Seek and ye shall find

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Seek and ye shall find

Recently a journalist friend was asked by a company to look into whether the company had been defrauded in an investment scheme. As it turned out, the question became moot when the company decided that the embarrassment of having being defrauded would be more costly than the monies they might recover.

Putting this issue aside, there are several questions that one might ask. The only one we will address here is whether investment should be preceded by an exercise of due diligence. As a company that makes part of its living by exercising due diligence on behalf of its customers, we would say yes. And yet there seem to be a number of reasons not to exercise due diligence.

For a start, it makes you feel less smart, as if you were not capable of making your own financial judgments: You were, after all, smart enough to make the money in the first place. And it also costs money, which reduces the return on investment.

As an example, we might look at the Bernie Madoff case. Bernie Madoff was, well, Bernie Madoff, and what kind of idiot would waste money investigating him before investing? As readers know, we had clients who had us look at Madoff before they invested. (We said his results were incongruent with the size and nature of the portfolios. We recommended against investing, and they followed our recommendation.) While we note that they were almost embarrassed about asking us to do it – this was Bernie Madoff, after all – they did it because they always ran significant investments by us before making an investment. They could just as easily have done the “smart” thing and not investigated – this was Bernie Madoff, after all – and saved themselves the tiny amount of money it cost to hire us.

Another reason not to exercise due diligence is that the returns are really good, and you don’t want to discover that your prince is really a frog. If returns are suspiciously high you want to take advantage of them, not ask

ÆGIS, February 2009 2how they are achieved. The last thing you want, particularly if the returns are unreasonably high, is having someone like us telling you not to invest.

On the other hand, a case can be made that our customers are right to recognize that while they are smarter about making money than we are, they are equally smart to recognize that their area of expertise does not overlap ours, and that it therefore makes sense to have us look to see whether their prospective investments are legitimate, fraudulent, or incongruent.

Indeed, we suspect that in hindsight, which is always 20/20, most, if not all, of those who lost everything with Madoff might regret not having spent an infinitesimal portion of what they lost to have hired us to have exercised due diligence on their behalf, thus preventing the loss in the first place.

We should also mention that in April of last year, we strongly advised our client against Stanford International Group for similar, but different, reasons. That story is for next month.

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