Standard II – Integrity of Capital Markets

The second standard, integrity, has two sub-parts:

I-A. Material Nonpublic Information

As per this standard, the Members and Candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information.

The main purpose of this standard to restrict members from indulging in insider trading. People with inside information can take advantage of the information and make gains, which would not be possible otherwise, and getting involved in any such activity is against the CFA Code.

There are two things that need clarity here. One is what constitutes “material” information, and the other is what is Nonpublic information.

A piece of information can be classified as material if the knowledge of it would impact the price of the security, or if it is something that investors would want to know before investing in a particular security. For example, information about earnings, merger, acquisition, change in assets, acquiring new patents, new customers, change in management, or any legal disputes, are all material information.

A piece of information is considered nonpublic until the time it is available to public in general. For example, the information about earnings, which has bee officially released by the company is considered public information. On the other hand, there is certain information that is selectively released to a small group on analysts, or is not disclosed to anyone outside the company.  An example could be a possible loss of a large customer, or talks about acquiring another firm. Till such time this kind of information is not made available to everyone, it is considered nonpublic and the CFA members and candidates should not make use of such information for their benefit or for the benefit of their clients.

Rules of thumb:

You must not act on the material nonpublic information

You must take reasonable care to protect the nonpublic information that you have access to.

Before acting on any information, you must make sure whether the information has been made selectively available to you or is it available to the public. 

I-B. Market Manipulation

As per this standard, the Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.

The market manipulation could be information-based or transaction-based.

Information-based manipulation refers to the situation where an analyst may spread false/misleading information that could propel trading. For example, an analyst may provide an exaggerated positive recommendation for a stock, which may lead to a hike in its price. The intention behind this could be to sell the stocks when the prices have jumped high.

Transaction-based manipulation could occur when a CFA member/candidate’s activities could artificially impact the price/volume of an asset to draw public’s attention. For example, an institutional investor with multiple accounts could trade in a stock to increase the trading volume significantly. Another transaction-based manipulation could be where the manipulator takes a dominant, controlling position in an asset so that he could exploit a derivative product.

Both information-based and transaction-based manipulation are a violation of Standard II-B.