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CFA Level III · Level III Core

Guidance for Standard II: Integrity of Capital Markets

Standard II of the CFA Institute Code and Standards protects market integrity. II(A) bars you from acting or causing others to act on material nonpublic information. II(B) bars practices that distort prices or trading volume to mislead participants. You solve cases by testing materiality, public status, and intent to mislead.

What this chapter covers

This chapter covers the two parts of Standard II. Standard II(A) deals with material nonpublic information (MNPI). Standard II(B) deals with market manipulation. Together they protect the fairness of markets and the trust of investors in prices.

You study four ideas under II(A): what makes information material and nonpublic, how the mosaic theory lets analysts combine public and immaterial nonpublic information, how firewalls and information barriers control the flow of MNPI inside a firm, and what to do when you actually receive MNPI. Under II(B) you learn the difference between legitimate trading and actions that mislead, including information-based and transaction-based manipulation.

This chapter sits inside Ethical and Professional Standards, a common core topic for every pathway. It connects to the rest of the paper because the same facts appear in item sets and essays on portfolio management, derivatives and private wealth. A trade on a tip, a research recommendation or a thinly traded security can all turn into a Standard II question. You apply the Code and Standards exactly as written in the official text, so precise wording matters.

Ethical and Professional Standards carries a topic weight of 10-15%, and Standard II is one of the most testable parts because the cases turn on small facts. Each item set and each essay set is worth 12 points in total. Each multiple-choice question in an item set is worth 3 points. The points for each item in an essay set are not disclosed. A misread fact can also lead you to a wrong answer on the other items in the set. The reasoning is also repeatable. If you learn the tests for materiality, public status and intent, you can apply them to any new vignette. That makes this a reliable place to earn points for the effort you put in.

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

  1. 1Standard II(A): Material Nonpublic InformationStart with the core rule and the definitions of material and nonpublic, since every later topic builds on them.
  2. 2Mosaic Theory and Public Information AnalysisNext learn what analysts may legitimately do, which marks the boundary of the rule you just studied.
  3. 3Firewalls and Information BarriersThen study the firm-level controls that stop MNPI from spreading, which are the compliance side of the rule.
  4. 4Standard II(A) Application: Handling MNPI in PracticeNow practise the actions to take when you receive MNPI, using the rule, the boundary and the controls together.
  5. 5Standard II(B): Market ManipulationMove to the second standard once II(A) is secure, so you do not mix up the two tests.

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

Treat this chapter as a skill of applying rules to facts, not a list to memorise. Build the tests first, then practise on cases.

  1. Read the text of Standard II(A) and II(B) slowly and write each in one sentence of your own.
  2. Write a short test for each idea: is it material, is it nonpublic, is the intent to mislead. Use the same checklist on every case.
  3. Learn the mosaic theory boundary with examples: public data and immaterial nonpublic data are fine, but a conclusion that is itself material and nonpublic is not.
  4. List the firm-level controls and what each one does, then link each control to the risk it reduces.
  5. Practise item sets first to train fact-spotting, then write essay answers that state the standard, the fact that breaches or satisfies it, and the action required.
  6. In essays, answer the command word exactly. If asked to identify, name the standard. If asked to recommend, give the action in one clear sentence.
  7. Review wrong answers and note which fact you missed, such as whether information was already public.

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

  • Treating all nonpublic information as prohibited

    Fix: Test both conditions every time. Immaterial nonpublic information can be used within the mosaic theory.

  • Assuming information is public because many people know it

    Fix: Ask whether it has been disseminated to the marketplace. Talk among a few insiders or in the market is not enough.

  • Misusing the mosaic theory for a tip

    Fix: Check whether any single piece is material and nonpublic. If it is, the mosaic defence fails.

  • Confusing a firewall with a complete solution

    Fix: Remember that firewalls are one control. They work with compliance monitoring, restricted and watch lists and escalation.

  • Calling any aggressive trade manipulation

    Fix: Look for intent to mislead or artificially affect price or volume, not just size or profit.

  • Writing vague essay answers

    Fix: Name the standard, cite the deciding fact and state the required action in a few words.

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

  • 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.

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 trading or causing others to trade on material nonpublic information. II(B) is about distorting prices or volume to mislead the market. The first focuses on information, the second on misleading conduct.

What makes information material?

Information is material if its disclosure would likely affect a security's price or if reasonable investors would want it before making a decision. Judge it by its likely impact, not by whether you personally find it important.

Can an analyst use the mosaic theory?

Yes. An analyst may combine public information with immaterial nonpublic information to reach a conclusion. The conclusion may be significant, but it is allowed only if no key input was material nonpublic information.

What should I do if I receive MNPI?

Do not trade on it or pass it on. Escalate to your compliance function so the firm can restrict the security and manage the information flow.

How should I write Standard II essay answers?

Follow the command word. State the relevant standard, point to the fact that decides the case, and give the action in one or two short sentences. Do not add extra points that were not asked for.