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Predicting fraud by investment managers

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  • Dimmock, Stephen G.
  • Gerken, William C.

Abstract

We test the predictability of investment fraud using a panel of mandatory disclosures filed with the SEC. We find that disclosures related to 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 find no evidence that investors receive compensation for fraud risk through superior performance or lower fees. We examine the barriers to implementing fraud prediction models and suggest changes to the SEC's data access policies that could benefit investors.

Suggested Citation

  • Dimmock, Stephen G. & Gerken, William C., 2012. "Predicting fraud by investment managers," Journal of Financial Economics, Elsevier, vol. 105(1), pages 153-173.
    • Handle: RePEc:eee:jfinec:v:105:y:2012:i:1:p:153-173
    DOI: 10.1016/j.jfineco.2012.01.002
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    1. 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, vol. 63(6), pages 2785-2815, December.
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    1. repec:bla:acctfi:v:57:y:2017:i:2:p:597-620 is not listed on IDEAS
    2. Debaere, Peter & Evans, Richard B., 2015. "Outsourcing vs. Integration in the Mutual Fund Industry: An Incomplete Contracting Perspective," CEPR Discussion Papers 10599, C.E.P.R. Discussion Papers.
    3. Eric Zitzewitz, 2012. "Forensic Economics," Journal of Economic Literature, American Economic Association, vol. 50(3), pages 731-769, September.
    4. Edelen, Roger M. & Evans, Richard B. & Kadlec, Gregory B., 2012. "Disclosure and agency conflict: Evidence from mutual fund commission bundling," Journal of Financial Economics, Elsevier, vol. 103(2), pages 308-326.
    5. Alexander Eisele & Tamara Nefedova & Gianpaolo Parise, 2015. "Are Star Funds Really Shining? Cross-trading And Performance Shifting In Mutual Fund Families," Post-Print hal-01458357, HAL.
    6. Aiken, Adam L. & Clifford, Christopher P. & Ellis, Jesse A., 2015. "Hedge funds and discretionary liquidity restrictions," Journal of Financial Economics, Elsevier, vol. 116(1), pages 197-218.
    7. Alexander Eisele & Tamara Nefedova & Gianpaolo Parise, 2016. "Are star funds really shining? Cross-trading and performance shifting in mutual fund families," BIS Working Papers 577, Bank for International Settlements.
    8. Bernhardt, Dan & Nosal, Ed, 2013. "Gambling for Dollars: Strategic Hedge Fund Manager Investment," Working Paper Series WP-2013-23, Federal Reserve Bank of Chicago.
    9. John A. Tatom & Reza Houston, 2011. "Predicting Failure in the Commercial Banking Industry," NFI Working Papers 2011-WP-27, Indiana State University, Scott College of Business, Networks Financial Institute.
    10. Cumming, Douglas & Dai, Na & Johan, Sofia, 2015. "Are hedge funds registered in Delaware different?," Journal of Corporate Finance, Elsevier, vol. 35(C), pages 232-246.

    More about this item

    Keywords

    Fraud; Investment fraud; Operational risk; SEC; Disclosure; Form ADV;

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • K2 - Law and Economics - - Regulation and Business Law
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law

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