One of the reason that Bernie Madoff was able to stay undetected for so long was that he could alternately charm and intimidate the young SEC staffers sent to investigate his firm. In the wake of that scandal, reports The Wall Street Journal, the SEC has developed a computer system that analyzes performance from thousands of hedge funds and looks for unusually good performance year-over-year that, like Mr. Madoff, seems too good to be true.
So far the data crunching effort has led to four indictments, a positive sign that has the SEC thinking about expanding the scope of their computerized scrutiny to include up to 20,000 mutual funds and private equity firms.
Wall Street’s reaction has been to suggest that this kind of scrutiny will have a chilling effect on managers who perform well. “There are people out there who have been committing fraud, and we want to get them and get them out of the system,” Robert Leonard, a partner at law firm Bingham McCutchen LLP who represents hedge funds told The Wall Street Journal. “I’m concerned there probably will be some chilling effect for managers who are knocking the cover off the ball.”
Right. Money managers with nothing to hide are going to begin tanking their own returns, rather than risk a SEC investigation? The financial sector has been relying on the world’s best mathematical minds and most powerful computers for decades to gain an edge. The fact that the SEC is just now beginning to use these methods to detect fraud is a shocking, if welcome sign that they realize they have a lot of catching up to do if they are going to keep pace with the bad actors in these markets. This will help them do a better job detecting those hard-to-identify bogus firms, the ones with zero name recognition and no website who list their address as a non-existent street in New Jersey.