Reading 2-II: Standards of Professional Conduct & Guidanc 2011, center, style, label, three

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Session 1: Ethical and Professional Standards
Reading 2-II: Standards of Professional Conduct & Guidance: Integrity of Capital Markets

LOS A.: Material Nonpublic Information.

 

 

Lisa Pierce, CFA, has been researching Lander Manufacturing for the past three weeks. She likes the company’s history of fulfilling its contracts on time and within budget. She learns from the uncle of a maintenance worker at Lander’s headquarters that a group of well-dressed individuals arrived at headquarters in a lime green-colored limousine. Pierce knows from publicly available information that Gilbert Controls needs a large supply of specialized motors in its domestic division. She also knows that the executive officers of Gilbert usually travel in a lime green limousine. Pierce concludes that it is very likely that Gilbert will offer a large contract to Lander. Based on this development and her prior research Pierce would like to acquire Lander Manufacturing shares for her client accounts.

Pierce should:

A) proceed to acquire the shares.

B) not acquire the shares because she possesses material nonpublic information.

C) not acquire the shares until after she has contacted Lander's management and encouraged them to publicly announce information about the Gilbert Controls contract. She should also wait until Lander has made the announcement and the public has had time to react to it and then make the acquisition.

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Standard II(A) prohibits members from taking investment action if they possess material nonpublic information. Pierce combined information that was not misappropriated, with her knowledge of the company, to reach a conclusion under the mosaic theory, which is permissible under the standards. She can proceed to buy the shares.

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Klaus Gerber, CFA, is a regular contributor to the Internet site WizeGuy. This past week Gerber has been incorrectly quoted as recommending that investors buy shares in Bradford, Inc. He is unaware that this message has been placed on the site as the quote was placed as a prank by an unknown source. This is the third time this has happened over the past month.

Fritz Fox, CFA, maintains and updates the WizeGuy site and has learned how to determine if the quotes being attributed to Gerber are actually valid. Several days later, he observes an investment recommendation, posted on the site, to buy Gresham, Inc. The investment recommendation is purported to be from Gerber, but Fox actually knows it to be bogus. He immediately sells 1,000 Gresham short and e-mails Gerber to inform him of the bogus recommendation. Gerber immediately issues a rebuttal, and Gresham falls by 14%. Fox's action is:

A) a violation of the Standard concerning fiduciary duties.

B) a violation of the Standard concerning use of material nonpublic information.

C) not in violation of the Code and Standards.

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Even though the information is false, this fact is known only to Fox and is thus nonpublic information. Since such recommendations have in the past had a significant affect on the price of the security in question, the information is clearly material. Fox is in violation of Standard II(A) Material Nonpublic Information.

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While working on her report, Jean Paul, CFA, learns from her friend in the investment banking department that the company she is analyzing can expect a tender offer very soon. Concerning this conclusion, Paul can:

A) trade on it, because it is public information.

B) trade on it, because she figured it out by herself.

C) not trade on it because it is material nonpublic information.

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According to Standard II(A), Material Nonpublic Information, an analyst is prohibited from trading on information that is both material and nonpublic.

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The mosaic theory is the idea that an analyst can:

A) make investment recommendations on the basis of several pieces of nonpublic information as long as the aggregate information remains nonmaterial.

B) base his recommendations on nonpublic material information only for the clients of the company, but not for the general public.

C) make recommendations or trade based on several pieces of public or nonpublic information, each piece by itself being nonmaterial, but when compiled the information becomes material.

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The mosaic theory permits an analyst to make recommendations based upon several pieces of public or nonmaterial information, even though the complied result is both material and nonpublic.

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Insider trading can be defined as information that is:

A) material and public.

B) material and nonpublic.

C) nonmaterial and nonpublic.

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Information is material if it would be important to the investor in their investment making decision. Information is nonpublic if it is not yet available to the public.

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An analyst is allowed to trade on information that he has predicted, such as a corporate action or event, using perceptive assembly and analysis of material public information or nonmaterial, non-public information. This is called the:

A) assessment theory.

B) deduction theory.

C) mosaic theory.

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This deductive reasoning is legal (does not constitute trading with inside information) and is called the mosaic theory.

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Which of the following statements concerning Standard II(A), Material Nonpublic Information, is CORRECT? A member:

A) can trade on material non-public information if the information was not obtained through a breach of duty.

B) can trade on material non-public information if the information has not been misappropriated.

C) cannot trade on material non-public information.

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Members cannot trade on material nonpublic information until that same information is made public. It does not matter if the information was not misappropriated or not obtained through a breach of duty

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A CFO who is a CFA Institute member is careful to make his press releases—some of them containing material and previously undisclosed information—clear and understandable to his readers. While writing a new release, he often has his current intern proofread rough drafts. He also sends electronic copies to his brother, an English teacher, to get suggestions concerning style and grammar. With respect to Standard II(A), Material Nonpublic Information, the CFO is:

A) not in violation of the Standard.

B) violating the standard by either showing the pre-release version to his intern or sending it to his brother.

C) only in violation by e-mailing the pre-release version to his brother but not the intern, because the intern is in essence an employee of the firm.

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Standard II(A), Material Nonpublic Information, says that a member must be careful about handling material non-public information. As a member of CFA Institute, the CFO must limit the people who see important information before it is released. It would not be appropriate to involve an intern or a relative in the process.

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A stockbroker who is a CFA Institute member is called on the telephone by the CEO of a large company. The CEO asks to buy shares of the CEO’s company for the accounts of the CEO’s children. In the course of the conversation, the CEO says this will really pay off when the upcoming takeover goes through. The stockbroker checks her sources and finds no information about the takeover. In this case the broker should:

A) only execute the order in compliance with Standard III(A), Loyalty, Prudence, and Care. Since the client is buying the stock for the children, there is not a problem.

B) execute the order for all clients as required by Standard III(B), Fair Dealing.

C) do neither of the actions listed here.

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Doing any of these actions would be a violation of Standard II(A), Material Nonpublic Information. Members and Candidates must not act or induce others to act on material nonpublic information.

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Don Benjamin, CFA, is the compliance officer for a large brokerage firm. He wants to prevent the communication of material nonpublic information and other sensitive information from his firm’s investment banking and corporate finance departments to its sales and research departments. The most common and widespread approach that Benjamin can use to prevent insider trading by employees is the:

A) Wall Street Rule.

B) legal list.

C) fire wall.

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To comply with Standard II(A), a fire wall provides an information barrier that prevents communication of material nonpublic information and other sensitive information from one department to another within a firm.