Ethics question help: material nonpublic information

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mr.devlilock

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Hi everyone,
i really need help understanding question 36 on pg 227 on the CFA curriculum.
In this scenario, Garcia heard on a squawk box that an analyst downgraded a company (this is a violation, but is dealt in a separate question) and he goes ahead and shorts a DIFFERENT company that is in the same industry. Why is this considered a violation from a material nonpublic standpoint? Ie where do you draw the line? If I act on that news by buying a different stock from a different sector because based on my analysis the two sectors are correlated, would this be a violation?
Any help would be much appreciated.. Thank you
 
Hmmm, not familiar but I guess that is erring on the side of caution. Was the downgrade due to something industry related? I guess as I type this out I can see the violation because if the company is a big one in the industry the whole index will probably drag down. Would be like selling an ETF short for the industry.
 
It’s basically a proxy trade. He acted on information that the general public did not have, regardless of which stock he shorted.
It’sthe premise behind the trade. If he shorted an ETF, it would still be a violation. Had he not heard about the downgrade, he would not have acted.
 
The effect of a sell rating on that company could have a material effect on other companies in the industry. So he is acting on material nonpublic information. It was on a practice exam I did a while back, can’t remember which one. This was the reasoning I got.
 
Thanks guys.
just a quick follow-up question. Hypothetically; in this same scenario, what if the downgrade on his specific company caused me to be concerned about the general economy, which prompted me to do some research in my field of expertise, which is oil and gas. Then, based solely on my adequate oil and gas research, I buy a stock.
Would this be a violation?
 
I’ve noticed the CFA curriculum treats this differently than the real legal system would, although I’ve seen at least one exception to what I’m about to write, so caveat emptor.
In the real world, there’s a specific set of elements which must be met before it can be considered trading on insider information.
In the CFA curriculum, there is still some test regarding materiality and whether public or not; however, the curriculum seems to be much more concerned with the issue of intent. If you intend to profit from insider information in any way, shape, or form, the CFA curriculum tends to call foul. Period.
 
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