What are the grey areas around Standard II(A) Material Nonpublic Information, and how does the mosaic theory work?

Question

AcadiFi · Accepted Answer

Standard II(A) — Material Nonpublic Information prohibits members from acting on or causing others to act on information that is both **material** and **nonpublic**. The challenge lies in determining when information crosses either threshold.

**Defining Material:**
Information is material if a reasonable investor would consider it important in making an investment decision, or if it would likely affect the security's price. Examples include unannounced earnings, merger plans, regulatory actions, or major contract wins/losses.

**Defining Nonpublic:**
Information is nonpublic until it has been disseminated broadly enough that the market has had time to digest it. A company press release on a major news wire is public; a tip whispered at a dinner party is not.

**The Mosaic Theory — Your Shield**

Mosaic theory permits analysts to form investment conclusions by combining:
1. **Public information** (financial statements, press releases, industry data)
2. **Non-material nonpublic information** (management tone during a factory tour, observations of foot traffic at retail stores)

As long as each individual piece of nonpublic information is **non-material on its own**, the analyst may synthesize them into an investment conclusion — even if the final conclusion itself would be material if disclosed.

**Scenario — Whitfield Capital Research (Compliant via Mosaic)**

Ana Reyes, an analyst at Whitfield Capital, is covering Solara Beverages:
- She reads Solara's 10-K and notes rising sugar costs (public, material)
- During a facility tour, a plant manager mentions they've been running extra weekend shifts (nonpublic, non-material alone)
- She notices from satellite imagery that Solara's distribution center parking lots are unusually full (public, non-material alone)
- A former Solara employee (now at a competitor) says the company culture has improved significantly (nonpublic, non-material alone)

Ana combines these pieces to conclude that Solara is likely experiencing a revenue surge. She upgrades to Buy. **This is compliant under mosaic theory** — she used public information and non-material nonpublic information.

**Scenario — Clearview Advisors (Violation)**

Tomas Bergman at Clearview Advisors plays golf with Solara's CFO, who mentions: "We're about to announce a 30% earnings beat next Tuesday." This single piece of information is both material and nonpublic. If Tomas trades on it or tells his clients to buy, he violates II(A).

```mermaid
flowchart TD
    A["Information Received"] --> B{"Is it material?"}
    B -->|No| C["Non-material info
Can use freely"]
    B -->|Yes| D{"Is it public?"}
    D -->|Yes| E["Material + Public
Can use freely"]
    D -->|No| F["MNPI — DO NOT TRADE
Do not share"]
    C --> G["Combine via Mosaic Theory
with public information"]
    G --> H["Form investment conclusion
(Compliant)"]
```

**Grey Area Examples:**
- **Overheard conversation at a conference** — If you overhear two executives discussing unannounced plans, that's MNPI even if it was accidental
- **Expert networks** — Hiring industry consultants is fine, but if they share specific client data from a company they recently left, it may be MNPI
- **Social media leaks** — A tweet from a company employee about upcoming layoffs may be nonpublic if the company hasn't officially confirmed it

**Exam Tip:** When in doubt, apply the two-step test: (1) Would a reasonable investor care? (2) Has the market had access? If both answers are yes to materiality and no to public dissemination, do not act.

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What are the grey areas around Standard II(A) Material Nonpublic Information, and how does the mosaic theory work?

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