CFA Level III · Level III Core

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

Full chapter guide

Key formulas

MNPI test: MNPI = Material AND Nonpublic; Both conditions must be met. Material but already public is not MNPI. Nonpublic but immaterial is not MNPI.
Materiality test: Material if disclosure would likely affect the security's price or a reasonable investor's decision; Consider the nature of the information, its source, its reliability and its likely impact on the issuer.
Nonpublic test: Nonpublic if not disseminated to the marketplace in general; Information given only to a select group, such as certain analysts, is still nonpublic.
Duty under Standard II(A): Do not act, and do not cause others to act, on MNPI; This covers personal accounts, client accounts and tips to third parties.
Mosaic theory: Public information + non-material nonpublic information = permitted conclusion; An analyst may reach a material conclusion this way without violating the Standard.
Mosaic theory test: Public information + nonmaterial nonpublic information → conclusion (allowed, even if the conclusion is material); Every individual input must be public or nonmaterial. The conclusion itself is not tested for materiality.
MNPI test: MNPI = material AND nonpublic; Both conditions must hold. If information is public, or if it is not material, Standard II(A) is not triggered by that piece.
Materiality test: Material if disclosure would likely affect price OR reasonable investors would want it before deciding; Source reliability and how specific the information is affect materiality.
Required action on MNPI: Do not act and do not cause others to act; encourage the issuer to make the information public; make the compliance or supervisory function aware under firm policy; If you hold MNPI, you also should not trade on it for clients or yourself. Where your firm has compliance procedures, follow them.
Firewall purpose: MNPI stays on one side of the barrier; trading and advice stay on the other; Applies between departments such as investment banking, research and asset management.
Watch list: Watch list = monitor trading and activity in names that may involve MNPI; Usually confidential and used by compliance. Does not by itself stop trading.
Restricted list: Restricted list = no trading and often no research or recommendations in the named securities; Typically circulated to relevant staff so they know to stop.
Core elements of a compliance procedure: Written policy + compliance review + access controls + lists + training + enforcement; A barrier is effective only when these work together.
Core rule: No action or causing others to act on information that is both material AND nonpublic; Both tests must be met for II(A) to apply. If either fails, II(A) is not triggered, though other standards may still apply to the member's conduct. II(A) applies regardless of how the information was obtained. If the source broke the law by passing it on, Standard I(A) may also be engaged. If you are unsure, consult compliance.
Materiality test: Material = likely to affect price, or a reasonable investor would want it before deciding; Source and specificity of the information matter. Vague or speculative information is less likely to be material.
Nonpublic test: Nonpublic = not yet disseminated to the marketplace; Information shared with a select group stays nonpublic. Public once broadly released and the market has had time to absorb it.
Mosaic theory: Public information + non-material nonpublic information = permitted conclusion; Not protected if any piece is itself material and nonpublic.
Recommended compliance response: Stop → do not trade or tip → escalate to compliance → firewall / restricted list; Do not rely on your own judgment when materiality or source is unclear.
Standard II(B) rule: Members and candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.; Intent to mislead is the element that separates manipulation from normal trading.
Information-based manipulation: Spreading false or misleading information (rumors, false statements) to affect prices or volume; No trade is needed for the act itself; the misleading information is the problem.
Transaction-based manipulation: Trades or orders that give a false or misleading impression of price, demand or volume, or that exploit a dominant market position; Examples: wash trades, artificial price at a key time, creating false volume.
Not a violation: Legitimate trading or strategy without intent to mislead, even if it moves price; Large trades and price impact alone do not breach the Standard.
Standard II(A) Material Nonpublic Information: Information is material if it would affect an investment's price or if reasonable investors would want it before deciding. It is nonpublic if it has not been made available to the marketplace. If both are true: do not act, and do not cause others to act.; Both tests must be met. Public or immaterial information does not trigger the ban.
Standard II(B) Market Manipulation: Prohibited: practices that distort prices or artificially inflate trading volume, with intent to mislead market participants. Also covers spreading false rumors to induce trading.; Intent to mislead is the key element. Legitimate trading that moves prices is not manipulation.
Code principle: Promote the integrity and viability of the global capital markets for the ultimate benefit of society.; Use this to justify why a standard exists. Link every answer back to it.
Mosaic theory: Public information + nonmaterial nonpublic information = permitted analysis.; An analyst may combine these pieces even if the conclusion is material, as long as no single material nonpublic item is used.

Quick revision

Standard 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 an investor's decision to trade.
Information is nonpublic until it is made available to the marketplace, not just to a few people.
Mosaic theory allows combining public information and immaterial nonpublic information to reach a conclusion.
Heavy trading or rumour alone does not make information public.
Firewalls restrict information flow between departments and support compliance with II(A).
If you receive MNPI, you should not trade on it and should escalate to compliance.
Standard II(B): do not engage in practices that distort prices or artificially inflate trading volume to mislead.
Manipulation can be information-based, such as spreading false rumours, or transaction-based, such as trades that create a false impression.
Intent to mislead is central to manipulation, so legitimate large trades are not automatically a breach.
Answer the exact command word and show the fact that decides the case.

Common mistakes

Treating any nonpublic information as MNPI. Fix: Always run both tests. Nonpublic but immaterial information is not MNPI under this Standard.
Thinking information is public because many people at one firm or a few analysts know it. Fix: Public means disseminated to the marketplace in general. A select group hearing it is not enough.
Saying the analyst violated the Standard because the final conclusion was material. Fix: Test each input. A material conclusion built from public and nonmaterial pieces is permitted under the mosaic theory.
Treating all nonpublic information as prohibited. Fix: Write MNPI = material AND nonpublic. Nonmaterial nonpublic information may be used.
Treating the watch list and restricted list as the same thing. Fix: Link watch to monitoring and confidentiality, and restricted to a trading and often research ban that staff can see.
Saying a firewall is enough on its own. Fix: Add compliance review, trading monitoring, training and enforcement to the answer.
Treating information shared with several analysts as public. Fix: Public means disseminated to the marketplace, not a select group. A closed call is still nonpublic.
Calling any research tip a mosaic theory case. Fix: Mosaic only protects pieces that are public or non-material. One material nonpublic piece ruins it.
Calling any large trade that moves the price manipulation. Fix: Look for intent to mislead. Price impact alone is not a violation.
Thinking manipulation needs actual trades. Fix: Remember information-based manipulation: false rumors or statements can breach II(B) without any trade.

Exam tips

Write both tests by name, material and nonpublic, in every constructed-response answer on this topic.
When the command word is determine or identify, say whether the information is MNPI and give the reason in one sentence per test.
For recommended-action questions, include do not act, do not tip, escalate to compliance and encourage public disclosure.
Watch for mosaic theory in vignettes. A conclusion built from public data and immaterial private details is usually not a violation.
In item sets, read the answer options for causing others to act. A tip to a client or friend is as wrong as trading yourself.
In a vignette, label each tidbit public, nonmaterial or MNPI before choosing an answer.
The trap answer says the analyst violated the Standard because the conclusion was material. Reject it if all inputs are public or nonmaterial.
Watch for words like 'specific', 'confidential', 'before announcement' and 'insider'. They signal MNPI.