Mosaic theory (investments)

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The mosaic theory in finance involves the use of security analyst personnel to gather information about a company or corporation to evaluate and determine its financial stability [1] . The security analysts not only have access to public information that's provided to all investors, but the analysts also have access to non-public, non-material information that is used to draw out more precise conclusions about a company or corporation[2]. The majority of investors do not have access to non-public, non-material information [2] . This information can be considered illegal if it is not under insider trading laws. Also, drawing out conclusions from the non-public material can be vague and draw out false conclusions about the company or corporation [2] . Security analysts then have to sort through the data collected and make recommendations to their clients or keep the information to themselves to use later for personal profit based on determining the underlying value of a company's securities [1] .

Finance Academic discipline studying businesses and investments

Finance is a field that is concerned with the allocation (investment) of assets and liabilities over space and time, often under conditions of risk or uncertainty. Finance can also be defined as the art of money management. Participants in the market aim to price assets based on their risk level, fundamental value, and their expected rate of return. Finance can be split into three sub-categories: public finance, corporate finance and personal finance.

Security analysis

Security analysis is the analysis of tradeable financial instruments called securities. It deals with finding the proper value of individual securities. These are usually classified into debt securities, equities, or some hybrid of the two. Tradeable credit derivatives are also securities. Commodities or futures contracts are not securities. They are distinguished from securities by the fact that their performance is not dependent on the management or activities of an outside or third party. Options on these contracts are however considered securities, since performance is now dependent on the activities of a third party. The definition of what is and what is not a security comes directly from the language of a United States Supreme Court decision in the case of SEC v. W. J. Howey Co.. Security analysis is typically divided into fundamental analysis, which relies upon the examination of fundamental business factors such as financial statements, and technical analysis, which focuses upon price trends and momentum. Quantitative analysis may use indicators from both areas.

A company, abbreviated as co., is a legal entity made up of an association of people, be they natural, legal, or a mixture of both, for carrying on a commercial or industrial enterprise. Company members share a common purpose, and unite to focus their various talents and organize their collectively available skills or resources to achieve specific, declared goals. Companies take various forms, such as:


Seal of the United States Securities and Exchange Commission Seal of the United States Securities and Exchange Commission.jpg
Seal of the United States Securities and Exchange Commission

Since the Commission's Fair Disclosure rule (Reg FD) was enacted, the viability of the mosaic theory has been retained within the United States under the Securities and Exchange Commission [2]. Broadly speaking, the SEC requires public corporations to register their stock sales and protects investors in the municipal securities markets [3] . Though it was not created by the Securities and Exchange Commission, it has placed a judicially imposed limitation on the information gathered by insider trading [4] . If the U.S. Securities and Exchange Commission deems that there is illegal insider trading, they can freeze assets tied to the company's shares. The Securities and Exchange Commission explains that this nonpublic information, known as research to the security analysts, isn't banned from “disclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer, that piece helps the analyst complete a "mosaic" of information that, taken together, is material”[3]. The SEC constantly are evaluating trends and when unknown traders purchase equity call options that are millions of dollars [3] . The SEC can also freeze accounts on suspicion of illegal insider trading when the accuracy and validity of information may be incorrect within the marketplace [2] . This had led to the legality of insider trading laws to be under intense scrutiny. Though it is legal under the United States Federal insider laws to utilize the mosaic information that is obtained by a securities analyst, it must be within the guidelines of the confidentiality that the company or corporation created [4] . For most companies within the United States and do business with the United States, these guidelines of confidentiality are required. Some of the controls that have mitigated the potential of illegal trading within the mosaic theory include the interactions between a company and consultants, notification in connection with approved consultants, remaining alert to potential issues, compliance oversight, information barriers, and being within the SEC guidelines [4] . These guidelines have made companies more transparent with their financial stability to the general public.

Regulation FD , ordinarily referred to as Regulation FD or Reg FD, is a regulation that was promulgated by the U.S. Securities and Exchange Commission (SEC) in August 2000. The regulation is codified as 17 C.F.R. 243. Although "FD" stands for "fair disclosure," as can be learned from the adopting release, the regulation was and is codified in the Code of Federal Regulations simply as Regulation FD. Subject to certain limited exceptions, the rules generally prohibit public companies from disclosing previously nonpublic, material information to certain parties unless the information is distributed to the public first or simultaneously.

U.S. Securities and Exchange Commission Government agency overseeing stock exchanges

The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government. The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, the nation's stock and options exchanges, and other activities and organizations, including the electronic securities markets in the United States.

