The 2009 PricewaterhouseCooper Global Economic Crime Survey was released last Friday and showed that Canada ranks fourth for reported corporate fraud in a survey spanning 54 countries and over 3000 participants. With 44% of respondents in the financial services sector experiencing an economic crime, it is no surprise that Canadians have had their fair share of reported Ponzi schemes over the last year.
As the global financial crisis pushed through the summit of public fear in March of 2009, Canada began to unravel what was to be one of numerous financial scams that affected the confidence of investors in this country. First, Weizhen Tang, a Toronto fund manager, defrauded his clients out of $60-million. Then Bertram Earl Jones here in Quebec stole $50-million from his trusting clients and finally, Milowe Allen Brost and Gary Allen Sorensen in Alberta embezzled approximately $100-million of their client's funds.
Hyman P. Minsky, in his excellent book "Stabilizing an Unstable Economy" shows that an increase in Ponzi finance is a symptom of fragility in the financial structure of an economy. During a financial crisis when markets begin their inevitable and often spectacular decline, fraudulent managers find themselves in a liquidity crunch unable to maintain the frail structure behind their house of cards. As clients ask to redeem their funds out of fear of loss and Ponzi fund managers are unable to raise more money to keep their sham alive, the scheme collapses.
The 2009 PricewaterhouseCooper Global Economic Crime Survey points out that the risk of fraud can be found in three distinct places. 68% of the risk of fraud comes from a particular incentive or pressure to commit the crime. 18% comes from having the opportunity to commit a crime and 14% from the perpetrator's attitude and rationalization toward the crime.
What investors must be aware of is that 95% of fund managers do not beat the overall market. Since investment management benefits from economies of scale, fund managers enrich themselves as their assets under management grow. This provides a strong incentive to lie for greedy managers who don't have a competitive advantage. In a lax regulatory environment like Canada's where regulators do not have the resources to police the market properly, the opportunity to commit the crime is also available.
What can investors do to protect themselves? Firstly, they must educate themselves. The internet provides a wealth of information regarding any topic of interest. Secondly, investors must be ready to perform extensive due diligence before they turn their money over to a fund manager. It is important to know what type of qualifications the fund manager has, whether or not they invest their own money in the funds and if they have audited statements from a reputable firm. Lastly, always be suspicious of consistent or above average returns. In a world where 95% of managers do not beat the market, above average consistent returns require an innovative and well thought out investment strategy.
For more information on this topic do not hesitate to contact me with your questions.
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