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CFA Level II · CFA Level II Exam

Guidance for Standard II: Integrity of Capital Markets

Standard II has two parts: II(A) bars you from acting or causing others to act on material nonpublic information, and II(B) bars practices that distort prices or artificially inflate trading volume to mislead market participants. You solve questions by testing the facts for materiality, public status and intent, then naming the Standard.

What this chapter covers

This chapter covers the two Standards that protect the fairness of markets. Standard II(A) deals with material nonpublic information (MNPI). Standard II(B) deals with market manipulation. Both ask you to put the market's integrity ahead of any gain for you, your firm or your client.

The chapter has a clear logic. First you learn what makes information material and nonpublic. Then you learn what you may do with information gathered through your own research, which is the mosaic theory. Then you learn how firms stop MNPI from moving around, using firewalls and information barriers. Last, you learn the two forms of manipulation: distorting price or volume, and misleading others through trades or false information.

At Level II, these Standards appear inside ethics item sets. A vignette describes people, conversations and trades. You must decide whether a violation took place, which Standard applies, and what the analyst should do. The same reading skill you use in other item sets applies here: find the facts that matter, ignore the noise, and apply the Standard as written. This chapter also links to Standard I(A) on knowledge of the law, Standard III on duties to clients, and Standard VI on conflicts of interest, so expect overlap in a single vignette.

Ethical and Professional Standards carries a 10-15% topic weight, and Standard II is a compact, rule-driven part of it. The decisions are often clear once you spot the key fact, such as whether information is both material and nonpublic, so careful preparation turns into reliable points. Because there is no minimum passing score per topic, strong ethics marks can offset weaker areas elsewhere, and a candidate who is careless here gives away marks that are within reach.

Guidance for Standard II: Integrity of Capital Markets: topics in the order to study them

  1. 1Ethics and Integrity of Capital MarketsStart with the purpose of Standard II and how it links to the wider Code, so the later rules make sense.
  2. 2Standard II(A): Material Nonpublic InformationThis is the core rule; you need its tests for materiality and public status before anything else.
  3. 3Mosaic Theory and Public Information AnalysisIt shows what is allowed under II(A), so study it right after the rule to see the boundary.
  4. 4Firewalls and Information BarriersThese are the compliance tools that put II(A) into practice, so they follow the rule and its limits.
  5. 5Standard II(B): Market ManipulationA separate Standard with its own tests; learn it last so it does not blur with MNPI rules.

How to prepare Guidance for Standard II: Integrity of Capital Markets

Treat this chapter as a set of tests you apply to facts. Read the Standard, learn its conditions, then practise spotting those conditions in vignettes.

  1. Read the text of Standards II(A) and II(B) once, then restate each in one sentence of your own.
  2. Build a two-question test for MNPI: is it material, and is it nonpublic? Add a third check: did you act or cause others to act on it?
  3. Learn what the mosaic theory permits: combining public information and nonmaterial nonpublic information to reach a conclusion.
  4. List the firewall elements: physical and departmental separation, limits on information flow, restricted and watch lists, and compliance review.
  5. For II(B), separate the two types of manipulation: distorting prices or inflating volume, and misleading others through trades or false information. Check for intent to mislead.
  6. Practise item sets. For each vignette, underline who knew what and when, name the Standard, then pick the action that protects the market.
  7. Review every wrong answer by writing the one fact you missed, such as a source that was public or a trade without intent to mislead.

Common mistakes in Guidance for Standard II: Integrity of Capital Markets

  • Treating any nonpublic information as forbidden.

    Fix: Always test both. Nonmaterial nonpublic information may be used within a mosaic.

  • Assuming information is public because many people know it.

    Fix: Ask whether it has been disseminated to the marketplace. Selective sharing is not public release.

  • Calling a research conclusion a violation because it moved the price.

    Fix: Check the sources. If the analyst used public and nonmaterial information, the mosaic theory protects the work.

  • Treating firewalls as optional or as a full defence.

    Fix: Remember firewalls are controls that must be effective in practice, and their elements include compliance monitoring and restricted and watch lists.

  • Labelling any large or aggressive trade as manipulation.

    Fix: Look for intent to mislead or an artificial effect on price or volume. Legitimate trading for a valid reason is not a breach.

  • Naming the wrong Standard in a mixed vignette.

    Fix: Identify the core act first: trading on MNPI points to II(A), distorting the market points to II(B). Then check for other Standards.

Last-day revision: Guidance for Standard II: Integrity of Capital Markets

  • 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.

Guidance for Standard II: Integrity of Capital Markets in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Guidance for Standard II: Integrity of Capital Markets: frequently asked questions

What is the difference between Standard II(A) and II(B)?

II(A) is about using or passing on material nonpublic information. II(B) is about practices that distort prices or volume to mislead others. One concerns information, the other concerns market behaviour.

What makes information material?

Information is material if its disclosure would likely affect the security's price, or if reasonable investors would want to know it before making an investment decision. The source and reliability of the information also matter.

Can an analyst use mosaic theory to justify any trade?

No. The mosaic theory covers conclusions built from public and nonmaterial nonpublic information. It does not allow you to act on information that is both material and nonpublic.

How are ethics questions asked at Level II?

They sit inside item sets, each with a vignette and 4 multiple-choice questions. You must find the facts that matter, name the Standard involved and choose the action that complies with the Code and Standards.