expertise.

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Compliance Practices

Achieve Public Dissemination

If a member or candidate obtains material nonpublic information, the member or candidate should make reasonable efforts to achieve public dissemination of the information. These efforts usually entail encouraging the issuing company to make the information public. If public dissemination is not possible, the member or candidate must communicate the information only to the designated supervisory and compliance personnel within the member’s or candidate’s firm and must not take investment action or alter current investment recommendations based on the information. Moreover, members and candidates must not knowingly engage in any conduct that may induce company insiders to privately disclose material nonpublic information.

Adopt Compliance Procedures

Members and candidates must comply with all compliance procedures adopted by their employer to prevent the misuse of material nonpublic information. Such procedures might address such areas as the review of employee and proprietary trading, the review of investment recommendations, the supervision of interdepartmental communications in multiservice firms, and informing compliance personnel of suspected inappropriate use of material nonpublic information.

Issue Press Releases

Members and candidates should encourage companies they follow to issue press releases prior to analyst meetings and conference calls and to script those meetings and calls to decrease the chance that further information will be disclosed. If material nonpublic information is disclosed for the first time in an analyst meeting or call, members and candidates should encourage the company to promptly issue a press release or otherwise make the information publicly available.

Comply with Firewall Restrictions and Procedures

Members and candidates must adhere to any firewall restrictions adopted by their firm. An information barrier commonly referred to as a “firewall” is the most widely used approach for preventing the communication of material nonpublic information within firms. It restricts the flow of confidential information to those who need to know the information to perform their jobs effectively. Elements of such a system include, but are not limited to, the following:

  • substantial control of relevant interdepartmental communications, preferably through a clearance area within the firm in either the compliance or legal department;
  • review of employee trading through the maintenance of “watch,” “restricted,” and “rumor” lists;
  • documentation of the procedures designed to limit the flow of information between departments and of the actions taken to enforce those procedures; and
  • heightened review or restriction of proprietary trading while a firm is in possession of material nonpublic information.

There should be no overlap of personnel between the investment banking and corporate finance areas of a brokerage firm and the sales and research departments or between a bank’s commercial lending department and its trust and research departments. For a firewall to be effective in a multiservice firm, an employee should be on only one side of the firewall at any time. Inside knowledge may not be limited to information about a specific offering or the current financial condition of a company. Analysts may be exposed to much information about the company, including new product developments or future budget projections that clearly constitute inside knowledge and thus preclude the analyst from returning to his or her research function. For example, an analyst who follows a particular company may provide limited assistance to the investment bankers under carefully controlled circumstances when the firm’s investment banking department is involved in a deal with the company. That analyst must then be treated as though he or she were an investment banker; the analyst must remain on the investment banking side of the wall until any information he or she learns is publicly disclosed. In short, the analyst cannot use any information learned in the course of the project for research purposes and cannot share that information with colleagues in the research department.

A primary objective of an effective firewall procedure is to establish a reporting system in which authorized people review and approve communications between departments. If an employee behind a firewall believes that he or she needs to share confidential information with someone on the other side of the firewall, the employee should consult a designated compliance officer to determine whether sharing the information is necessary and how much information should be shared. If the sharing is necessary, the compliance officer should coordinate the process of “looking over the wall” so that the necessary information will be shared and the integrity of the procedure will be maintained.

Comply with Personal Trading Limitations

Members and candidates must comply with their employers’ restrictions or prohibitions on personal trading by employees. Such practices may include firm monitoring of personal trading, mandating periodic reports of personal transactions, and implementing a restricted list and watch list of companies.

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Application of the Standard

Example 1 (Acting on Nonpublic Information)

Barnes, the president and controlling shareholder of the SmartTown clothing chain, decides to accept a tender offer and sell the family business at a price almost double the market price of its shares. He describes this decision to his sister (SmartTown’s treasurer), who conveys it to her daughter (who owns no stock in the family company at present), who tells her husband, Staple. Staple, however, tells his stockbroker, Halsey, who immediately buys SmartTown stock for himself.

Comment: The information regarding the pending sale is both material and nonpublic. Staple violated Standard II(A) by communicating the inside information to his broker. Halsey also violated the standard by buying the shares on the basis of material nonpublic information.

