CFA Level II · CFA Level II Exam

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

Full chapter guide

Key formulas

Standard II(A) test: Violation if: information is material AND nonpublic AND you act or cause others to act on it; If the information is public or immaterial, trading on it is not a II(A) violation. If it is both material and nonpublic, acting or causing others to act on it is a violation. Also consider the source and any duty of confidence.
Standard II(B) test: Violation if: practice distorts price or artificially inflates volume AND intent to mislead market participants; Intent to mislead is a required element of II(B). Large or aggressive trades with a genuine investment purpose are not manipulation.
Stricter rule applies: Follow the stricter of the law and the Code and Standards; Use when a vignette says local rules are looser than the Code.
Core duty: Possess material nonpublic information → do not act and do not cause others to act; Both conditions must be met. If either is missing, Standard II(A) does not prohibit the trade, though other Standards may apply.
Materiality test: Material = likely to affect the security's price OR likely to be important to a reasonable investor's decision; Consider how specific the information is, how reliable the source is, and how large its likely impact is.
Nonpublic test: Nonpublic = not yet disseminated to the marketplace in general; Disclosure to a select group, such as a private analyst call, does not make information public.
Mosaic theory: Public information + nonmaterial nonpublic information → permitted conclusion; An analyst may use public and nonmaterial nonpublic information. The resulting conclusion is not a violation, even if it is material.
Required response: Do not trade or tip → inform compliance → encourage public release where appropriate; Firewalls and information barriers support this duty.
Standard II(A) rule: Do not act or cause others to act on material nonpublic information; Applies to trading and to recommending or encouraging others to trade.
Material information: Likely to affect price, or reasonable investors would want it before deciding; Assess the information itself, not the final conclusion.
Mosaic theory test: Public information + nonmaterial nonpublic information + your analysis = permitted, even if the conclusion is material; Each individual nonpublic piece must be nonmaterial, and none may come from a breach of duty.
Action when you hold MNPI: Do not trade or tip; take it to supervisor or compliance; Firewalls and compliance procedures support this.
Firewall purpose: MNPI stays on one side of the barrier; trading and research stay on the other; Information moves only on a need-to-know basis, and crossings go through compliance.
Watch list: Watch list = confidential list of names monitored for unusual trading; no automatic ban; Used early, when a deal is possible but not firm. Limited circulation, compliance only.
Restricted list: Restricted list = names where the firm has MNPI or is involved; no firm research or recommendations, no proprietary trading, and employee personal trading typically restricted; Solicited client trades may still occur. The list can be shared more widely, usually without stating the reason.
Core rule: Standard II(A): do not act or cause others to act on MNPI; Applies to individuals; firm procedures help members comply.
Compliance elements: Barrier + need-to-know + compliance review + personal trading limits + documented procedures; Remember these as the parts of a sound MNPI policy.
Core test for a violation: Violation = distorting act (false information or manipulative transaction) + intent to mislead market participants; Both parts must be present. A price effect alone is not enough.
Information-based manipulation: Spreading false or misleading information to influence prices or volume; Includes rumors designed to move a price.
Transaction-based manipulation: Trades that distort the price or artificially inflate trading volume, or create a false impression of activity; Judged by purpose, not by the size of the trade.
Legitimate activity: Trades or strategies with a valid economic purpose and no intent to mislead are permitted; Large trades, hedging and genuine analysis can move prices without violating the Standard.

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 a security's price or if reasonable investors would want it before deciding.
Information is nonpublic until it has been made available to the marketplace.
Selective disclosure to a few analysts does not make information public.
Mosaic theory: public information plus nonmaterial nonpublic information may be used to reach a conclusion.
An analyst's conclusion from a mosaic is not a violation even if the conclusion itself is material, provided the inputs were public or nonmaterial nonpublic information; if any input was MNPI, II(A) applies.
Firewalls limit information flow between departments, such as investment banking and research.
A restricted list is shared with employees and limits or prohibits trading and recommendations in the listed securities; a watch list is confidential and used to monitor trading for suspicious activity.
If you believe you hold MNPI, do not act or cause others to act; promptly inform your supervisor or compliance, and where appropriate make reasonable efforts to achieve public dissemination.
II(B): do not engage in practices that distort prices or artificially inflate trading volume to mislead market participants.
Spreading false rumours to move a price is market manipulation.
Trading with intent to mislead is the key test; a large legitimate trade is not a violation by itself.

Common mistakes

Treating any nonpublic information as a violation Fix: Always test both material and nonpublic. Immaterial nonpublic details can feed the mosaic.
Saying that possessing material nonpublic information is itself a violation Fix: Possession alone is not a violation of II(A). The violation is acting or causing others to act on it. The member should not act, should encourage the firm to adopt compliance procedures such as firewalls, and may escalate to compliance. Whether the stock goes on a restricted list is a matter of firm policy, not something the Standard requires.
Treating information as public because several people know it. Fix: Public means available to the marketplace in general. A private briefing to a few analysts is still nonpublic.
Assuming only trading is a violation. Fix: The Standard also bans causing others to act. Tipping a friend or advising a client on the basis of the information is a violation.
Saying the analyst violated II(A) because the final conclusion was material. Fix: Judge each input. A material conclusion built from public and nonmaterial pieces is allowed.
Thinking all nonpublic information is prohibited. Fix: Only material nonpublic information is restricted. Nonmaterial nonpublic information may be used in the mosaic.
Treating the watch list and restricted list as the same thing. Fix: Watch list is confidential monitoring. Restricted list stops the firm issuing research or recommendations and doing proprietary trading in the name, and typically limits employee personal trading.
Believing a firewall is only a physical wall. Fix: A firewall includes policies, system access limits, need-to-know rules, and compliance oversight.
Treating any trade that moves the price as manipulation Fix: Look for intent to mislead. Price impact from genuine demand is normal market behavior.
Thinking only trading can be manipulation Fix: Remember information-based manipulation: false rumors and misleading statements also violate II(B).

Exam tips

Name the Standard in your head before reading the options; it narrows the choices fast.
Look for the word 'acts' or 'trades': II(A) needs action on the information, not mere knowledge.
In manipulation vignettes, hunt for a stated purpose. Intent usually appears as a motive such as boosting performance or a bonus.
Prefer answers that stop the conduct and escalate to compliance over answers that ignore or hide the issue.
No marks are lost for wrong answers, so always answer every question.
Always test material and nonpublic as two separate questions, and write both before looking at the options.
Watch for selective disclosure. If information went only to a few analysts, it is still nonpublic.
Expect tipping scenarios. The answer is a violation even if the tipper did not trade.