Tuesday, December 11, 2012

Happy (We Hope) Madoff Day

By Tim Husson, PhD and Tim Dulaney, PhD

It was four years ago today that Bernie Madoff was arrested for perpetrating his estimated $65 billion fraud.  Coming right on the heels of the SEC and FINRA's year-end investor warnings, Paul Sullivan at the New York Times has suggested that December 11 should be declared Madoff Day, where we reflect upon how to protect ourselves from investment fraud.
Protecting yourself against fraud, or simply bad advice, is easier said than done. The most common advice is to make sure your money is held by an independent custodian or firm whose job is to keep your money safe. That wasn’t the case with either the Madoff or Stanford fraud. But that is only one small step.
The article goes on to discuss the importance of checking out your adviser for any disciplinary history as well as not trusting any sizable amount to a single adviser.  Prudent advice to be sure.

But sometimes it is simply very difficult to tell a genius from a charlatan.  As discussed in the article, Madoff's returns have been found to be statistically improbable, a result echoed by other academic work.  But of course, unsophisticated investors cannot be expected to perform and interpret such calculations themselves -- and the academics didn't find this fraud statistically improbable until after the fact.  This is similar to the information asymmetry that exists in lots of fraudulent investment schemes, especially those that rely on personal relationships with clients.

So we at SLCG propose that on this Madoff Day, we should not just consider how to protect our own investments from fraud and mismanagement, but think of what we can all do to educate others about financial safety.  Analysts, reporters, advisers, brokers, or anyone who takes the responsibility for advocating for retail investors should take this time to think of how they can be even more vigilant in identifying and drawing attention to financial impropriety in all of its forms.

1 comment:

Please keep comments appropriate. Malicious comments or solicitations will be removed.