Standard II — Markets — CFA L1 Ethics

Standard II protects market integrity. The two sub-standards address insider trading and market manipulation — the most-tested ethics topics on CFA L1 exam.

Foundation

II(A) Material Non-Public Information (MNPI): don't trade or cause others to trade on MNPI. Material: would a reasonable investor consider it important in trading decision? Earnings, M&A, regulatory action, large management changes — typically material. Non-public: not yet broadly disseminated. II(B) Market Manipulation: don't engage in practices that distort prices or trading volume artificially. Includes pump-and-dump, wash trades, spoofing, painting the tape, false rumours.

Deep Dive

Mosaic theory — the escape valve from II(A): synthesising publicly available info + non-material non-public information into a non-obvious investable conclusion is permitted. This is what equity research analysts do. Line: - Legitimate (mosaic): "I synthesised many small, non-material, public/non-material-non-public sources into investable thesis" - Illegitimate (MNPI): "I confirmed earnings beat with friend at firm before public announcement" Indian context: SEBI Insider Trading Regulations 2015 stricter than CFA on certain dimensions: - Trading windows: prohibited periods around earnings - Designated persons: designated as restricted from trading during certain windows - Pre-clearance requirements - Stricter reporting

Advanced

Most-tested CFA L1 trap on II(A): scenario sounds like MNPI but is actually mosaic. Read carefully: - If analyst pieced together from public sources + minor non-material confirmations: mosaic, OK - If analyst received specific upcoming earnings number from insider: MNPI, violation Pump-and-dump on social media (II(B)) increasingly common. CFA tests recognition: small-cap stocks promoted on Telegram/WhatsApp, pumped, dumped on followers — coordinated manipulation = violation regardless of intent.

Regulatory references

CFA Standards II(A)-II(B)
SEBI Insider Trading Regulations 2015
SEBI PFUTP Regulations

Common mistakes & pitfalls

Confusing mosaic with MNPI.
Trading during corporate trading window.
Tipping others while trying to be helpful.
Pump-and-dump on social media.

Frequently asked

Mosaic theory in practice?

Combine publicly available + non-material non-public info to form investable conclusion. Legitimate analysis. Document sources to defend if challenged.

What if I overhear MNPI accidentally?

Don't use it. Don't share. Notify compliance. Document the situation. Refrain from trading the security till information becomes public.

Practice questions

Click each question to reveal the answer and explanation.

Q 1

MNPI = ?

(a)Material Non-Public Information
(b)Material Non-Provider Insurance
(c)Multilateral Negotiated Property Investment
(d)No standard meaning

Correct: (a) Material Non-Public Information

Material Non-Public Information. Both elements required: must be material AND non-public.

Q 2

Mosaic theory permits:

(a)Trading on insider info
(b)Synthesising public + non-material non-public into conclusion
(c)Bribing insiders
(d)Manipulating prices

Correct: (b) Synthesising public + non-material non-public into conclusion

Mosaic: combining public and non-material non-public sources into investable conclusion. Legitimate analyst work.

Q 3

Pump-and-dump = ?

(a)Legitimate trading
(b)II(B) Market Manipulation violation
(c)Standard hedging
(d)Algorithm only

Correct: (b) II(B) Market Manipulation violation

Pump-and-dump: artificially inflating price (pumping) then dumping on retail buyers. II(B) Market Manipulation. Heavy penalty.

Q 4

If you overhear MNPI accidentally, you should:

(a)Trade quickly before others find out
(b)Don't use; notify compliance; refrain from trading
(c)Share with friends
(d)Email compliance officer's competitor

Correct: (b) Don't use; notify compliance; refrain from trading

Don't use. Notify compliance. Refrain from trading. Wait until info is public. Even accidental possession of MNPI restricts trading.

Q 5

Which is materiality test?

(a)Stock would move >5%
(b)Reasonable investor would consider important
(c)CEO would announce
(d)Auditor confirms

Correct: (b) Reasonable investor would consider important

Materiality: would a reasonable investor consider it important? Subjective but contextual. Ask: "If this came out tomorrow, would price move?" — if yes, likely material.

Educational purposes only. The numbers, returns, and examples used in this lesson are illustrative. Past performance does not guarantee future results. Mutual fund and securities investments are subject to market risks. This lesson is not investment advice; for advice tailored to your circumstances, consult a SEBI-registered Investment Adviser. Read our full disclaimer.