Posts this month
A blog on financial markets and their regulation
India’s wealthy have encountered their Madoff moment with the fraud in the Gurgaon (New Delhi) branch of Citibank in which a relationship manager defrauded the wealth management clients of the bank of over Rs 3 billion (about $65 million). The relationship manager promised high rates of return and persuaded clients to sign blank cheques which were used to transfer the funds to bank accounts of the manager’s family members.
Why do wealthy people fall for such frauds? Why do they venture into such unregulated products where they have much lower levels of protection? I think this has a lot to do with people extrapolating their experiences of the pre reform era (prior to 1991) to the modern largely deregulated economy:
I do not believe that greater regulation is the answer to the problem. If the underlying investor attitude does not change, regulating one set of products would only drive investors to another set of unregulated products. The whole genesis of blank cheques probably lies in a misguided attempt to “empower” the investors by using a nondiscretionary portfolio management system.
In a nondiscretionary portfolio management system, the advisor only gives advice, and it is the investors that supposedly take all the decisions. By contrast, a discretionary portfolio management system is more like a mutual or a hedge fund where the client has little voice in investment decisions. A nondiscretionary system appears to give more power to the investors and is intended to protect investors from wrong investment decisions by the advisor. However, by getting investors to sign blank cheques and instruction forms, advisors are able to run what is effectively a discretionary portfolio management system while maintaining the documentary pretence of running a nondiscretionary system. Far from empowering the investor, the result is to leave investors vulnerable to fraud. In retrospect, investors might have been better off in a discretionary system.
Personally, I think financial regulators should not waste excessive amount of resources or time pursuing the Citi fraud for several reasons. First, the fraud involved unregulated products. Second, the fraud is well covered by normal criminal laws regarding theft and misappropriation. Third, the victims are very wealthy investors who are well capable of hiring the best lawyers and investigators to go after the bank. The regulators’ time and resources are much better spent on regulated products involving small investors who are less capable of looking after themselves.