Example 2 (Controlling Nonpublic Information)

Peter, an analyst with Scotland and Pierce Incorporated, is assisting his firm with a secondary offering for Bright Ideas Lamp Company. Peter participates, via video conference call, in a meeting with Scotland and Pierce investment banking employees and Bright Ideas’ CEO. Peter is advised that the company’s earnings projections for the next year have significantly dropped. Throughout the video conference call, several Scotland and Pierce salespeople and portfolio managers walk in and out of Peter’s office, where the call is taking place. As a result, they are aware of the drop in projected earnings for Bright Ideas. Before the call is concluded, firm personnel trade the stock of Bright Ideas Lamp Company on behalf of the firm’s clients and the firm’s proprietary account.

Comment: Peter violated Standard II(A) because he failed to prevent the transfer and misuse of material nonpublic information to others in his firm. Peter’s firm should have adopted information barriers to prevent the communication of nonpublic information between departments of the firm. Firm personnel who are members or candidates and who traded on the information also violated Standard II(A) by trading on inside information.

Example 3 (Selective Disclosure of Material Information)

Levenson is an analyst based in Taipei who covers the Taiwanese market for her firm, which is based in Singapore. She is invited, together with the other 10 largest shareholders of a manufacturing company, to meet the finance director of that company. During the meeting, the finance director states that the company expects its workforce to strike next Friday, which will cripple productivity and distribution. Can Levenson use this information as a basis to change her rating on the company from “buy” to “sell”?

Comment: Levenson must first determine whether the material information is public. According to Standard II(A), if the company has not made this information public (a small group forum does not qualify as a method of public dissemination), she must not use the information.

Example 4 (Determining Materiality)

Fechtman is trying to decide whether to hold or sell shares of an oil-and-gas exploration company that she owns in several of the funds she manages. Although the company has underperformed the index for some time already, the trends in the industry sector signal that companies of this type might become takeover targets. While she is considering her decision, her doctor, who casually follows the markets, mentions that she thinks that the company in question will soon be bought out by a large multinational conglomerate and that it would be a good idea to buy the stock right now. After talking to various investment professionals and checking their opinions on the company, as well as checking industry trends, Fechtman decides the next day to accumulate more stock in the oil-and-gas exploration company.

Comment: Although information on an expected takeover bid may be generally material and nonpublic, in this case, the source of information is unreliable, so the information cannot be considered material. Therefore, Fechtman is not prohibited from trading the stock based on this information.

Example 5 (Applying the Mosaic Theory)

Teja is a buy-side analyst covering the furniture industry. Looking for an attractive company to recommend to clients, he analyzes several furniture makers by studying their financial reports and visiting their operations. He also talks to some designers and retailers to find out which furniture styles are trendy and popular. Although none of the companies that he analyzes are clear buy recommendations, he discovers that one of them, Swan Furniture Company (SFC), may be in financial trouble. SFC’s extravagant new designs have been introduced at substantial cost. Even though these designs initially attracted attention, the public is now buying more conservative furniture from other makers. Based on this information and on a profit-and-loss analysis, Teja believes that SFC’s next-quarter earnings will drop substantially. He issues a sell recommendation for SFC. Immediately after receiving that recommendation, investment managers start reducing the SFC stock in their portfolios.

Comment: While company information on quarterly earnings data is material and nonpublic, Teja based his conclusion about the earnings drop on public information and pieces of nonmaterial nonpublic information (such as opinions of designers and retailers). Therefore, trading based on Teja’s correct conclusion is not prohibited by Standard II(A).

Example 6 (Applying the Mosaic Theory)

Clement is a senior financial analyst who specializes in the European automobile sector at Rivoli Capital. Because he has been repeatedly nominated by many leading industry magazines and newsletters as a “best analyst” for the automobile industry, he is widely regarded as an authority on the sector. After speaking with representatives of Turgot Chariots—a European auto manufacturer with sales primarily in the Asia-Pacific (APAC) region—and after conducting interviews with salespeople, labor leaders, his firm’s APAC currency analysts, and banking officials, Clement analyzed Turgot Chariots. He concluded that (1) its newly introduced model will probably not meet sales expectations, (2) its corporate restructuring strategy may face serious opposition from unions, (3) the depreciation of the South Korean won should lead to pressure on margins for the industry in general and Turgot’s market segment in particular, and (4) banks could take a tougher-than-expected stance in the upcoming round of credit renegotiations with the company. For these reasons, he changes his conclusion about the company from “market outperform” to “market underperform.” Clement retains the support material used to reach his conclusion in case questions later arise.

Comment: To reach a conclusion about the value of the company, Clement pieced together a number of nonmaterial or public bits of information that affect Turgot Chariots. Therefore, under the mosaic theory, Clement did not violate Standard II(A) in drafting the report.

