What is Mosaic Theory?
The mosaic theory refers to a method of analysis used by security analysts to gather information about a corporation. The mosaic theory involves collecting public, non-public, and non-material information about a company to determine the underlying value of its securities and to enable the analyst to make recommendations to clients based on that information.
The mosaic theory is a style of financial research in which the analyst uses a variety of resources to determine the value of a company, stock or other security.
The mosaic theory necessitates that the analyst gathers public, non-public, and non-material information about a company.
How Does the Mosaic Theory Work?
For example, let’s assume that John Doe is an analyst at Company XYZ. He pores over the company’s 10-K and 10-Q, as well as published media reports and published reports from other analysts. Based on this information, he realizes that Company XYZ is about to make a tender offer for Company ABC.
Company XYZ has not disclosed this information, and none of the other analysts have realized what’s going on. John is the first, and he came to that conclusion the same way an artist assembles tiny tiles to make a picture (hence the term).
Knowledge of an imminent tender offer that has not been disclosed yet is considered material, nonpublic information — insider information. However, because John did not obtain this information from insiders (for example, he did not hear it from a Company XYZ employee) he would not be doing anything illegal if he were to trade the shares of Company XYZ based on the merger information.
Why Does the Mosaic Theory Matter?
The mosaic theory is a great way to gain insight into companies and profit from that insight. However, it is important for analysts who arrive at such conclusions to keep records and disclose how they did their analyses.
In at least one case — the insider trading case of billionaire Raj Rajaratnam (who has been charged with 14 counts of securities fraud and conspiracy) — the defendant unsuccessfully argued that he used a variety of public information to discover material, nonpublic information.
In other words, judges and juries are often skeptical of the argument that your sudden, billion-dollar trading profits were the result of simply using bits of public information.
Despite the explanation above, it is very hard to determine what constitutes insider information. Raj Rajaratnam’s case highlighted the same issue as well.
There is no clear, legally available definition as well. In the eyes of law material, non-public information constitutes inside information. But, deciding if the information is material or not is left to the law and for juries to decide.