International Law

The Regulators We Deserve

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Paul Wilmott has the best take on the larger picture in the Madoff ponzi and the role of regulation.

"There is no disincentive for dishonest behaviour in investment banking at the moment, in fact the opposite.

If someone wants to invest with a manager they think might be dishonest but successful then they will ignore the dishonesty.

If the investor loses their shirt then tough, serves them right. (Of course, it won't be their money, so anyone found not having done their full due diligence ought to be arrested.)

I know of several people who manage money who have broken serious laws, lawbreaking that would prevent them managing money.

And I know of some investors who know that I know, but who, when considering investing with these people, deliberately do not ask for my opinion as part of their due diligence.

Why not?

Because once they hear what I have to say then they would no longer be able to invest with the crooked, but oh-so-smooth and convincing manager.

If you've ever bought a dodgy DVD at the market, or a hi-fi from a man in the pub, then you are just as culpable.

And you therefore might find some sympathy for a lot of people being blamed at the moment. I haven't, and I don't.

When I first realised, several years ago, that due diligence is deliberately not being done I proposed that formal psychometric testing be part of the process of setting up a hedge fund or managing money.

I know this is easy to criticize or trivialize, especially by all the 'left-brainers' working in finance.

But equally I'm not a great fan of having to pass multiple-choice exams to get letters after your name showing how many regulations you know, I don't think this has much relevance today.

But in this business trust is so important. In a world where we never get to know the people looking after our life savings, as we might have done in the old days, I can think of no other simple indicator of testing trustworthiness.

Some people are dishonest, some can't be trusted.

Do you care? I do, and always have. Maybe other people don't, that's greed at work, but they will eventually, perhaps only after they've lost lots and lots of money."

Regulation works not by preventing fraud, but by preventing the expectation of fraud. When the players in an industry, whatever industry, have contempt for themselves, their industry, and most importantly their marks -previously known as clients- the regulatory scheme falls apart.

Wilmott is right to point out the confidence and not calculation ought to be selected for when handing over the reigns of financial stewardship.

Regulators are a type of threat, who expected bite is worse than their bark. But expectations matter or are dependent on culture -when a vast variety of individuals who knew what Madoff was up to, or guessed that he was either front running, engaged in fake trades, or simply scamming failed to pass the information on to the regulator, we have a large problem. $50 Billion worth of a problem.

The regulators have no choice now but to grab power, entrench themselves with more paper regulation, with no discernible long term effect on preventing fraud.

Of course, if you are a Keynesian you might think this worthless expenditure of public money just the correct kind of economic stimulus.

Full post as published by Misleading Advertising Law on December 18, 2008 (boomark / email).