CFA Level I · CFA Level I Exam

Guidance for Standard II: Integrity of Capital Markets: formula sheet

Full chapter guide

Key formulas

Standard II(A) wording: 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.; Applies to trading and to tipping others. Both are prohibited.
Test for a violation: Material AND nonpublic → do not act or cause others to act; If either test fails, Standard II(A) is not triggered by that information.
Materiality test: Material if it would likely affect the security's price OR reasonable investors would want it before deciding; Consider source reliability, specificity and impact on value.
Nonpublic test: Nonpublic = not yet disseminated to the marketplace; A selective disclosure to a few people does not make it public.
Mosaic theory: Public information + nonmaterial nonpublic information = permitted conclusion; Allowed even if the final conclusion is material, but only if no single piece is material nonpublic information and none was obtained through a breach of duty. It does not allow use of a material nonpublic piece.
Standard II(A) core rule: Material + Nonpublic = do not act or cause others to act; Both conditions must be met. If either is missing, the information is not MNPI under this Standard.
Materiality test: Material if disclosure would likely move the price, or reasonable investors would want it before investing; Source and reliability of the information also matter. Rumours from a doubtful source are weaker than firm facts.
Nonpublic test: Nonpublic = not yet disseminated to the marketplace; Information given only to selected analysts or to a small group is still nonpublic.
Mosaic theory: Public information + nonmaterial nonpublic information → conclusion permitted; Allowed only if no single input is material and nonpublic. A material nonpublic input breaks the mosaic.
Standard II(A) core rule: Do not act or cause others to act on MNPI; Applies to material information that is not yet public. Information is public once available to the marketplace at large.
Materiality test: Material = likely to affect price OR reasonable investors would want it; Source and reliability of the information also matter.
Firewall components: Barrier + limited access + compliance control + records; The information barrier is the primary method the guidance gives for preventing MNPI misuse within a firm.
Watch list vs restricted list: Watch list = monitor, confidential, limited distribution; Restricted list = firm stops proprietary trading and recommendations, shared with employees without reasons; Watch list names are monitored for trading, and the firm may limit or restrict research and recommendations on them as its policy dictates. Restricted list names are circulated to employees without reasons, the firm stops proprietary trading and recommendations on them, and employee trading is also restricted under firm policy.
When the firm cannot isolate MNPI: Barrier not enough → restricted list → stop proprietary trading and recommendations; The firm should not trade for its own account or recommend the security until the information is public. Unsolicited client trades may continue.
Standard II(B) wording: Do not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.; Learn the three elements: distort prices, artificially inflate volume, intent to mislead.
Information-based manipulation: Spreading false or misleading information (e.g., rumors) to induce others to trade; Includes false rumors and misleading statements meant to move a price.
Transaction-based manipulation: Trades that give a false impression of price or activity, or that build a controlling position to manipulate a related price; Examples: wash trades, and trading to create artificial price or volume signals.
Test for a violation: Distortion of price or volume + intent to mislead = violation; Impact alone, without intent to mislead, is not a violation.

Quick revision

II(A): do not act or cause others to act on material nonpublic information.
Information is material if its disclosure would likely affect the security's price or an investor's decision to trade.
Information is nonpublic until it has been made available to the marketplace.
Mosaic theory: an analyst may combine public information with immaterial nonpublic pieces to reach a conclusion.
A conclusion drawn from public and immaterial nonpublic information is not a breach, even if the conclusion is material. If a material nonpublic piece was used, II(A) applies.
A firewall (information barrier) limits the flow of MNPI between departments.
An information barrier (firewall) is the primary tool for preventing the misuse of MNPI. Firms also use restricted and watch lists, limits on personal trading and similar controls alongside it.
If you receive MNPI, do not trade on it; ask compliance and encourage the company to disclose it publicly.
II(B): do not engage in practices that distort prices or artificially inflate trading volume with intent to mislead.
Manipulation can be transaction-based (such as wash trades) or information-based (such as spreading false rumours).
Intent to mislead is central to II(B); legitimate trading that moves prices is not manipulation.
Market integrity supports trust, efficient capital allocation and the wider economy.

Common mistakes

Treating all nonpublic information as prohibited. Fix: Check materiality too. Nonmaterial nonpublic information can be used, including in mosaic research.
Thinking only trading is a violation. Fix: The standard says act or cause others to act. Tipping a client or friend is also a violation.
Thinking a significant conclusion is MNPI Fix: Test the inputs. A material conclusion built only from public and nonmaterial pieces is allowed under mosaic theory.
Treating all nonpublic information as forbidden Fix: The Standard needs both material and nonpublic. Nonmaterial nonpublic information may be used in the mosaic.
Treating the watch list and restricted list as the same thing. Fix: Remember: watch list is confidential monitoring; restricted list is shared with employees without reasons and goes with the firm stopping proprietary trading and recommendations, with employee trading also restricted under firm policy.
Thinking a firewall allows trading on MNPI as long as the barrier exists. Fix: The firewall only helps prevent misuse. Anyone holding MNPI still cannot trade or cause others to trade.
Treating any large trade that moves the price as manipulation. Fix: Require intent to mislead. Legitimate large trades and block trades are allowed.
Confusing II(B) with II(A) Material Nonpublic Information. Fix: II(A) concerns acting on or causing others to act on material nonpublic information. II(B) concerns distorting prices or volume to mislead.

Exam tips

Always name both tests, material and nonpublic. Wrong options often drop one of them.
Watch for tipping. Passing material nonpublic information to a friend or colleague who trades is a violation even if the member does not trade.
Mosaic scenarios usually have an analyst building a view from public data. The usual answer is no violation.
When the member has already received a leak, the best action is usually to stop trading and escalate to compliance, not to ignore or share it.
Link II(A) with firewalls and restricted lists, which are the usual compliance controls tested alongside it.
Hunt for the one input that is both material and nonpublic. Most questions turn on whether such a piece exists.
If every input is public or nonmaterial, expect the answer to permit the research. Do not be pulled by the word nonpublic.
Reject options that call a conclusion MNPI simply because it is important or because it took effort to reach.