CFA CFA Level 3 Proprietary trading procedure: Standard II(A) Material Nonpublic Information

Ethics

Proprietary trading procedure: Standard II(A) Material Nonpublic Information

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      I am reading about the Proprietary trading procedure, there is a paragraph that I do not understand.

      “This concern is particularly important in the relationships between small, regional broker/dealers and small issuers. In many situations, a firm will take a small issuer public with the understanding that the firm will continue to be a market maker in the stock. In such instances, a withdrawal by the firm from market-making acts would be a clear tip to outsiders.”

      Can anyone please give an example? and please explain what is the “clear tip” to outsiders? and what kind of firm does it refer to? why the concern is important in small/regional issuers? thank you in advance.

      wealthcreator voted up
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      I’m assuming you’re referring to this passage:

      Procedures concerning the restriction or review of a firm’s proprietary trading while the firm possesses material nonpublic information will necessarily depend on the types of proprietary trading in which the firm may engage. A prohibition on all types of proprietary activity when a firm comes into possession of material nonpublic information is not appropriate. For example, when a firm acts as a market maker, a prohibition on proprietary trading may be counterproductive to the goals of maintaining the confidentiality of information and market liquidity. This concern is particularly important in the relationships between small, regional broker/dealers and small issuers. In many situations, a firm will take a small issuer public with the understanding that the firm will continue to be a market maker in the stock. In such instances, a withdrawal by the firm from market-making acts would be a clear tip to outsiders. Firms that continue market-making activity while in the possession of material nonpublic information should, however, instruct their market makers to remain passive with respect to the market—that is, to take only the contra side of unsolicited customer trades.

      This basically means that if you’re a firm that’s a market-maker to an issuer, and if you now possess material nonpublic information, prohibiting all prop activity itself might be bad for the market, because you’re reducing liquidity and sending (possibly inaccurate) signals just by stopping trading activity.

      Say BigBucksBank acts as a market-maker to SmallFry tech company, and this week BigBucksBank receives some material nonpublic information about SmallFry – maybe a substantial credit application. If BigBucksBank has a policy of immediately stopping trade in SmallFry stock, two problems arise:

      Since BBB is a market-maker in SF stock, SF stock will have a liquidity problemIf the market sees BBB stopping trade in SF stock when they’re previously market makers, then they may panic as they may think that SF is in trouble (rightly or wrongly)

      wealthcreator voted up
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      Thanks for sharing it!

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