## **Learning Outcomes**

This article explains how CFA Institute standards govern professionalism, misconduct, market manipulation, and the use of material nonpublic information in an exam-relevant way, including:

- Identifying common forms of professional misconduct and explaining why they violate Standard I(D)
- Distinguishing legitimate market activity from manipulative practices such as wash trades, spoofing, and rumor-spreading
- Assessing when information is both material and nonpublic, and recognizing situations where trading or communication is prohibited
- Applying the composite theory to research scenarios without relying on material nonpublic information
- Evaluating fact patterns to determine a member’s responsibilities to dissociate, escalate, and document suspected violations
- Determining appropriate firm-level procedures, controls, and reporting channels that support ethical market conduct
- Practicing exam-style reasoning to choose the most compliant course of action in scenario-based multiple-choice questions
- Interpreting how local laws, regulations, and firm policies interact with the CFA Institute Code and Standards when addressing misconduct and market abuse issues
- Strengthening exam technique by isolating the standard being tested, eliminating distractor answers, and justifying the correct response using precise ethical reasoning

## **CFA Level 2 Syllabus**

For the CFA Level 2 exam, you are expected to understand and apply the rules related to professionalism, communication, and market conduct, with a focus on the following syllabus points:

- Recognizing and preventing misconduct, including fraud or deceitful practices
- Identifying market manipulation methods and their consequences
- Defining and correctly handling material nonpublic information in investment decisions
- Differentiating between legitimate research (composite theory) and prohibited trading on inside information
- Applying appropriate procedures and safeguards to avoid and address misconduct

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which of the following most accurately describes market manipulation?  
   a) Trading to take advantage of anticipated price movement  
   b) Spreading false rumours to impact a security's price  
   c) Posting market research online  
   d) Analyzing price trends using technical analysis

2. If a CFA member receives material nonpublic information from a corporate executive, what action is permitted?  
   a) Trade immediately before the news is public  
   b) Communicate the information to all clients  
   c) Wait until the information becomes public before considering trades  
   d) Share analysis with colleagues only

3. True or False?  
   Failure to prevent or report unethical conduct by colleagues may be considered knowing participation in a violation.

4. What is the difference between material nonpublic information and the composite theory?

## **Introduction**

Professionalism and ethical communication are core duties for CFA charterholders. The CFA Code and Standards require members to reject dishonest practices, avoid manipulating markets, and never misuse confidential or inside information. This article focuses on the types of misconduct most often tested on the exam—market manipulation and possession or misuse of material nonpublic information.

> **Key Term: misconduct**
> Any dishonest, fraudulent, or deceitful behavior in professional duties. Includes actions that undermine integrity, such as falsifying records or misleading clients.
>
> **Key Term: market manipulation**
> Actions intended to mislead market participants by distorting prices or artificial trading volume, including spreading false information or executing trades to create a deceptive market appearance.
>
> **Key Term: material nonpublic information**
> Information that is both material to an investor's decision and not yet available to the public, such that acting on it would provide an unfair advantage.

## **Forms of Professional Misconduct**

Professional misconduct covers a spectrum of unethical behaviors. This includes lying on expense reports, covering up errors, falsifying records, and any action reflecting poorly on an individual's integrity or the investment profession. Even attempts to resolve personal issues or disputes through misuse of the CFA Institute Professional Conduct Program violate the Standards.

Standard I(D): Misconduct prohibits dishonest or illegal activity both inside and outside one's professional duties. Fraud, theft, deception—and knowingly failing to prevent or report these—are violations. Private actions that influence professional reputation (such as criminal acts or bankruptcy due to fraud) may also trigger disciplinary review.

## **Market Manipulation**

Market manipulation is any activity intended to deceive or mislead by distorting prices or creating false trading volume. Typical examples include:

- Spreading rumors to affect a security’s price
- "Wash trades" or matched orders to artificially increase volume
- Coordinating trades to mislead others, e.g., trading between funds managed by the same individual to influence market perception
- Placing orders with the intent to cancel, simply to move prices or induce reactions ("spoofing")

Market manipulation includes both actions (executing deceptive trades) and communication (disseminating false or misleading information). Intent to mislead is required for an action to constitute manipulation.

> **Key Term: wash trade**
> Transactions where the same party acts as both buyer and seller to generate the appearance of activity and influence the market price or volume.

## **Material Nonpublic Information**

Material nonpublic information relates to company news or data a reasonable investor would consider important in investment decisions, and which has not been publicly disseminated. Examples include:

- Earnings results before official release
- Upcoming significant transactions (mergers, takeovers)
- Credit rating changes prior to public disclosure
- Advance knowledge of regulatory rulings

Members must not act or cause others to act based on such information until it is widely available in the market. Selective disclosure (e.g., to analysts before a public announcement) is not considered public.

Composite theory allows analysts to combine public information with nonmaterial nonpublic information to develop an investment view, as long as the final assessment is not based on material nonpublic information.

> **Key Term: composite theory**
> The approach of forming investment conclusions by combining public data with nonmaterial nonpublic information, without using any single piece of material nonpublic information.

## **Responsibilities and Procedures**

If a member becomes aware of or suspects misconduct or a market abuse incident, immediate action is required:

- Dissociate from ongoing unethical or illegal activity—even if it means resigning.
- Inform the supervisor and compliance (seek advice if not clear).
- Document steps taken to dissociate and report.
- Reporting to authorities is advised or may be required by law, but not always required by the Standards.

Employers should have written compliance procedures, regular training on ethics, and procedures for reporting breaches. Members should encourage firms to:

- Maintain an effective code of ethics and written compliance policy
- Provide updated training and reference materials on applicable law and the Code
- Set up channels for reporting suspected violations

### **Worked Example 1.1**

_A CFA member suspects that a colleague is front-running client orders and trading ahead in a personal account. After reporting this to compliance, no action is taken. What is the most appropriate next step?_

> **Answer:**  
> The member must dissociate from the activity—cease working with the colleague or team, document the report, and seek legal counsel. If possible, seek transfer, or as a last resort, resign from the firm.

### **Worked Example 1.2**

_A portfolio manager receives material nonpublic information about a pending merger during a client meeting. The client requests the manager act quickly and purchase shares. What should the manager do?_

> **Answer:**  
> The manager must not act or cause others to act on the information until it is public. Explain to the client that trading is prohibited and would violate both the law and the Code.

### **Exam Warning**

> **Do not assume information distributed in analyst conference calls or closed meetings is public.** If in doubt, treat it as nonpublic and refrain from trading until official disclosure.

## **Summary**

Upholding professional standards means acting honestly and preserving the integrity of financial markets. Market manipulation, trading on material nonpublic information, or failing to prevent misconduct are clear violations that can lead to penalties. CFA members and candidates must always use independent judgment, avoid deception, and communicate truthfully.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Misconduct extends to all dishonest, fraudulent, or deceitful behavior, not just illegal acts
- Market manipulation includes creating misleading appearance of activity or prices, by either action or communication
- It is prohibited to act on or disseminate material nonpublic information until made public
- Composite theory permits use of a combination of public and nonmaterial nonpublic information, but not trading on material nonpublic data
- CFA members must dissociate from and report violations, using compliance processes
- Firms should have written codes and procedures for professional conduct and ethical reporting

## **Key Terms and Concepts**

- misconduct
- market manipulation
- material nonpublic information
- wash trade
- composite theory

Professionalism and communication - Misconduct market manipulation and material nonpublic information