Biases Fuel Investment Fraud Problem

Video Transcript

Kelly Kesner: I’m Kelly Kesner with this week’s Investor’s Watchdog University. With me is Pat Huddleston, the founder of Investor’s Watchdog. And this week we’re going to talk about why is investment fraud still a problem. Investment fraud has been around for hundreds of years going all the way back to Ponzi’s time and probably before that. We spoke a few weeks ago about Ponzi. And the market goes up; the market goes down. We have different products being introduced and yet we still have investment fraud. Pat, why is it still around? Why is it not going away and, in fact, getting worse?
Pat Huddleston: Well, Kelly, the answer to that question could be the biggest benefit that people could get out of this video series because the answer is not what you think it is. I would ask most of you out there why so many lose so much to investment fraud. Most of you based on my surveys and I do these all over the country would say gullibility, greed or low intelligence are the primary culprits. And you’re talking about the victims of these things, that they’re gullible.
They’re greedy. They’re not very smart. As it turns out, that’s not the case. Those aren’t the cause. The problem is our brain wiring. Psychologists and Neuroscientists are discovering all the time that our brains are just pre-wired for certain functions that help us in some context, but actually hurt us in other context and that’s the case with the way our brains think about investments just naturally.
Kelly Kesner: I’ve actually read something about that. Doesn’t the CIA train its analysts to basically analyze the cognitive biases or be aware of them so they can be aware of problems that they encounter?
Pat Huddleston: They do. They teach them. Listen unless you’re able to assess your own thinking, unless you can think about how you think you are bound to miss things. You are bound to see things that aren’t there. You’re bound to miss things, big things that are there. And so if you want to google CIA and cognitive biases, you’ll be able to see those studies for yourself. I recommend it.
Terrific reading. You need to know what’s going on. There’s some specific biases I talk about in the vigilante investor that we’ll just briefly cover today. First of all, the optimism bias. That is the bias that leads us to believe there must be gullibility or greed that’s to blame for all these things. Why is that? Because none of us would describe ourselves that way, you see.And so the optimism bias makes us think that while disasters including financial disaster might happen to other people it cannot happen to us. We think we’re safe. But, usually when I say that pessimists think, “Well, I can stop listening now. I’m not an optimist.” But, this is a level of optimism that affects everybody. All of us are optimistic enough to go out of our doors every day and so the optimism bias affects us all. And when we’re meeting with a stockbroker or investment advisor it never occurs to us because of this bias that this person might cost us everything that we worked for someday.
Kelly Kesner: Are there other biases that may be specific to investment scams? This optimism bias sounds kind of innate and you’re not even aware of it. Are there ones you might be more aware of when dealing with investments?
Pat Huddleston: Well, that’s the sneaky thing about cognitive biases. They’re all going on behind the curtain of your conscious thought, so you’re not really aware of them unless you come to Investor’s Watchdog University and you’re learning about them. There are others that we’ll talk about including one called the congruent bias that is very, very sneaky and actually jumps on you and affects you when you’re out there doing your own investigation. The failure to identify the impact of these biases has really caused traditional due diligence methods to fail. It’s one of the reasons behind Bernie Madoff.
It’s one of the reasons behind all of the Ponzi schemes you saw come forward 2008 to present time. And due diligence investigators need to start working those concepts into the way that they investigate. Usually the people who do due diligence investigations are very smart folks. They may have very impressive credentials, but they don’t have fraud specific experience. That means they may evaluate impressive, legitimate investments all day every day. They may be able to talk to you about ratios, and standard deviations, and all that kind of thing, but they never actually swam in an ocean of fraud, if you will. They don’t know what a cleverly disguised fraud looks like. And so what we need to start insisting is that our due diligence investigators have fraud specific experience.
Kelly Kesner: And, Pat, I’m sure with your experience at the FCC and with everything you’ve done with Investor’s Watchdog you’re going to be able to help. And through your book and through Investor’s Watch blog be able to educate people to be aware of some of these biases and then help recognize some of the frauds that are out there.
Pat Huddleston: That’s it, Kelly. Exactly right. Just being able to know these biases exist make you better. Reading stories of actual scams makes you even better. And so watching Investor’s Watchdog University, reading blogs, reading books will make you much better able to protect yourself and those who depend on you.
Kelly Kesner: Well, we were just here to introduce you to some of these biases today, but we’re going to go into them in greater depth in the future. For now that’s it for this week. Class dismissed.
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