COS 2: Integrity of Capital Markets

Question 1

Code Of Standards 2: Integrity of Capital Markets

2A: Material Non-public Information

Answer 1

Information is “material” if its disclosure would probably have an impact on the price of a security or if reasonable investors would want to know the information before making an investment decision.

ex. earnings (EPS), pending M&A, change in assets, innovations, drug phases, management changes, legal disputes, defaults, bankruptcy, large block orders, auditor opinions, new licenses, patents

Question 2

2A: Material Non-public Information: Test

Answer 2

• consider source and effect
• if price effect is unclear –> it may not be considered material
• information about trials of a new drug, product, or service under development from qualified personnel involved in the trials is likely to be material, whereas educated conjecture by subject experts not connected to the trials is unlikely to be material.

Question 3

2A: Material Non-public Information: Non-public

Answer 3

Information is “nonpublic” until it has been disseminated or is available to the marketplace in general (as opposed to a select group of investors). “Disseminated” can be defined as “made known.”

• Information that is made available to analysts remains nonpublic until it is made available to investors in general.
• Analysts must be aware that a disclosure made to a room full of analysts does not necessarily make the disclosed information “public.
• A m/c may use insider information provided by the source company for the specific purpose of conducting due diligence according to the business agreement between the parties for such activities as mergers, loan underwriting, credit ratings, and offering engagements.

Question 4

2A: Mosaic Theory

Answer 4

• A financial analyst gathers and interprets large quantities of information from many sources. The analyst may use significant conclusions derived from the analysis of public and NON-material nonpublic information as the basis for investment recommendations and decisions even if those conclusions would have been material inside information had they been communicated directly to the analyst by a company.
• Under the “mosaic theory,” financial analysts are free to act on this collection, or mosaic, of information without risking violation.
• Analysts should save and document all their research

Question 5

2A: Material Non-public Information: Social Media

Answer 5

• Some social media platforms require membership in specific groups in order to access the published content. Members and candidates participating in groups with membership limitations should verify that material information obtained from these sources can also be accessed from a source that would be considered available to the public (e.g., company filings, webpages, and press releases).
• Members and candidates may use social media platforms to communicate with clients or investors without conflicting with this standard. As long as the information reaches all clients or is open to the investing public, the use of these platforms would be comparable with other traditional forms of communications, such as e-mails and press releases.
• MUST DO: complete all appropriate regulatory filings related to information distributed through social media platforms.

Question 6

2A: Material Non-public Information: Using Industry Experts

Answer 6

• M/c may provide compensation to individuals for their insights without violating this standard, but are ultimately responsible for ensuring that they are not requesting or acting on confidential information received from external experts, which is in violation of security regulations and laws or duties to others.
• Firms connecting experts with m/c often require both parties to sign agreements concerning the disclosure of material nonpublic information
• Even with the protections from such compliance practices, if an expert provides material nonpublic information, members and candidates would be prohibited from taking investment actions on the associated firm until the information became publicly known to the market.

Question 7

2A: Material Non-public Information: Investment Research Reports

Answer 7

• When a particularly well-known or respected analyst issues a report or makes changes to his or her recommendation, that information alone may have an effect on the market and thus may be considered material.
• such a report would have to be made public at the time it was distributed to clients.
• Investors who are not clients of the analyst can either do the work themselves or become clients of the analyst to gain access to the analyst’s expertise.

Question 8

2A: Material Non-public Information: Recommended Procedures

Answer 8

1. Achieve Public Dissemination
   
   • encourage issuer to make inform. public
2. Adopt Compliance Procedures
   
   • review of employee and proprietary trading, the review of investment recommendations, documentation of firm procedures, and the supervision of interdepartmental communications in multiservice firms.
3. Adopt Disclosure Procedures
   
   • ensure that information is disseminated to the marketplace in an equitable manner
   • treat all analysts equally despite reports (+ or -)
4. Issue Press Releases
   
   • Companies should consider issuing press releases prior to analyst meetings and conference calls and scripting those meetings and calls to decrease the chance that further information will be disclosed. If material nonpublic information is disclosed for the first time in an analyst meeting or call, the company should promptly issue a press release or otherwise make the information publicly available.
5. Firewall Elements
   
   • An information barrier commonly referred to as a “firewall” is the most widely used approach for preventing the communication of material nonpublic information within firms. It restricts the flow of confidential information to those who need to know the information to perform their jobs effectively.

      - interdepartmental communications
      - review of employee trading through the maintenance of “watch,” “restricted,” and “rumor” lists;
      - documentation of the procedures designed to limit the flow of information between departments and of the actions taken to enforce those procedures; and
      - heightened review or restriction of proprietary trading while a firm is in possession of material nonpublic information.

Question 9

Continued… 2A: Material Non-public Information: Recommended Procedures

Answer 9

6. Appropriate Interdepartmental Communications
   
   • procedures concerning interdepartmental communication, the review of trading activity, and the investigation of possible violations should be compiled and formalized.
7. Physical Separation of Departments and Files

8.