Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

An analyst combines nonpublic information with public information to make an investment recommendation. According to CFA Institute Standards, what is the most accurate statement regarding this action?

1. This is a violation of CFA standards.

2. This action is acceptable under the mosaic theory.

3. This is acceptable if it results in a better informed recommendation.

4. This action requires additional disclosures to clients.

The correct answer is: This action is acceptable under the mosaic theory.

The action described—combining nonpublic information with public information to make an investment recommendation—is evaluated under the framework of the mosaic theory, which is recognized in the CFA Institute Standards. The mosaic theory posits that analysts can gather and piece together various bits of public and nonmaterial nonpublic information to form a comprehensive understanding of a security's value. This approach is acceptable because it does not violate CFA standards as long as the nonpublic information is not material or the analyst is careful in distinguishing what constitutes material nonpublic information. Analysts using the mosaic theory can create investment recommendations based on a thorough analysis of all available information without being considered to be acting on undisclosed material information, which could breach ethical guidelines. In contrast, the other choices present misconceptions about the use of nonpublic information. For example, stating that this action is a violation of CFA standards would misinterpret the guidelines set for ethical conduct, as the use of nonmaterial nonpublic information is permissible under specific circumstances. Similarly, indicating that additional disclosures to clients are required or that the action is only acceptable if it leads to better-informed recommendations does not accurately reflect the CFA standards regarding ethical investment analysis.