International Law

Markopolos on SEC Oversight

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Felix Salmon, writing at Portfolio, is impressed with Markopolos' testimony and accepts it as evidence that the SEC failed because of the Madoff fraud.

(Mark Cuban, writing at his blog the blogmaverick, has similar praise for Harry Markopolos.)

"Markopolos's indictment of the SEC is utterly compelling, especially the fact that it is staffed with far too many lawyers and far too few professionals with any financial-industry experience.

Markopolos also has some choice words for the Wall Street Journal, to whom he gave the Madoff story on a plate: Gary Weiss has the details, but suffice to say that the WSJ never published anything."

Unfortunately, for any real reform, Salmon, Weiss and others will make the easy criticism that the SEC isn't experienced enough in modern complex derivatives to spot fraud.

This simple, easy and undoubtedly will produce the wrong result - hire more PhD/JD types who understand decision theory and litigate fraud.  (Oh, that would be be me!)

But, ike many complex frauds which arrive seemingly on our doorstop without warning, we have to back up and look at the past without benefit of foresight and with some theory of how surprises can occur when we are looking for them.

Perhaps, in my opinion, the best place to start with the latter - a theory of warning failure, is the categorization of some of the possible reasons for why in general a warning system might fail. 

The best place to start with Tom Schelling's introduction to Pearl Harbor: Warning and Decision by Roberta Wohlstetter.

Schelling lists a cascade of reasons which explain in general why we can be surprised when we are most prepared for the warning which ends up be a surprise.

Here is a small list of possible failures:

1.  Those responsible may be negligent.  Or they might not, but failure to share information efficiently.

2.   There may be gaps in intelligence.  Or the intelligence might be all there, but rendered incomplete because of superfluous concerns of confidentiality.

3.   The alarm bell may fail.  Or it might be ringin loud and clear, but turned off by the watchman who has heard too many false alarms.

4.  The watchman may be sleeping when the alarm sounds.  Or he may be wide awaked and alert, but fearful that his superiors are sleeping and don't wish to be disturbed.

Others can generated from this pattern.

It is worthwhile remembering that even with an unambiguous attack on Pearl Harbor, General MacArthur left the airplanes grounded for 8-10 hours after the attack. 

Even when we expect the unexpected, we are going to be very slow to react -otherwise it wouldn't be unexpected.

Full post as published by Misleading Advertising Law on February 04, 2009 (boomark / email).