We’re using cookies, but you can turn them off in Privacy Settings.  Otherwise, you are agreeing to our use of cookies.  Accepting cookies does not mean that we are collecting personal data. Learn more in our Privacy Policy.

The Standard

Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants. 

Test your understanding of Standard II(B)


Standard II(B) requires that members and candidates uphold market integrity by prohibiting market manipulation. Market manipulation includes practices that distort security prices or trading volume with the intent to deceive people or entities that rely on information in the market. Market manipulation damages the interests of all investors by disrupting the smooth functioning of financial markets and lowering investor confidence.

Market manipulation may lead to a lack of trust in the fairness of the capital markets, resulting in higher risk premiums and reduced investor participation. A reduction in the efficiency of a local capital market may negatively affect the growth and economic health of the country and may also influence the operations of the globally interconnected capital markets. Although market manipulation may be less likely to occur in mature financial markets than in emerging markets, cross-border investing exposes all global investors to the potential for such practices.

Market manipulation includes (1) the dissemination of false or misleading information and (2) transactions that deceive or would be likely to mislead market participants by distorting the price-setting mechanism of financial instruments. The development of new products and technologies increases the incentives, means, and opportunities for market manipulation. Additionally, the complexity and sophistication of the technologies used for communicating with market participants have created new avenues for manipulation.

Information-Based Manipulation

Information-based manipulation includes, but is not limited to, spreading false rumors to induce trading by others. For example, members and candidates must refrain from “pumping up” the price of an investment by issuing misleading positive information or overly optimistic projections of a security’s worth only to later “dump” the investment (i.e., sell it) once the price, fueled by the misleading information’s effect on other market participants, reaches an artificially high level.

Transaction-Based Manipulation

Transaction-based manipulation involves instances where a member or candidate knows or should know that his or her actions could distort the price of a security. This type of manipulation includes, but is not limited to, the following:

  • Transactions that artificially affect prices or volume to give the impression of activity or price movement in a financial instrument, which represent a diversion from the expectations of a fair and efficient market
  • Securing a controlling, dominant position in a financial instrument to exploit and manipulate the price of a related derivative and/or the underlying asset

Standard II(B) is not intended to preclude transactions undertaken on legitimate trading strategies based on perceived market inefficiencies. Legitimate trading activity may appear abusive, especially where the market is illiquid or volatile. The intent of the action is critical to determining whether it is a violation of this standard.

Manipulative practices can vary according to the type of asset class and the features of the particular market. The following is a nonexhaustive list of indicators that may signal market manipulation:

  • Orders entered for an unusually short time period
  • Orders above market price
  • Orders resulting in no change in beneficial ownership
  • Orders that intend to change the bid or offer prices and are canceled before they are executed
  • Orders on both sides of the trade using different platforms
  • Coordinated action by two or more traders in a market with a small number of participants
Back to top

Compliance Practices

Members and candidates must comply with their firm’s policies and procedures designed to prevent manipulative trading, which could include the following:

  • Procedures designed to prevent placing and canceling orders with the intent to deceive others into buying or selling securities at artificial prices
  • Real-time monitoring or systematic surveillance practices across multiple platforms that are designed to identify such activities as suspicious order entries, potential improper coordination among customers, wash trading, transactions in cross-product securities that manipulate the price of an underlying security, and other types of manipulative trading activity
  • Implementation of an automated order management system and pretrade controls to attempt to identify and prevent manipulative orders
  • Controls that address the use of trading algorithms for manipulative trading practices
  • Trade exception reporting
Back to top

Application of the Standard

Example 1 (Independent Analysis and Company Promotion)

The principal owner of Financial Information Services (FIS) entered into an agreement with two microcap companies to promote the companies’ stock in exchange for stock and cash compensation. The principal owner caused FIS to disseminate emails, design and maintain several websites, and distribute an online investment newsletter—all of which recommended investment in the two companies. The systematic publication of purportedly independent analyses and recommendations containing inaccurate and highly promotional and speculative statements increased public investment in the companies and led to dramatically higher stock prices.

Comment: The principal owner of FIS violated Standard II(B) by using inaccurate reporting and misleading information under the guise of independent analysis to artificially increase the stock price of the companies.

Example 2 (Personal Trading Practices and Price)

Gray is a private investor in Belgium who bought a large position several years ago in Fame Pharmaceuticals, a German small-cap security with limited average trading volume. He has decided to significantly reduce his holdings owing to the poor performance of the company. Gray is worried that the low trading volume for the stock may cause the price to decline further as he attempts to sell his large position.

Gray divides his holdings into multiple accounts in different brokerage firms and private banks in the names of family members, friends, and even a private religious institution. He then creates a rumor campaign on various blogs and social media outlets promoting the company.

