Mosaic Theory and Material Nonpublic Information Explained (CFA Standard II(A))

Mosaic theory and material nonpublic information are among the most tested ideas in CFA Ethics, and they sit at the heart of Standard II(A). This article explains in plain language what makes information material and nonpublic, how mosaic theory lets analysts build conclusions legitimately, and how firms use firewalls to stop sensitive information from leaking into trading decisions.

What Standard II(A) Material Nonpublic Information Requires

Standard II(A) is part of the section on the Integrity of Capital Markets. In simple terms, if you have information that is both material and nonpublic, you must not trade on it and you must not cause anyone else to trade on it. Passing a tip to a friend, a relative or a client who then trades is just as much a violation as trading yourself.

The reason is fairness. Markets work well when investors believe that prices reflect information available to everyone. If insiders and their contacts consistently profit from secret information, ordinary investors lose confidence, and capital becomes more expensive for everyone. For a broader view of where this Standard fits, see our guide to the CFA Code and Standards.

What Makes Information "Material"?

Information is material if its release would be likely to affect the price of a security, or if a reasonable investor would want to know it before making an investment decision. Two features help you judge materiality:

• Specificity. A precise fact, such as "the company will announce a 40% drop in quarterly profit next week", is much more likely to be material than a vague comment that "business is a bit slow".
• Reliability of the source. Information from a company's finance director carries more weight than a rumour overheard at a conference. The closer the source is to the facts, the more likely the information is material.

Typical examples of potentially material information include earnings figures before release, a planned merger or acquisition, a major regulatory decision, the loss of a key customer, a dividend change, a significant lawsuit or a large new contract. Information about trading activity, such as a big pending order from a large fund, can also be material even though it is not about the company itself.

What Makes Information "Nonpublic"?

Information is nonpublic until it has been disseminated to the market and investors have had a reasonable chance to act on it. Telling a small group of analysts on a private call is not public dissemination. A press release distributed through a widely used news service, a stock exchange filing or a public webcast usually is.

Timing matters. Even after an announcement, there may be a short period before the market has realistically absorbed the news. Trading in the seconds after a release, using a preview obtained from an insider, would still be a problem.

Mosaic Theory: Building Conclusions the Right Way

Mosaic theory says that an analyst may reach a conclusion about a company by combining many pieces of information, as long as each piece is either public or nonpublic but immaterial. The analyst may then act on that conclusion, even if the conclusion itself would be material had the company announced it directly.

Think of it like a mosaic picture made from small tiles. No single tile reveals the image, but a skilled analyst who arranges enough tiles can see it. Good analysis is rewarded, which is exactly what the profession wants to encourage.

A fictional mosaic example

Kabir is an analyst at the fictional Nilgiri Research covering a listed cement producer. Over several weeks he:

1. Reads public data showing that government road-building tenders have slowed.
2. Notices from satellite images sold by a data vendor that fewer trucks are leaving the company's main plant.
3. Speaks to dealers, who say orders have been soft but share no confidential figures.
4. Hears from the company's investor relations team, in a general comment, that "the monsoon has been long".

None of these items is material and nonpublic on its own. Kabir combines them and concludes that the company will likely miss earnings estimates. He downgrades the stock. This is an acceptable use of mosaic theory. He should keep records of his research so that he can show how he reached the conclusion if anyone later questions it.

When the mosaic breaks

Now change one fact. Suppose a plant manager tells Kabir privately that the company's internal forecast shows profits falling by half, and that the board will announce it next Friday. That single piece is specific, comes from a reliable insider and has not been released. It is material nonpublic information. Kabir cannot trade or change his recommendation based on it, regardless of how much other public research he has done. Adding public tiles does not "clean" a material nonpublic tile.

What to Do If You Receive Material Nonpublic Information

Coming into possession of such information is not itself a violation. Acting on it is. A sensible response includes:

• Not trading and not recommending any action based on the information.
• Not passing it on to anyone who might trade.
• Reporting it to the firm's compliance department so the security can be placed on a watch or restricted list.
• Where appropriate, encouraging the source company to make public disclosure.

In the exam, an answer choice suggesting the analyst should "wait until it is announced and then trade" is usually fine for the post-announcement trade, while any choice involving trading or tipping before release is a violation.

Firewalls and Other Firm Procedures

Large firms often have departments that naturally receive sensitive information, such as corporate finance or investment banking, alongside research and trading teams who must not use it. To manage this risk, firms use information barriers, commonly called firewalls. Effective firewall procedures typically include:

• Physical and system separation of departments that hold sensitive information from those that trade or publish research.
• Controlled communication, where contact between departments goes through compliance staff.
• Watch lists and restricted lists that identify securities where the firm holds or may hold sensitive information, limiting employee and proprietary trading.
• Review of employee trading, including pre-clearance and monitoring of personal accounts.
• Documented policies and training so every employee understands the rules.

Smaller firms that cannot physically separate teams may need stricter restrictions, such as limiting trading in affected securities altogether. A firewall does not make it acceptable to use the information; it reduces the chance that the information spreads.

Material Nonpublic Information vs. Market Manipulation

Standard II has two parts, and candidates sometimes mix them up. The table below highlights the difference.

Aspect	II(A) Material Nonpublic Information	II(B) Market Manipulation
Core concern	Using secret, price-sensitive information	Distorting prices or trading volume
Typical example	Trading before a merger is announced	Spreading false rumours or trading back and forth to create fake volume
Key question	Is the information material and not yet public?	Is the intent to mislead other market participants?

How This Topic Is Tested at Level 1 and Level 2

At Level 1, questions are usually short scenarios asking whether a specific action violates Standard II(A), or which piece of information makes a mosaic invalid. You need to identify the material nonpublic element quickly. The CFA Level 1 Ethics course includes chapter tests that drill exactly these distinctions.

At Level 2, the same ideas appear inside longer vignettes. A case might describe an analyst meeting company management, a colleague in investment banking and a client who trades shortly afterwards, and then ask several questions about who, if anyone, violated the Standards. The CFA Level 2 Ethics course uses case-based questions to build this skill. Our article on strategy for CFA Level 2 Ethics case questions explains how to approach these vignettes.

Frequently Asked Questions

Is it a violation just to receive material nonpublic information?

No. Receiving the information is not a violation. The violation happens if you trade on it or cause others to trade. You should avoid acting on it and inform your compliance department.

Can an analyst use expert networks or industry contacts?

Yes, as long as the analyst does not obtain material nonpublic information from them. Talking to suppliers, customers or industry experts about general trends can be a legitimate part of building a mosaic.

Does mosaic theory protect an analyst who has one material nonpublic piece?

No. Mosaic theory only applies when every piece is public or nonmaterial. A single material nonpublic piece taints the conclusion, and the analyst must not act on it.

Why should analysts document their mosaic research?

Good records show regulators, employers and clients how a conclusion was reached using legitimate sources. This protects the analyst if a recommendation later appears to anticipate a company announcement.

Test your understanding of Standard II(A) with realistic questions. Start with the free demo in the CFA Level 1 Ethics course, which includes the first mock test, chapter test and notes, or move to case-based practice in the CFA Level 2 Ethics course.