Integrity of Capital Markets - II(A) Material Nonpublic Information

LOS

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What is Standard II of the SoPC? Integrity of Capital Markets

What is Standard II(A) of the SoPC? Material Nonpublic Information

What is the primary directive of Standard II(A), Material Nonpublic Information? 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 that information.

How is “material” information defined? Information is material if its disclosure may affect the price of a security, or if reasonable investors would want to know the information before investing.

What seven topics would be considered “material” in an insider trading context? 1. A forthcoming dividend declaration or mission. 2. Corporate reorganizations or takeovers. 3. The acquisition or loss of a major contract. 4. A major purchase or sale of company assets. 5. An event of default. 6. Knowledge of forthcoming press coverage of a company’s affairs, whether positive or negative. 7. Substantial increases or decreases in earnings projections.

Under what circumstances is information considered nonpublic? Information is nonpublic if it has not been disseminated to the marketplace in general, or if investors have not had an opportunity to react to the information. Note that disclosing the information to a selected group of analysts does not make it public. For example, a disclosure made to a room full of analysts does not make the disclosed information “public.”

a. demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations of issues involving issues of personal integrity

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What should a member do if they receive material nonpublic information in confidence? The member should encourage the company make the material nonpublic information available to the public.

Under Standard II(A), can you use both material public information and nonmaterial nonpublic information making investment decisions? Yes, this is Mosaic Theory

b. distinguish between conduct that conforms to the Code and Standards and conduct that violates the Code and Standards

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How does the source of information help to determine materiality of information? The less reliable a source, the less likely the information provided would be considered material.

Aside from Material Nonpublic information, what are the other types of information that are not prohibited in this Standard? 1. Nonmaterial public information 2. Nonmaterial nonpublic information 3. Material public information

What is Mosaic Theory? Mosaic Theory is when an analyst pieces together publicly available information to conclude an investment position. I.e. a “mosaic” of information.

Is Mosaic Theory a breach of SoPC Standard II(A)? Why? No, because all the information used is public information so even if the investment position is novel the information is acceptable. Be sure to keep records of the research.

If you gain several pieces of non-material non-public information from a company, and combine that information to conclude to make a trade, is that a violation of Standard II(A)? No, this is Mosaic theory, as long as every individual piece of information is non-material.

One: Material nonpublic information is revealed by an investor relations representative at a quarterly conference call for analysts. Two: Material nonpublic information is revealed by the CEO during a conference call for analysts. Which, if either, of these can you trade on? You can trade on One but not on Two. One is now public information because it’s on the quarterly conference call and divulged by the investor relations representative. Two is a select analysts conference call and divulged by the CEO, hence not public yet and should not be traded on.

c. recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct

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In investment terms, what is a “fire wall” and what does it do? A “fire wall” is a physical and digital separation of employees within a single firm, in order to prevent transmission of material nonpublic information from one department of a firm to another department.

What are the four minimum elements of implementing a firewall? 1. Substantial control (preferably by the compliance department) of relevant interdepartmental communications. 2. Review of employee trading through effective maintenance of some combination of “watch,” “restricted,” and “rumor” lists. 3. Documentation of the procedures designed to limit the flow of information between departments and of the enforcement actions taken pursuant to those procedures. 4. Heightened review or restriction of proprietary trading while the firm is in possession of material nonpublic information.

Why would a firm place certain securities on a restricted list so that employees can not trade them? If the firm has material nonpublic information about a company, it’s a good idea to put that company on the restricted list so employees don’t attempt to trade on the information.

Under what circumstance would a stock watch list want to be restricted to a subset of employees at a firm? If the watch list might reveal to people outside the firm that it is engaged in activity that generates material nonpublic information and that signal might result in unwanted trading activity then the watch list should be restricted to only a few employees.

The corporate finance division of an investment bank wants the business of a company. The brokerage department currently has a “sell” recommendation for this firm. The head of corporate finance writes the head of brokerage and asks him to change the rating to “buy”. Under Standard II(A) what should the head of brokerage do? The head of brokerage should remove the company from the research universe and put it on a restricted list, only giving factual information about the company.