Universities and Investment Fraud: Knowledge about Operational Due Diligence and Investment Performance Analysis, with a Bit of Skepticism as Well, Can Help Prevent Getting Tangled Up in Investment Scandals
Logue, Ann C., University Business
WESTRIDGE CAPITAL MANAGEMENT, formed in 1996, promised investors enhanced cash returns by trading equity index futures. The firms performance was so attractive, a host of pensions and endowments invested with it, including Bowling Green State University (Ohio), Carnegie Mellon University (Pa.), Ohio Northern University, and the University of Pittsburgh. In 2009, the Securities and Exchange Commission alleged that staff at Westridge invested very little client money. Instead, the SEC claims, the company's managers "misappropriated the rest to pay for their lavish and luxurious lifestyles."
The SEC filed charges after the National Futures Association, which oversees trading in derivatives, audited Westridge and found irregularities. Company executives refused to cooperate with the investigation. However, they did accept a $21 million deposit from the University of Pittsburgh the day after the NFA began its audit.
The Westridge scandal isn't the only one that has snared colleges. Tufts (Mass.) and Yeshiva (N.Y.) universities both had funds invested with Bernie Madoff, who served on the Yeshiva board of trustees while perpetrating what may be the largest investment fraud ever. Other educational institutions have avoided frauds in their endowments, but were hurt when major donors were victims.
"This can happen to anybody. You don't have to be stupid," says Pat Huddleston, a former SEC enforcement branch chief and the CEO of Investor's Watchdog of Kennesaw, Ga., which provides due diligence services. The institutions affected by the Westridge and Madoff scandals had savvy people on board. Likewise, the list of Bernie Madoff victims includes leaders in the venture capital and mutual funds industries, along with experienced business owners and professionals. Another Ponzi scheme was uncovered in 2010. It was operated by a Florida money manager named Wayne McCleod, who stole retirement investments from officers of the FBI, Drug Enforcement Agency, and Immigration and Customs Enforcement--people trained to look for cons.
Although it's important to have smart staffers and sophisticated trustees, that's only a start. Higher ed institutions should have employees and volunteers trained in operational due diligence, investment performance analysis, and the value of a little skepticism about their fellow human beings. It may seem awkward, but it actually fits into the spirit of knowledge and inquiry that is the hallmark of higher education. "There's a lot of thought that goes into everything that happens here," says Bronte Jones, treasurer of St. John's College (Md.). St. John's standardized its investment due diligence practices as part of a comprehensive institutional financial plan put into place in early 2008.
Victims and Perpetrators
No one sets out to be a victim of fraud. Huddleston says he has talked to countless defrauded investors over the years, who had believed that it could never happen to them. This belief "blinds institutional investors as well as individual investors to the possibility of fraud," he says. The first step to preventing fraud, then, is accepting that it is possible.
Along with the anecdotal evidence on the Madoff and Westridge who's who list, research shows sophisticated investors can be taken in. In 2006, the National Association of Securities Dealers (NASD), a predecessor organization to the Financial Industry Regulatory Authority (HNRA), issued a study on investment fraud. Although it examined senior citizens and their behavior as individual investors, it revealed some surprises that may apply to broader groups. Namely, victims of fraud scored higher on tests of financial literacy than people who were not ripped off. They had more education, more income, and were more likely to rely on their own experience and knowledge. The NASD analysts were unsure if those who were defrauded suffered a gap between what they knew and what they did, if they were tangled by their own expertise, or if expertise was simply no protection against the tactics of a confidence artist. …