JAD (Java Application Descriptor) file is used mainly for OTA (Over-the-Air) download of MIDlets. Nokia PC Suite Application Installer also uses information in JAD file. JAD file is a plain text file which explains the major parameters of a MIDlet. There are five required paramets and a few commonly used optional ones.
JAR (Java Archive) is a file which contains MIDlet class file, other classes referred to by MIDlet and resource files. It also contains Manifest.mf text file, which has mostly the same information as JAD file.
JAD and/or Manifest are used by JAM (Java Application Manger) in the phone to check that the MIDlet is valid and to fetch the JAR and install the application.
Basically JAR and JAD don't need to be in the same directory as JAD contains parameter "MIDlet-Jar-URL: MyMidlet.jar". This parameter tells JAM where JAR file can be found. Most commonly they are in the same directory.