Gray begins to buy and sell the stock using the accounts in hopes of raising the trading volume and the price. He conducts the trades through multiple brokers, selling slightly larger positions than he bought on a tactical schedule, and over time, he is able to reduce his holding as desired without negatively affecting the sale price.

Comment: Gray violated Standard II(B) by fraudulently creating the appearance that there was greater investor interest in the stock through the online rumors. Additionally, through his trading strategy, he created the appearance that there was greater liquidity in the stock than actually existed. He manipulated the price through both misinformation and trading practices.

Example 3 (Creating Artificial Price Volatility)

Murphy is an analyst at Divisadero Securities & Co., which has a significant number of hedge funds among its most important brokerage clients. Some of the hedge funds hold short positions on Wirewolf Semiconductor. Two trading days before the publication of a quarter-end report, Murphy alerts his sales force that he is about to issue a research report on Wirewolf that will include the following opinions:

  • Quarterly revenues are likely to fall short of management’s guidance
  • Earnings will be as much as 5 cents per share (or more than 10%) below consensus
  • Wirewolf’s highly respected chief financial officer may be about to join another company.

Knowing that Wirewolf has already entered its declared quarter-end “quiet period” before reporting earnings (and thus would be reluctant to respond to rumors), Murphy times the release of his research report specifically to sensationalize the negative aspects of the message in order to create significant downward pressure on Wirewolf’s stock—to the distinct advantage of Divisadero’s hedge fund clients. The report’s conclusions are based on speculation, not on fact. The next day, the research report is broadcast to all of Divisadero’s clients and to the usual newswire services.

Before Wirewolf’s investor relations department can assess the damage on the final trading day of the quarter and refute Murphy’s report, its stock opens trading sharply lower, allowing Divisadero’s clients to cover their short positions at substantial gains.

Comment: Murphy violated Standard II(B) by aiming to create artificial price volatility designed to have a material impact on the price of an issuer’s stock.

Example 4 (Personal Trading and Volume)

Sekar manages two funds—an equity fund and a balanced fund—whose equity components are supposed to be managed in accordance with the same model. According to that model, the funds’ holdings in stock of Digital Design Inc. (DD) are excessive. Reduction of the DD holdings would not be easy, however, because the stock has low liquidity. Sekar decides to start trading larger portions of DD stock back and forth between his two funds to slowly increase the price; he believes market participants will see growing volume and increasing price and become interested in the stock. If other investors are willing to buy the DD stock because of such interest, then Sekar will be able to get rid of at least some of his overweight position without inducing price decreases. In this way, the whole transaction will be for the benefit of fund participants, even if additional brokers’ commissions are incurred.

Comment: Sekar’s plan would be beneficial for his funds’ participants but is based on artificial distortion of both trading volume and the price of the DD stock and thus constitutes a violation of Standard II(B).

Example 5 (Creating Artificial Price Volatility)

Gordon, an analyst of household products companies, is employed by a research boutique, Picador & Co. Based on information that she has gathered during a trip through Latin America, she believes that Hygene, Inc., a major marketer of personal care products, has generated better-than-expected sales from its new product initiatives in South America. After modestly boosting her projections for revenue and for gross profit margin in her worksheet models for Hygene, Gordon estimates that her earnings projection of US$2.00 per diluted share for the current year may be as much as 5% too low. She contacts the chief financial officer (CFO) of Hygene to try to gain confirmation of her findings from her trip and to get feedback regarding her revised models. The CFO declines to comment and reiterates management’s most recent guidance of US$1.95–US$2.05 for the year.

Gordon decides to try to force a comment from the company by telling Picador & Co. clients who follow a momentum investment style that consensus earnings projections for Hygene are much too low; she explains that she is considering raising her published estimate by an ambitious US$0.15–US$2.15 per share. She believes that when word of an unrealistically high earnings projection filters back to Hygene’s investor relations department, the company will feel compelled to update its earnings guidance. Meanwhile, Gordon hopes that she is correct at least with respect to the earnings direction and that she will help clients who act on her insights to profit from a quick gain by trading on her advice.

Comment: By exaggerating her earnings projections in order to try to fuel a quick gain in Hygene’s stock price, Gordon is in violation of Standard II(B). However, it would have been acceptable for Gordon to write a report that,

  • framed her earnings projection in a range of possible outcomes and
  • outlined clearly the assumptions used in her Hygene models that took into consideration the findings from her trip through Latin America.

Example 6 (Pump and Dump Strategy)

In an effort to pump up the price of his holdings in Moosehead & Belfast Railroad Company, Weinberg logs on to several investor chatrooms to start rumors that the company is about to expand its rail network in anticipation of receiving a large contract for shipping lumber.

Comment: Weinberg violated Standard II(B) by disseminating false information about Moosehead & Belfast with the intent to mislead market participants.

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.

Share on Facebook Share on Weibo Share on Twitter Share on LinkedIn