Learning Module 4 of Ethical and Professional Standards 10–15% of the exam

Guidance for Standard II: Integrity of Capital Markets

2 lessons. About 14 minutes in cram mode, 64 minutes in full.

Start with lesson 1 Learn with Sensei Read the module summary Practice this module

Lessons

1
Standard II(A): Material Nonpublic Information
demonstrate 8 min cram, 40 min full
2
Standard II(B): Market Manipulation
demonstrate 6 min cram, 24 min full

What the exam expects you to do

Demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity.Standard II(A): Material Nonpublic Information
Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.Standard II(A): Material Nonpublic Information
Identify conduct that conforms to the Code and Standards and conduct that violates the Code and Standards.Standard II(A): Material Nonpublic Information

Module summary

The whole module on one sheet, organised by lesson: what to memorize, how the ideas fit together, the formulas and the key terms. No paragraphs, just what you need to revise.

Hide what I know

How deeply to learn each part

Know the idea: Understand it in general. It frames other topics, but you will not calculate with it.
Use it: Understand it well enough to solve a question with it. Recognize when it applies.
Memorize: Learn it by heart. The exam will not give it to you.

Standard II(A): Material Nonpublic Information

Known

MemorizeStandard II(A): the two gates

Gate	Information passes if	Pushes it through
Material	It would affect the price, or a reasonable investor would want it	Specific, reliable source, clear price effect
Nonpublic	It has not been made available to the market in general	Told to a few analysts or a closed group: still nonpublic

Memory hook Two gates, both must be open. Material AND nonpublic: freeze. Either one closed: the Standard does not bite.

Know it cold Both gates open: do not act, do not cause others to act (no trading, no tipping, no hinting through changed recommendations).

MemorizeIf you receive it

Step	Action
1	Do not trade and do not alter recommendations
2	Encourage the issuer to make it public
3	If it cannot be made public, tell only supervisory and compliance staff

Memory hook Freeze, push it public, tell compliance. Never "publish it yourself" or "tell big clients".

Know it cold Firewall: compliance clearance of cross-department talk, watch / restricted / rumor lists, documentation, heightened proprietary-trading review; plus physical separation and no personnel overlap.

Key terms

material nonpublic information Memorize
materiality Memorize
public dissemination Memorize
mosaic theory Memorize
industry experts and expert networks Use it
firewall Memorize
watch list and restricted list Memorize
insider trading Know the idea

Is the information covered by II(A)?

Information you holdabout an investment

Material and nonpublic Memorize both gates open
- Do not act or cause others to act no trades, no tips
- Encourage public disclosure then tell compliance if it cannot be made public
Material but public Memorize already disseminated
- Free to use II(A) no longer applies
Nonpublic but not material Memorize small details
- Mosaic theory may be combined with public facts into a conclusion

What a firewall contains

Firewallthe main control against misuse of inside information

Compliance clearance Memorize cross-department communication goes through compliance or legal
Lists Memorize watch, restricted and rumor lists to review employee trading
Physical separation Memorize banking away from sales and research
No personnel overlap Memorize an employee is on one side of the wall at a time
Documentation and proprietary trading review Use it record the controls; restrict firm trading while holding inside information

Standard II(B): Market Manipulation

Known

MemorizeStandard II(B): two types and one test

Type	What it is	Examples
Information-based	Spreading false or misleading information to induce trading	False rumors; pump and dump; exaggerated projections
Transaction-based	Trades that give a false impression of activity, price or liquidity, or a dominant position used to force prices	Wash trades, matched orders; squeeze of a derivative or its underlying asset
Legitimate	Trades on a genuine view, tax or arbitrage purposes	Not manipulation even if the price moves

Memory hook Talk it up or trade it up: information or transactions. The test is the same for both: was it meant to mislead?

Know it cold Violation needs intent to mislead (or knowing the trades would distort). A price move alone is never enough.

MemorizeIndicators of manipulation (a non-exhaustive list)

Indicator	In short
Orders open for an unusually short time	In and out before anyone can trade against them
Orders above the market price	Priced to move the market, not to deal
Orders with no change in beneficial ownership	Buyer and seller are the same owner
Orders meant to move the bid or offer, then cancelled	Spoofing: show interest, then withdraw
Orders on both sides via different platforms	A hidden round trip
Coordinated action by traders in a thin market	Together they can move a price that trades little

Memory hook Fast in, fast out, same owner, both sides, or a crowd in a thin market: the orders look real but are not meant to deal.

Know it cold An indicator is a warning sign, not proof. Intent to mislead still decides.

Key terms

market manipulation Memorize
information-based manipulation Memorize
transaction-based manipulation Memorize
pump and dump Memorize
wash trading Use it
market squeeze Use it
intent to mislead Memorize
indicators of manipulation Memorize
spoofing Use it

Indicators of manipulation

Warning signs in order activitynon-exhaustive; not proof on their own

Orders open an unusually short time Memorize in and out almost at once
Orders above the market price Memorize priced to move the market
No change in beneficial ownership Memorize the same owner on both sides
Orders meant to move the bid or offer, then cancelled Memorize spoofing
Orders on both sides via different platforms Memorize a hidden round trip
Coordinated action in a thin market Memorize several traders acting together

Compliance practices for II(B)

Catching manipulation before it happensfive practices

Anti-spoofing procedures Use it rules against placing orders you mean to cancel
Real-time surveillance across platforms Use it one view of all venues
Automated order management and pre-trade controls Use it block suspect orders before they reach the market
Controls on trading algorithms Use it test and supervise them
Trade exception reporting Use it flag unusual trades for review

Is it market manipulation?

Conduct that moves price or volumethen ask about intent

Information-based manipulation Memorize misleading statements
- False rumors to induce trading by others
- Pump and dump talk up what you hold, then sell into the rise
Transaction-based manipulation Memorize misleading trades
- False activity or price wash trades, matched orders
- Dominant position squeeze a derivative or the underlying asset
Legitimate strategy Memorize no intent to mislead
- Trades on a genuine view valuation, tax, arbitrage