Are Big Investment Banks Especially Prone to Financial Fraud

By on May 25, 2013. Posted in .

Why do big investment banks and scandals seem to be synonymous?

Separate blogs last summer by economist Gary Becker and legal scholar Richard Posner from the University of Chicago’s law school Is Banking Unusually Corrupt? You can find their blogs here through the July 2010 sublink. Basically, they answer affirmatively, pointing to post-Great Recession financial incidents involving investment banks considered among the most stable.

Disagreement, but one conclusion

Posner describes a business model that “attracts people who have a taste for risk and attach a very high utility to money.” He concludes, “The banks resist effective regulation . . . because their managers are better off with the Darwinian business model, which enables the reaping of short-term profits great enough to compensate-not the country, but the bank’s managers and investors-for an increased risk of bankruptcy.”

While Posner argues that banks resist effective regulation, Becker posits, “A highly regulated industry that manages enormous sums of money is likely to attract more than the average number of individuals who are willing to cut corners and violate regulations and laws, and sometimes their own company’s rules, in the attempt to make very large incomes for themselves.”

Big money breeds greed

Although they may cite different causes-too much regulation versus not enough-the conclusion is inevitable. Yes, big money creates an environment where financial professionals are prone to cut corners. So, too, does the industry. You don’t seem to find as many financial scandals in big companies occupying other industries.

The appetite for risk exists from the top down, as few executives discourage advisors, traders or other financial professionals from taking actions that might affect everyone’s bonuses. I can tell you, from my decades on Wall Street, that financial professionals generally are prone to taking greater risks for greater rewards.

Your goal, as an investor, is to understand you have final decision-making power. Even if you prefer to give your advisor free rein in trading investments for you, understand that you have the power to hire and fire when they don’t meet your goals and expectations.

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