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Predicting Fraud by Investment Managers

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  • Wil liam C. Gerken
  • Stephen G. Dimmock

Abstract

We test the predictability of investment fraud using a panel of mandatory disclosures filed with the U.S. Securities and Exchange Commission (SEC). We show that past regulatory and legal violations, conflicts of interest, and monitoring have significant power to predict fraud. Avoiding the 5% of firms with the highest ex ante predicted fraud risk would allow an investor to avoid 29% of fraud cases and over 40% of the total dollar losses from fraud. We examine the ability of investors to implement fraud prediction models based on the disclosure filings, and suggest changes in SEC data access policies that could benefit investors.

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File URL: http://indstate.edu/business/NFI/leadership/papers/2011-WP-09_Gerken.pdf
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Bibliographic Info

Paper provided by Indiana State University, Scott College of Business, Networks Financial Institute in its series NFI Working Papers with number 2011-WP-09.

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Length: 44 pages
Date of creation: May 2011
Date of revision:
Handle: RePEc:nfi:nfiwps:2011-wp-09

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Keywords: Fraud; Investment Fraud; Operational Risk; SEC; Disclosure; Form ADV;

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References

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  1. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  2. Stephen Brown & William Goetzmann & Bing Liang & Christopher Schwarz, 2008. "Estimating Operational Risk for Hedge Funds: The ?-Score," Yale School of Management Working Papers, Yale School of Management amz2559, Yale School of Management, revised 11 Sep 2009.
  3. Karpoff, Jonathan M & Lott, John R, Jr & Wehrly, Eric W, 2005. "The Reputational Penalties for Environmental Violations: Empirical Evidence," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 48(2), pages 653-75, October.
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  6. Fung, William & Hsieh, David A, 2001. "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 14(2), pages 313-41.
  7. Jeffrey A. Busse & Amit Goyal & Sunil Wahal, 2010. "Performance and Persistence in Institutional Investment Management," Journal of Finance, American Finance Association, American Finance Association, vol. 65(2), pages 765-790, 04.
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  9. Eric Zitzewitz, 2005. "How Widespread is Late Trading in Mutual Funds?," Finance, EconWPA 0501002, EconWPA.
  10. Stephen Brown & William Goetzmann & Bing Liang & Christopher Schwarz, 2008. "Mandatory Disclosure and Operational Risk: Evidence from Hedge Fund Registration," Journal of Finance, American Finance Association, American Finance Association, vol. 63(6), pages 2785-2815, December.
  11. Gary S. Becker, 1968. "Crime and Punishment: An Economic Approach," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 76, pages 169.
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  13. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, American Finance Association, vol. 52(1), pages 57-82, March.
  14. Bollen, Nicolas P. B. & Pool, Veronika K., 2008. "Conditional Return Smoothing in the Hedge Fund Industry," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 43(02), pages 267-298, June.
  15. Karpoff, Jonathan M & Lott, John R, Jr, 1993. "The Reputational Penalty Firms Bear from Committing Criminal Fraud," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 36(2), pages 757-802, October.
  16. Nicolas P.B. Bollen & Veronika K. Pool, 2009. "Do Hedge Fund Managers Misreport Returns? Evidence from the Pooled Distribution," Journal of Finance, American Finance Association, American Finance Association, vol. 64(5), pages 2257-2288, October.
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Citations

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Cited by:
  1. John A. Tatom & Reza Houston, 2011. "Predicting Failure in the Commercial Banking Industry," NFI Working Papers, Indiana State University, Scott College of Business, Networks Financial Institute 2011-WP-27, Indiana State University, Scott College of Business, Networks Financial Institute.
  2. Bernhardt, Dan & Nosal, Ed, 2013. "Gambling for Dollars: Strategic Hedge Fund Manager Investment," Working Paper Series, Federal Reserve Bank of Chicago WP-2013-23, Federal Reserve Bank of Chicago.
  3. Eric Zitzewitz, 2012. "Forensic Economics," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 50(3), pages 731-69, September.

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