Finding Bernie Madoff: Detecting Fraud by Investment Managers

45 Pages Posted: 19 Mar 2010 Last revised: 11 May 2010

See all articles by Stephen G. Dimmock

Stephen G. Dimmock

National University of Singapore; Asian Bureau of Finance and Economic Research (ABFER)

William Christopher Gerken

University of Kentucky - Finance

Date Written: March 16, 2010

Abstract

Using a panel of mandatory SEC disclosure filings we test the predictability of investment fraud. We find that past regulatory and legal violations, conflicts of interest, and monitoring are significantly associated with future fraud. Avoiding the 5% of firms with the highest fraud risk allows investors to avoid 29.7% of investment frauds. The predictability of fraud is not driven entirely by small frauds. While minor frauds and fraud by rogue employees are highly predictable, even after excluding these cases we are able to predict at least 24.1% of frauds at a false positive rate of 5%. There is no evidence that investors are compensated for fraud risk through lower fees or superior performance. We also find that investors react strongly to the discovery of fraud, resulting in significantly higher rates of firm death and investor outflows. Our results provide tools for investors and regulators seeking to predict investment fraud.

Suggested Citation

Dimmock, Stephen G. and Gerken, William Christopher, Finding Bernie Madoff: Detecting Fraud by Investment Managers (March 16, 2010). Available at SSRN: https://ssrn.com/abstract=1572136 or http://dx.doi.org/10.2139/ssrn.1572136

Stephen G. Dimmock (Contact Author)

National University of Singapore ( email )

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Asian Bureau of Finance and Economic Research (ABFER) ( email )

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William Christopher Gerken

University of Kentucky - Finance ( email )

College of Business & Economics
Lexington, KY 40506-0034
United States

HOME PAGE: http://www.willgerken.com

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