Example 7 (Analyst Recommendations as Material Nonpublic Information)

The next day, Clement prepares to be interviewed on a global financial news television program where he will discuss publicly for the first time his changed recommendation on Turgot Chariots. While preparing for the program, he mentions to the show’s producers and Zito, the journalist who will be interviewing him, the information he will discuss. Just prior to going on the air, Zito sells her holdings in Turgot Chariots. She also phones her father with the information because she knows that he and other family members have investments in Turgot Chariots.

Comment: When Zito receives advance notice of Clement’s change of opinion, she knows it will have a material impact on the stock price, even if she is not aware of Clement’s underlying reasoning. She is not a client of Clement but obtains early access to the material nonpublic information prior to publication. Her trades are based on material nonpublic information; thus, she violated Standard II(A). Zito further violated the standard by relaying the information to her father. It would not matter if he or any other family member traded; the act of providing the information violated Standard II(A).

Example 8 (Acting on Nonpublic Information)

Kellogg is a retired investment professional who manages his own portfolio. He owns shares in National Savings, a large local bank. A close friend, Mayfield, is a senior executive at National. National has seen its stock price drop considerably, and the news and outlook for the bank have not been positive in recent months. In a conversation about the economy and the banking industry, Mayfield relays the information that National will surprise the investment community in a few days when it announces excellent earnings for the quarter. Kellogg is pleasantly surprised by this information, and thinking that Mayfield, as a senior executive, knows the law and would not disclose inside information, he doubles his position in the bank. Subsequently, National announces that it had good operating earnings but had to set aside reserves for anticipated significant losses on its loan portfolio. The combined news causes the stock to go down 60%.

Comment: Even though Kellogg believes that Mayfield would not break the law by disclosing inside information, Kellogg violated Standard II(A) by purchasing additional shares of National. The fact that he lost money on the purchase does not absolve Kellogg for trading on material nonpublic information. It is the member’s or candidate’s responsibility to make sure, before executing investment actions, that comments about earnings are not material nonpublic information.

Example 9 (Materiality Determination)

Nadler, a trader for a mutual fund, gets a text message from another firm’s trader, whom he has known for years. The message indicates that the trader believes a particular software company is going to report strong earnings when the firm publicly announces in two days. Nadler has a buy order from a portfolio manager within his firm to purchase several hundred thousand shares of the stock. Nadler is aggressive in placing the portfolio manager’s order and completes the purchases by the following morning, a day ahead of the firm’s planned earnings announcement.

Comment: There are often rumors and whisper numbers before a release of any kind. The text message from the other trader would most likely be considered market noise. Unless Nadler knew that the trader had an ongoing business relationship with the public firm, he had no reason to suspect he was receiving material nonpublic information that would prevent him from completing the trading request of the portfolio manager.

Example 10 (Using an Expert Network)

McCoy is the senior drug analyst at a mutual fund. Her firm hires a service that connects her to experts in the treatment of cancer. Through various phone conversations, McCoy enhances her understanding of the latest therapies for successful treatment. This information is critical to McCoy for making informed recommendations of the companies producing these drugs.

Comment: McCoy is appropriately using the expert networks to enhance her evaluation process. She neither asked for nor received information that may be considered material and nonpublic, such as preliminary trial results. McCoy is allowed to seek advice from professionals within the industry that she follows.

Example 11 (Using an Expert Network)

Watson is a research analyst working for a hedge fund. To stay informed, Watson relies on outside experts for information on such industries as technology and pharmaceuticals, where new advancements occur frequently. The meetings with the industry experts often are arranged through networks or placement agents that have specific policies and procedures in place to deter the exchange of material nonpublic information. Watson arranges a call to discuss future prospects for one of the fund’s existing technology company holdings, a company that was testing a new semiconductor product. The scientist leading the tests indicates his disappointment with the performance of the new semiconductor. Following the call, Watson relays the insights he received to others at the fund. The fund sells its current position in the company and buys many put options because the market is anticipating the success of the new semiconductor and the share price reflects the market’s optimism.

Comment: Watson violated Standard II(A) by passing along material nonpublic information concerning the ongoing product tests, which the fund used to trade in the securities and options of the related company. Watson cannot simply rely on the agreements signed by individuals who participate in expert networks that state that he has not received information that would prohibit his trading activity. He must make his own determination whether information he received through these arrangements reaches a materiality threshold that would influence his trading.

About the Author(s)

CFA Institute

CFA Institute is the global association of investment professionals that sets the standard for professional excellence and credentials. The organization is a champion of ethical behavior in investment markets and a respected source of knowledge in the global financial community. Our aim is to create an environment where investors’ interests come first, markets function at their best, and economies grow.

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