What it is:
In the finance world, the mosaic theory refers to a research approach whereby the analyst arrives at a conclusion by piecing together bits of publicly available information.
How it works/Example:
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 of Company XYZ based on the information.
Why it matters:
The mosaic theory is a great way to gain insight into companies and 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 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.