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Not investment advice. Educational reading. See Disclaimer.
L.3 · INTERMEDIATE · 2 MIN

Material Nonpublic Information and the Insider-Trading Line

The single brightest line in investment ethics is also a criminal-law line: you may not trade, or tip others to trade, on material nonpublic information. 'Material' means a reasonable investor would consider it important in deciding to buy or sell -- it would, or could, move the price (a coming earnings miss, an unannounced merger, a failed drug trial, the loss of a huge customer). 'Nonpublic' means it has not yet been broadly disseminated to the market. Information has to be BOTH to be off-limits: public-and-material is just good analysis; nonpublic-but-trivial is harmless. The prohibition exists to keep markets fair -- if insiders and their friends could trade ahead of everyone else, ordinary investors would be permanently, structurally disadvantaged, and trust in the market would collapse. Markets run on the belief that the price reflects information available to all, not a private channel for the connected.

Quiz · 5 questions ↓

When you can and cannot trade on information

InformationMaterial?Public?Trade on it?
Tomorrow's surprise acquisition, heard from an insiderYesNoNo -- classic illegal insider trading
An earnings beat, already announced in a press releaseYesYesYes -- this is just acting on public news
The CEO prefers a certain font in slide decksNoNoYes -- nonpublic but immaterial, no price impact
Your own mosaic of public filings + lawful expert callsYes (your edge)Built from public piecesYes -- the mosaic theory: legal research

Material AND nonpublic: both tests must hold

Both tests must be met for information to be off-limits: material AND nonpublic. Skilled analysis assembles many public and immaterial pieces into a valuable conclusion -- that is the lawful mosaic theory and it is the whole point of research. What is forbidden is the shortcut: one decisive secret fact, obtained through someone's breach of a duty to keep it confidential.

How the ban reaches tippees

The prohibition reaches far beyond officers and directors. Anyone who receives material nonpublic information through a breach of a duty of confidentiality -- a tippee -- inherits that duty if they knew or should have known the source breached it. The chain matters more than the job title: a friend, a relative, a contractor, a journalist passing a tip down the line can all be liable. Two further traps: direction is symmetric (selling to dodge a loss is exactly as illegal as buying to capture a gain), and merely passing the tip onward without trading yourself (tipping) is itself a violation. The safe response to an apparent leak is not to use it -- it is to refuse it and, in a professional setting, report it.

Is mosaic-built research insider trading

An analyst painstakingly combines public 10-K filings, satellite images of store parking lots they purchased, and lawful interviews with industry consultants (who share no confidential client data) to conclude a retailer's quarter will be strong, then buys the stock before earnings. Is this illegal insider trading?

The edge is legal; the source is the crime

An informational edge is not the crime -- the source is. The mosaic theory protects exactly this work: diligent analysts are supposed to know more than the lazy ones, and assembling public filings, lawful data, and non-confidential expert color into a sharper view is the legitimate engine of price discovery. It becomes insider trading only when a decisive piece is material, nonpublic, and reached the trader through someone breaching a duty of confidentiality. Hard, lawful research that produces an edge is the system working as intended; a single whispered secret is the system being cheated.

The insider-trading rule in one line

So far

Material plus nonpublic plus a breached confidence equals do not trade and do not tip -- in either direction, regardless of your job title, and even if the call is right. The lawful counterpart is the mosaic theory: an edge built from public and non-confidential pieces is the research process working as designed. Hold the whole path together as one habit: a fiduciary puts the client first, manages conflicts instead of exploiting them, and never converts a secret into a trade. That is the trust the entire market -- and every other analytical skill you learn here -- quietly depends on.

Check your understanding

Sit with the ideas.

At a dinner, the CFO of a public company mentions to a friend -- an investor with no role at the company -- that next week's earnings will badly miss guidance, before any announcement. The investor sells their entire stake the next morning, avoiding a large loss when the miss is announced. Why is this illegal insider trading even though the investor does not work at the company?

Why:
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Other lessons in this course.

  1. 01Fiduciary Duty: The Client Comes First
  2. 02Conflicts of Interest and Fair Dealing
  3. 03Material Nonpublic Information and the Insider-Trading Line— reading now
  4. 04Reading a Track Record Without Being Fooled
  5. 05Ethics in Practice: Calling the Hard Cases
  6. 06Independence and Objectivity: Reading Conflicted Research
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