Views on improving the integrity of global capital markets
03 December 2010

Harry Potter and the Dark Mosaic

Posted In: Insider Trading, US SEC

A rumor is circulating that the longstanding practice of searching for and gathering individual pieces of nonpublic data to create a fuller research picture of a particular investment opportunity is somehow, well, inappropriate or far worse — illegal insider trading. The venerable “mosaic theory,” as it’s known, is being demonized as if it were part of the dark arts.

A public already angry at the markets and the financial services industry in general is now bracing for another round of scandals and revelations that could brand even legitimate investment analysts a bunch of cheaters. Meanwhile, industry veterans are up in arms that a traditional tool, practiced by many of the nation’s top researchers and analysts, may be banned or otherwise deemed shameful. It is understandable. Indeed, after nearly two and half years of constant ethical lapses and turmoil in this industry, everyone is a little gun shy.

CFA Institute has long supported the technique of thorough, diligent, and honest research. The most talented analysts differentiate themselves in a number of ways, including the ability to transcend the obvious and look for hidden facts and circumstance that augment the investment-decision-making process. There is plenty of opportunity in this realm for ethical analysts to distinguish themselves without crossing over to the dark side — where an analyst, hedge fund manager, or anyone else for that matter, knowingly gains access to material, nonpublic information from people who should not be sharing it, and then trades on that information. 

In the end, analysts, hedge funds, and others can try to defend that type of activity by claiming the mosaic theory as a defense. But that will not make it so, or otherwise diminish the appropriateness of the mosaic tool, when applied properly. Analysts and investment managers who use the technique as originally intended can sleep well knowing that they are keeping investment industry demons at bay. 

CFA Institute Code of Ethics and Standards of Professional Conduct

About the Author(s)
Kurt Schacht, JD, CFA

Kurt Schacht, JD, CFA, is the Senior Head, Advocacy Advisor, Capital Markets Policy at CFA Institute, where he oversees advocacy efforts and the development, maintenance, and promotion of the highest ethical standards of practice for the global investment management industry.

1 thought on “Harry Potter and the Dark Mosaic”

  1. x3er says:

    Great point indeed! The mosaic theory is at risk to become a silent (for now) victim of the crisis dislocations – mockery ( is just the first step. The real threat comes of course in the context of the ongoing insider investigations into the practice of expert networks. There is a likelihood that this will have political repercussions going over the top, which then kills the last incentives to legally look for the pieces of the puzzle, and with it the drive for information efficiency. I hope CFA Institute will defend its stance with conviction, and convincingly!

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