Edited by Phoebus Athanassiou
Chapter 8: Hedge Funds and the Detection of Managerial Fraud
Veronika Krepely Pool* INTRODUCTION Hedge funds are among the most active financial markets participants. While no official statistics exist, it is commonly cited that they account for at least half of the daily trading volume on the major exchanges.1 Yet hedge funds are perhaps also the least transparent financial institutions. Taking advantage of the safe harbor provisions of the securities statues, hedge funds have historically escaped registration with the Securities and Exchange Commission (SEC) as well as disclosure requirements and are currently only subject to the anti-fraud provisions of the law.2 Their lack of transparency raises questions about how common fraud is in the industry and whether the sector’s opaqueness increases the propensity for unscrupulous managerial behavior. Recent hedge fund scandals have further exacerbated these suspicions. Moreover, while the number of scandals (and that of regulatory enforcement cases against hedge funds) is relatively small, the instances of fraud that do come to light tend to be very brazen. Could this suggest that, while perhaps common, hedge fund fraud is often undetected, especially if it does not lead to the fund’s demise? What do we know about managerial wrongdoing in the hedge fund industry? The purpose of this chapter is to address those questions by surveying academic research on hedge fund fraud. This is a relatively new but fast-growing research area. While managerial wrongdoing can take many different forms, the literature and this survey focus on what Bollen and Pool (2010) refer to as ‘reporting violations’. These involve untruthful Indiana University,...
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