Mosaic Theory - Market Abuse

Hi all,

Had a question about mosaic theory and how it applies to the below scenario.

Suppose a famous hedge fund manager carries out reasearch and finds that a certain stock is massively overvalued. He subsequently creates a big short position in the stock. Any research from this manager usually has an impact on the stock price.

The manager then releases his research to the market, subsequently covering his short position once the share price drops on his research being made public.

How does the mosaic theory apply to this? Is the manager doing something wrong here as he is clearly having an impact on the price and benefiting from it. That said whatever he has done is only for the benefit of his clients, he has not spread rumours or misinformation and has only made public the results of his in depth research.



I don’t see anything wrong given the facts at hand; I’m assuming that his research doesn’t rely on material nonpublic information.

I think it’s a violation. One should avoid taking a position if he/she knows the report will have an impact on the stock as others could argue that it’s market manipulation. Although his research is objective and thorough, the intention was to benefit from the short position and the issuance of the report (to accelerate the recognition of this mispricing).

Obviously, Dicarprio and wolves on the wall street would respectfully disagree.

It’s only market manipulation if it’s not a legitimate trading strategy.

This appears to be a legitimate trading strategy. As far as we can tell, it’s based on public information. there is nothing wrong with a legitimate strategy that will impact price or volume.

As for the intent being to benefit fromthe short position . . . well, every trading strategy aims to benefit from its position; that’s why traders take that position.

Are you saying that FHFM (famous hedge fund manager) has an obligation to the market to reveal his research before he makes his trades? That’s . . . well . . . absurd. Are you saying that he is obligated to withhold his research from the market? Again, absurd.

I totally agree with you that it’s a legitimate trading strategy and I’m sure as a charterholder, you are be more famaliar w this subject than I am.

I think what I’m trying to say is

As a CFA charterholder (assuming FHFM is one), he’s obligated to avoid these series of actions that can be interpreted as market manipulation. If this FHFM starts to profit on all the stocks that he issues a report on, wouldnt that have an impact on objectivity and independence of research on the reports he issues? And we are not even sure if he disclosed his holdings of the stocks on the reports as required by the codes and standard.

Knowingly issuing this report to accelerate the recognition of profit for himself at the disadvantage of other investors (those who lend him stocks to short), he is in violation of the codes and standards - market manipulation. He should not have taken a position on the stocks before the issuance of the report or let the market respond to this mispricing naturally if he does short the stocks.

Again, this is just my personal opinion and it may not be correct so please share what you think.


In my opinion it is violation, if he is making his research public after acting himself on the research making public for others clients, the fact that markets react to his research by material changes in price, there are other subscribers/ clients for his research report or else at least he should make the research available only to subscribed/paid clients at least before acting himself.

Why does he he owe his insights on publicly available information to investors other than his clients?

“The manager then releases his research to the market, subsequently covering his short position once the share price drops on his research being made public.”

If you are doing a research & before making it public, you are acting means that you are not giving others an opportunity to act fairly on that report, before release of research report it is material non public information, he dont have any obligation if he does not make his research public, making research public means research was not meant for only internal consumption.

Public here need not be to released for everyone, it can making public to only paid clients.

Mosaic theory is research done using small information, the example above is pure market manupulation and will be crime.

I think that there’s a fundamental misunderstanding here. If you start with only public information (and there is nothing to indicate that FHFM started with anything other than public information) you _ cannot _ create nonpublic information. It’s impossible, by the definitions of public and nonpublic.

The fact that FHFM found a clever way to interpret the public data – a way that the rest of the investing world missed – doesn’t change that fundamental fact. The information is public, and you’re not prohibited in any way from using public information.

Mosaic theory is combining nonmaterial, nonpublic information with public information. Here, there is no nonpublic information, material or not.

Market manipulation is a practice that distorts prices or artificially inflates trading volume with the intent to mislead market participants. FHFM is not distorting prices (his research indicates that prices are already distorted, and his release of his research will have the likely effect of restoring prices to their proper level), he is not artificially inflating trading volume, and he has no intent to mislead market participants. In no way are his actions market manipulation.

“It’s only market manipulation if it’s not a legitimate trading strategy.”

"Standard II(B) is not intended to preclude transactions undertaken on legitimate trading strategies on perceived market inefficiecies. The intent of the action is critical to determine whether it is a violation of this standard."

His intention is clearly to use the report as a tool to profit for himself at the costs of other investors so his trading strategy may be legitimate but the issuance of the report is a violation of the standard.

Please show me where his intention is to _ mislead _ market participants.

He doesn’t owe a duty to all investors, just his clients and the integrity of the market - which he has not impacted given he had a reasonable basis and legitimate strategy.


There is an almost exact case study discussed in CFA digest (Ethics corner) Nov/Dec 2012 issue by Dorothy C. Kelly. The only thing i dont see in the above case study is that whether the manager disclosed his/her position in the report

No voilation whatsoever as long as there 1) diligence & reasonable basis & 2) Disclosure. It further goes on to say how short selling is NOT market manipulation (as is potrayed in the media).

S2000Magician, knowing your reputation and knowledge its hard to question you, would you please see this question in context of Example 11 and 13 in curriculum under mosaic theory, which states that "its a violation if analyst in question can cause material effect by his report " also by trading in advance is a violation. Please have a look and explain

You flatter me too much; I’m as fallable as they come.

I haven’t a copy of the curriculum, so I cannot see these examples. However, I’d offer this:

  • I suspect that the statement, “it’s a violation if analyst in question can cause material effect by his report” is taken out of context. Such an unqualified statement would mean that any analyst’s report that could cause a material effect would be a violation. That cannot possibly be true; no analyst would ever issue any report if it were.
  • Trading in advance of your clients is a violation, but trading in advance of the rest of the trading public cannot possibly be: nobody could ever trade because someone always has to go first. You owe no duty to the rest of the trading public apart from maintaining integrity of capital markets: you may not lie, cheat, or steal, but you certainly don’t have to broadcast your strategy to everyone before you implement it. Macy’s does not have to tell Gimbels.

I’d love to see those examples so that I can put them into context. There’s more to them than the brief summaries you’ve mentioned here.

As usuual i guess S2000magician is right…after againg going through the example i realized that my understanding was flawed, My further question is regarding the underlying example. S2000Magician please help---- Had it been a client who had traded before the report was discussed on television would it been a violation? and had Clement who had prepared the report traded for self before releasing the report, will it be a violation? Analyst is a known figure in investment industry and usually his reports have material impact on the securities. By using public information he has infered that the securities will underperform. (Analyst Recommendations as Material Nonpublic Information): The next day, Clement is preparing to be interviewed on a global financial news television program where he will discuss his changed recommendation on Turgot Chariots for the first time in public. While preparing for the program, he mentions to the show’s producers and Mary Zito, the journalist who will be interviewing him, the information he will be discussing. Just prior to going on the air, Zito sells her holdings in Turgot Chariots. Comment: When Zito receives advance notice of Clement’s change of opin- ion, she knows it will have a material impact on the stock price, even if she is not totally aware of Clement’s underlying reasoning. She is not a client of Clement but obtains early access to the material nonpublic information prior to publication. Her trades are thus based on material nonpublic information and violate Standard II(A). .