Standard II(A) – Material Non-Public Information

CFA Institute members and candidates should not act on material nonpublic information in their possession or cause others to act on it.

If the publication of information will affect the price of a security or if reasonable investors would wish to know about it before making an investment decision, it is considered material. It is considered “nonpublic” until the information has been disseminated or made available to the broader public.

Application 1: Disclosure of Material Information

Anne Feinstein is an equity analyst based in Sydney and covers the Korean manufacturing sector. She is on a conference call with five leading analysts and the CFO of a major fashion retail company. In the call, the CFO discloses that most of the firm’s workforce is set to go on strike indefinitely. This would cripple production and productivity, so the CFO informs the analyst that the firm is expected to miss its expected earnings expectations for the next two quarters. Feinstein goes on to update her recommendation to a “Sell.”

Has Feinstein violated Standard II(A) – Material Nonpublic Information?

1. Yes, she is not allowed to take any investment actions on nonpublic information.
2. No, the information is considered public because the conference call included several other analysts – therefore, the information is public.
3. Yes, Feinstein is not permitted to talk to management. She is not allowed to get insider information.

Solution

The correct answer is A. 

She has violated Standard II(A) – Material Nonpublic Information because she changed her investment recommendation. Feinstein needs to determine whether the material information she received is publicly known. The information would be considered nonpublic – it has not been disseminated to the broader public. As a result, Feinstein is not allowed to act on the information.

Application 2: Using Expert Networks

Jamal Saadiq is a portfolio manager at Sanford Asset Managers. She specializes in technology stocks and wants to get deeper insights into the sector. Saadiq hires an industry expert and compensates him for his time. Saadiq leaves their session better informed and enhances her research reports and conclusions.

Would Saadiq’s actions violate Standard II(A) – Material Nonpublic Information?

1. Yes, because she is using the knowledge of the expert to enhance her research.
2. No, because she is allowed to hire industry experts to enhance her knowledge.
3. Yes, because she compensated the industry expert for insider information.

Solution

The correct answer is B. 

Saadiq has not violated Standard II(A) – Material Nonpublic Information. She has not received any information that could be considered material and nonpublic. Saadiq is permitted to seek advice from industry experts to enhance her research.

Application 3: Mosaic Theory

Alison Kaitu is an equity analyst that covers the consumer discretionary sector. She is working on a research report on Zang Corporation. Zang Corporation is listed on the NYSE and quickly became a “hot” stock. Zang Corp. has beat analyst earnings expectations over three successive quarters in a very competitive manufacturing industry. Kaitu, however, is suspicious of Zang’s extraordinary growth and performance published in its filings. She decides to visit Zang’s manufacturing plants and observes that many of the factories have been closed or have limited production activity. Kaitu issues a “sell” recommendation based on the combination of her fundamental analysis and the observations she gained on her visit.

Has Kaitu violated Standard II(A) – Material Nonpublic Information?

1. Yes, she used material information to arrive at her recommendation.
2. No, she is allowed to use a combination of public information and nonmaterial nonpublic information to arrive at her conclusions.
3. Yes, her knowledge of Zang’s manufacturing activities would be considered insider information.

Solution

The correct answer is B. 

Kaitu is permitted to use a combination of public information (Zang’s fillings) and nonmaterial nonpublic information (her observations at Zang’s manufacturing plants). Before issuing her recommendation, she needed to determine the materiality of her observations. In this case, her observations were taken independently. Additionally, any other investor or analyst could potentially make the same observations if they went deeper into their investigations of Zang. Her observations alone would not be considered material. Under the mosaic theory, Kaitu has not violated Standard II(A) – Material Nonpublic Information.

Application 4: Using Information Nonpublic

Wilson Orengo, CFA, is an investment manager at Jumji Inc., an investment company. During a weekend night out at a local joint, Orengo overhears Enock Otieno, CEO of a Royal bank,  talking about an acquisition the bank intends to make in a few months. The following day Wilson buys himself the banks’ shares in anticipation of the acquisition announcement. Wilson did not buy shares for his client’s accounts.

Under the CFA Institute  Code and Standards, Wilson’s actions:

1. violates the CFA Institute Code and Standards because he bought his shares before buying for his clients.
2. does not violate the CFA Institute Code and Standards because the shares bought are his own.
3. violates the CFA Institute Code and Standards because of using information nonpublic

Solution

The correct answer is C.

Wilson violated Standard II(A)  because of using information nonpublic. The bank making an acquisition is not public information. Additionally, this information is material because its disclosure would affect the price of the bank’s shares.

A is incorrect. Wilson violates the CFA Institute Code and Standards but not because he bought himself the bank’s shares and not his employer. He violates Standard II(A) because of trading on nonpublic information.

B is incorrect. CFA Institute members and candidates should not act on material nonpublic information in their possession or cause others to act on it.

LOS 3(a): Evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards of Professional Conduct.

LOS 3(b): Explain how the practices, policies, or conduct does or does not violate the CFA Institute Code of Ethics and Standards of Professional Conduct.