Posted by David Bernstein: Madoff and the Wall Street Culture of Fraud: http://volokh.com/archives/archive_2008_12_07-2008_12_13.shtml#1229142037
The Madoff ponzi scandal is, in a way, surprising only because of its size. A friend of mine (who happens to be a plaintiffs' lawyer) and I were talking a while back about how much of "retail" Wall Street has been built on sharp practices, albeit perhaps not illegal ones (though there is plenty of that, too; see, e.g., churning). Consider one minor example, that I think is indicative of how many on Wall Street have long done business: new issues of closed-end funds. Closed-end funds are traded on exchanges, and can sell at discounts or premiums, usually the former. When a new closed-end fund comes on the market, the usual price is $15 per share, and investors are asked to pay an additional 8%. Here's the rub: the vast majority of funds soon trade at a discount to net asset value. So if your broker sells you, or your money manager buys for you, a new issue of a closed-end fund, you typically fall behind more than 10% almost immediately: 8% plus whatever discount emerges. Why would anyone, then, recommend a new issue, or buy it for their client, instead of waiting for a few weeks after the issue comes out, and buying the fund at a discount without the 8% fee? Hint: It's not because he is looking out for his clients' best interests. A few states--my recollection is that Michigan is one--requires that brokers act as fiduciaries for their clients, but that is rarely enforced even in those states. While there are certainly some good, honest, investment consultants and brokers out there, too many of them have the ethics, and for that matter, unfortunately, the talents, of stereotypical used car salesmen. _______________________________________________ Volokh mailing list [email protected] http://lists.powerblogs.com/cgi-bin/mailman/listinfo/volokh
