What is the mosaic theory in CFA ethics, and how does it differ from trading on material nonpublic information?

Question

AcadiFi · Accepted Answer

The mosaic theory is one of the most nuanced and frequently tested ethics concepts at CFA Level II. It defines when an analyst can legitimately use information that isn't publicly available — and when doing so crosses the line into illegal insider trading.

**Standard II(A) — Material Nonpublic Information:**
CFA members must not act or cause others to act on information that is both:
1. **Material** — a reasonable investor would consider it important in making an investment decision
2. **Nonpublic** — not yet disseminated to the market through recognized channels

Trading on MNPI violates the Standard and likely violates securities laws (e.g., SEC Rule 10b-5).

**The Mosaic Theory:**
Analysts are permitted to form investment conclusions by combining:
- **Public information** (financial statements, press releases, industry reports)
- **Non-material nonpublic information** (observations from site visits, conversations with suppliers, channel checks)

The key insight: **individually non-material pieces of nonpublic information can be combined with public data to form a material conclusion — and acting on that conclusion is permissible.**

**Example 1 — Mosaic Theory (Permissible):**

Sara Whitman, CFA, is analyzing Lakeview Semiconductor. She:
1. Reads Lakeview's public 10-Q showing $340M in revenue last quarter (public)
2. Visits a Lakeview factory and notices a third production shift has been added (non-material nonpublic — one factory doesn't tell you about the whole company)
3. Speaks with a Lakeview supplier who mentions component orders increased 40% (non-material nonpublic — one supplier's data point)
4. Reviews industry data showing semiconductor demand is rising 12% YoY (public)

Sara concludes Lakeview will beat earnings estimates and recommends a buy. **This is allowed under mosaic theory.** Each nonpublic piece was individually non-material, but her analytical skill combined them into a material conclusion.

**Example 2 — MNPI Violation (Not Permissible):**

David Park, CFA, is analyzing Cascadia Energy. The CEO tells David at a private dinner: "We're going to announce a $2 billion acquisition of Ridgeline Power next Tuesday." David buys Cascadia shares on Monday.

**This is a clear violation.** The acquisition is a single piece of information that is both material (would affect the stock price) and nonpublic (not yet announced). No amount of mosaic theory analysis justifies acting on it.

**Example 3 — The Gray Area:**

Megan Torres, CFA, researches Brightwell Pharmaceuticals. A mid-level scientist casually mentions at a conference: "Our Phase III trial data is looking really positive." This is trickier:
- Is it material? Arguably yes — Phase III results for a key drug candidate would significantly impact the stock
- Is it nonpublic? Yes — the results haven't been formally announced
- **Conclusion:** This is likely MNPI. Megan should not trade until the data is publicly released.

**The Decision Framework:**

| Question | If Yes... |
|---|---|
| Is the single piece of information material on its own? | Cannot trade — it's MNPI |
| Is it nonpublic but individually non-material? | Can use as part of mosaic analysis |
| Did you combine multiple non-material nonpublic pieces with public data? | Permissible under mosaic theory |
| Could the source reasonably expect confidentiality? | Exercise extra caution |

**Exam Tip:** CFA Level II ethics vignettes love to present scenarios where the analyst receives information at industry conferences, from company tours, or from supplier conversations. Ask yourself: "Is this single piece of information, by itself, material?" If yes, it's MNPI regardless of how you obtained it. If no, it can be part of your mosaic.

Practice more ethics scenarios in our CFA Level II question bank.

What is the mosaic theory in CFA ethics, and how does it differ from trading on material nonpublic information?

Master Level II with our CFA Course

Related Questions

Practice Questions