Insider trading is the trading of a public company's stock or other securities based on material nonpublic information about the company. In various countries, some kinds of trading based on insider information is illegal. This is because it is seen as unfair to other investors who do not have access to the information, as the investor with insider information could potentially make larger profits than a typical investor could make. The rules governing insider trading are complex and vary significantly from country to country. The extent of enforcement also varies from one country to another. The definition of insider in one jurisdiction can be broad, and may cover not only insiders themselves but also any persons related to them, such as brokers, associates, and even family members. A person who becomes aware of non-public information and trades on that basis may be guilty of a crime.

Under insider trading laws, analysts may not use material non-public information to help select their trades. But traders might be able to piece together non-material non-public information and material public information into a mosaic, which may increase in value when properly compiled and documented. The theory is also referred to more colloquially as the scuttlebutt method by Philip Fisher in Common Stocks and Uncommon Profits .

Philip Arthur Fisher American businessman

Philip Arthur Fisher was an American stock investor best known as the author of Common Stocks and Uncommon Profits, a guide to investing that has remained in print ever since it was first published in 1958.

Mosaic theory involves collecting information from different sources, public and private, to calculate the value of security. Applying the mosaic theory is as much art as it is science. [1] An analyst gleans as many pieces of information as possible, determines if they tell a story that makes sense, and decides whether to recommend a trade.

It is also a legal theory used to uphold the classification of information, holding that a collection of unclassified information might add up into a classified whole.[7] [8] The theory has also been applied to legal reasoning in the context of the Fourth Amendment where the continuous use of GPS surveillance was found to violate the subject's "reasonable expectation of privacy" [3] .

Fourth Amendment to the United States Constitution Prohibits unreasonable searches and seizures

The Fourth Amendment to the United States Constitution is part of the Bill of Rights. It prohibits unreasonable searches and seizures. In addition, it sets requirements for issuing warrants: warrants must be issued by a judge or magistrate, justified by probable cause, supported by oath or affirmation, and must particularly describe the place to be searched and the persons or things to be seized.

Legality of the Mosaic Theory

Though the Supreme Court recognized the legality of the Mosaic Theory in Dirks v. SEC, the concerns have arisen with the potential of illegal insider trading happening within analysts [2] . Analysts can take advantage of vague insider trading laws and this brings of the legality of it. Securities analysts can obtain non disclosed information from company insiders that an average investor cannot [2] . Under insider trading law, this advantage is an unlawful method [2] . To combat this issue, confidentiality agreements as well as operating under internal policy guidelines are in place [2] . Section 10(b) of the Securities Exchange Act of 1934 and Exchange Act Rule 10b-5 falls under the category when unknown traders purchase equity call options that are millions of dollars [2] .

The mosaic theory relies heavily on the U.S. economy's fluctuation and stock market [3] . Without public corporations being transparent, the mosaic theory would be ineffective and the stock market would be vulnerable to sudden shifts as hidden information comes out [3] . Thus, it is illegal for Unites States public companies to not be transparent with their corporate profitability [3] .

Court Cases

In May 2011, US District Judge Richard J. Howell sentenced Raj Rajaratnam, the founder of the Galleon Group hedge fund, to eleven years in prison who was found guilty of fourteen counts of insider trading [5] . During the high-profile trial of investor Raj Rajaratnam, defense attorneys used the mosaic theory to argue against allegations of insider trading [3] . These arguments were ultimately unsuccessful. Though it was ten years shorter than the requested amount of time, it constitutes as the longest prison sentence given to an insider trading case [5] . Under the Securities Exchange Acts15 USC §78j(b) and 17 CFR §240.10b-5, Rajaratnam and other Galleon traders were convicted with fraud and conspiracy [5] . They profited tens of millions of dollars of insider trading and based their arguments off of the mosaic theory [5] . So far, this is the only court case that has used the mosaic theory in court to validate insider trading in the court of law.

See also


  1. 1 2 3 Davidowitz, A. S. (2019). "Abandoning the 'Mosaic Theory' of Securities Analysis Constitutes Illegal insider Trading and What to do about it". 6 Wash. U. J. L. & Pol’y281.
  2. 1 2 3 4 5 6 7 8 Fisch, Jill (2013). "Regulation FD: An Alternative Approach to Addressing Information Asymmetry".
  3. 1 2 3 4 5 6 7 "UBS Global Asset Management Insider Trading Policies and Procedures". SEC. 2012.
  4. 1 2 3 Becker, D. M. (2000). "Speech by SEC Staff: New Rules, Old Principles". SEC.
  5. 1 2 3 4 Hautekiet J. (2011). "The Galleon Insider Trading Case: How To Sentence a Seemingly Victimless Crime?". Berkeley University of California.

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