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Level III Core · Guidance for Standard II: Integrity of Capital Markets

Ethics, Society and the Capital Markets for CFA Level III

Updated 8 October 2026 · Fact-checked

Ethics supports capital markets because investors only commit capital when they trust prices, information and intermediaries. Standard II protects that trust by banning trading on material nonpublic information and market manipulation. To solve a question, identify the conduct, link it to market integrity, name the standard, and state the action required.

Understand Ethics, Society and the Capital Markets

A capital market moves savings to productive uses. It works only if people believe prices reflect real information and that no one gets an unfair, hidden edge. If that belief fails, investors demand higher returns, trade less, or leave. Liquidity falls and the cost of raising capital rises. This is how weak ethics harms society, not just one client.

The CFA Institute Code and Standards treat this as a duty. Members must place the integrity of the investment profession and the interests of clients above their own interests. They must also promote the integrity and viability of the global capital markets. Standard II is where that duty becomes specific rules.

Standard II has two parts. Standard II(A) says you must not act or cause others to act on material nonpublic information. Standard II(B) says you must not engage in practices that distort prices or artificially inflate trading volume with intent to mislead market participants.

Think of trust as shared infrastructure. One person who trades on inside information may gain a profit, but every other participant bears a cost: they trade at worse prices and trust the market less. Exams test whether you see this wider harm and whether you choose the action that protects it.

At Level III you will see these ideas inside portfolio scenarios, such as a manager under performance pressure, a trader who hears a tip, or a firm that wants to support a stock price. You apply the same logic each time.

Key rules to remember

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.

How to solve Ethics, Society and the Capital Markets questions

Use this method on any item set or essay question about ethics and market integrity. Answer the command word exactly and keep your reasoning short.

  1. 1Read the conduct described and write down who did what, and what information or trading was involved.
  2. 2Ask whether any information is material and whether it is nonpublic. Check both separately.
  3. 3Ask whether any trading or communication could distort prices or mislead participants, and whether intent is present.
  4. 4Name the standard: II(A) for information, II(B) for manipulation. Check if other standards also apply, such as I(D) Misconduct or III(B) Fair Dealing.
  5. 5State the harm to market integrity or investor trust in one sentence.
  6. 6Give the required action: stop trading, do not pass on the information, escalate to compliance, or document the research basis.
  7. 7Match your answer to the command word. If asked to 'identify', name only. If asked to 'justify', add the reason. If asked to 'recommend', state the action.
  8. 8For multiple-choice, eliminate options that act on the information or conceal the problem, then pick the one that protects the market.

Quickest way: Two-question screen

When to use it: Use when you have under two minutes for a multiple-choice item on market integrity.

  1. Ask: is the information both material and nonpublic? If yes, any trading or tipping is a violation.
  2. Ask: is someone trying to move a price or volume to mislead? If yes, it is manipulation.
  3. If neither is true, the conduct is likely permitted, such as mosaic-theory research.
  4. Pick the option that stops the conduct and escalates to compliance, not the one that benefits the client or firm.

Common mistakes in Ethics, Society and the Capital Markets

  • Treating all nonpublic information as prohibited.

    Students remember 'nonpublic' and forget 'material'.

    Fix: Always test materiality first. Nonmaterial nonpublic information can be used under mosaic theory.

  • Thinking the Standard applies only if the member profits personally.

    Insider trading is imagined as a personal gain case.

    Fix: The standard covers acting or causing others to act. Trading for clients or tipping others is also a violation.

  • Calling any price-moving trade manipulation.

    Large orders visibly move prices, so students assume wrongdoing.

    Fix: Look for intent to mislead or a false impression. Legitimate large trades are not manipulation.

  • Choosing 'wait until the information is public' without stopping other actions.

    Students focus on timing only.

    Fix: The member should also avoid passing the information on and should consult compliance.

  • Writing general statements about ethics without naming the standard.

    Students rely on common sense instead of the Code.

    Fix: Name Standard II(A) or II(B) and tie the answer to market integrity and investor trust.

Worked examples

Example 1

A portfolio manager learns from a friend at a listed company that a large takeover bid will be announced next week. The news is not public. A colleague suggests buying the stock for client portfolios because it would benefit clients. Which action is consistent with the Code and Standards, and why?

Show the solution
  1. Information: a takeover bid would affect the price, so it is material.
  2. It has not been announced, so it is nonpublic.
  3. Both tests are met, so Standard II(A) applies.
  4. Buying for clients is acting on the information. The benefit to clients does not remove the violation.
  5. Required action: do not trade, do not pass the information on, and inform compliance.
  6. Reason: trading on it would give an unfair edge and weaken investor trust in the market.

Answer: The manager should not trade on the information or tell others, and should consult compliance. This is a Standard II(A) matter: the information is material and nonpublic, and acting on it harms market integrity even if clients would benefit.

Example 2

A trader at an asset manager buys small amounts of an illiquid stock repeatedly at the end of each quarter to lift its price before performance is reported. The trader says the stock is undervalued. Is this a violation? Justify your answer.

Show the solution
  1. Identify the conduct: repeated purchases timed at quarter end in a thinly traded stock.
  2. Test purpose: the aim is to raise the reported price, not to invest at fair value.
  3. This misleads participants and clients about the stock's value, so intent to mislead is present.
  4. Standard II(B) prohibits practices that distort prices with intent to mislead.
  5. Belief that the stock is undervalued does not justify distorting the price at reporting dates.
  6. Harm: prices no longer reflect true supply and demand, which reduces trust in the market.

Answer: Yes. This is market manipulation under Standard II(B) because the trades are designed to distort the price and mislead others. The trader's valuation view does not excuse it.

Exam tips

  • Always test material and nonpublic separately and show both in your answer.
  • In essay answers, name the standard and add one phrase on market integrity to earn the justification point.
  • Read command words in bold. Answer 'identify' with a name and 'justify' with a reason.
  • In multiple-choice, reject any option where the member trades first and checks later.
  • Watch for mosaic theory scenarios: public plus nonmaterial information is allowed.

Ethics, Society and the 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.

Ethics, Society and the Capital Markets: frequently asked questions

Why do ethics matter in capital markets?

Markets depend on trust. If investors think prices are rigged or insiders profit unfairly, they trade less and demand higher returns. That raises the cost of capital and harms society.

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

II(A) covers acting on material nonpublic information. II(B) covers practices that distort prices or volume to mislead. One concerns information, the other concerns deceptive market activity.

Is it a violation to analyze public information and reach a material conclusion?

No. Under mosaic theory, an analyst may combine public and nonmaterial nonpublic information. The conclusion can be material without breaching Standard II(A).

What should a member do after receiving material nonpublic information?

Do not trade on it and do not pass it to others. Inform compliance so the firm can take steps such as restricting the security.