We test the predictability of investment fraud using a panel of mandatory disclosures filed with the U.S. Securities and Exchange Commission (SEC). We show that past regulatory and legal violations, conflicts of interest, and monitoring have significant power to predict fraud. Avoiding the 5% of firms with the highest ex ante predicted fraud risk would allow an investor to avoid 29% of fraud cases and over 40% of the total dollar losses from fraud. We examine the ability of investors to implement fraud prediction models based on the disclosure filings, and suggest changes in SEC data access policies that could benefit investors.
The SEC and its cumbersome disclosures, regulations, and oversight, failed to catch the largest Ponzi scheme in history. Maybe some supercrunching algorithms can catch it?