Exploiting a Loophole to Gain Outsized Returns

I believe in the efficient markets hypothesis, which holds that new, publicly-available information is immediately incorporated into the price of a stock or bond. Burton Malkiel, the author of A Random Walk Down Wall Street, observed that despite intensive efforts to find predictable patterns or anomalies, many of the patterns disappear soon after being discovered, leaving little room for the most adept investor to benefit from them.

The ramifications of the efficient market hypothesis are profound. If you accept that markets are random and efficient, predictions about the future direction of the market should be ignored. Efforts to research stocks and bonds, in order to find mispricing, should be abandoned as futile.

It's difficult for many investors to accept the teachings of Malkiel and others who have spent their lives studying the capital markets and publishing their research in peer-reviewed journals. Most of the securities industry is premised on the opposite view: Persuading you they have the ability to engage in market timing, stock picking, and fund manager selection. Ironically, few of those purporting to have this expertise have legitimate credentials, and even fewer have subjected their views to scrutiny by respected journals.

It was therefore surprising when I reached the conclusion there is a way to game the system, notwithstanding the efficiency of the markets, and achieve outsize returns. My inspiration came from an unlikely source: Peter Madoff, the brother of disgraced swindler, Bernard Madoff, who is currently serving a 150-year sentence for running a massive Ponzi scheme.

Peter Madoff, an attorney by training, served as chief compliance officer at his brother's firm. He admitted to falsifying documents, lying to securities regulators, and filing sham tax returns, and was sentenced to ten years in prison.

He denied knowing anything about Bernard's Ponzi scheme, which he claims he learned of shortly before Bernard was arrested. His contention is the key to understanding the loophole.

For acting as chief compliance officer, Peter was rewarded handsomely. He earned about $40 million in the decade beginning in 1998 and lived a lavish lifestyle. According to one survey, the average compensation for chief compliance officers is $125,000, a fraction of Peter Madoff's salary. Judge Laura Taylor, who sentenced Peter Madoff, found his claim of ignorance to be "not believable."

That's when I had my epiphany. Any student of the market knows that steady returns, year after year, regardless of market conditions, are virtually impossible. No legitimate, audited mutual fund had ever reported the returns claimed by Bernard Madoff. Surely, some of the investors in these funds knew Bernard Madoff was engaged in some kind of illegal activity, but elected to invest with him anyway, because they thought they were getting steady returns, without taking meaningful risk.

The recent spate of insider trading convictions and indictments indicates other investors may be exploiting the same loophole. They believe some hedge funds may be achieving stellar returns by using illegal, inside information, but they don't care because they are only focused on returns. They also correctly believe there is no risk of prosecution in doing so. They don't know illegal activity is taking place. It's just a suspicion. If anyone questions them, they can always use Peter Madoff's denials as a defense.

Now you have a way to "beat the market", without taking unacceptable risk. The consummate greed of the securities industry shows no sign of abating. Not even the threat of meaningful prison terms seems to deter them. If you have flexible ethics, there's no shortage of opportunities.

As convicted hedge fund manager Raj Rajaratnam famously stated in a wiretapped conversation: "Bring it on baby."

Dan Solin is a senior vice president of Index Funds Advisors. He is a New York Times best selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now: How to Defend Yourself Against Rigged Markets, Wall Street Greed, and the Threat of Financial Collapse, will be published on December 31, 2012.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.



More From US News & World Report

--

Get stories like this on the Yahoo app and discover more every day.
Download it now.
Loading...
  • HP Inc. tops Street 3Q forecasts but outlook clips stock
    HP Inc. tops Street 3Q forecasts but outlook clips stock Associated Press - 23 minutes ago

    Shares in HP Inc. tumbled in extended trading Wednesday after the personal computer and printer maker beat expectations with its results for its fiscal third quarter but its outlook for the current quarter ... … More »

  • Syria regime launched chemical attacks, IS used mustard gas: UN report
    Syria regime launched chemical attacks, IS used mustard gas: UN report AFP News - 25 minutes ago

    A UN investigation has established that President Bashar al-Assad's forces carried out at least two chemical attacks in Syria and that Islamic State jihadists used mustard gas as a weapon, according to a report seen by AFP on Wednesday. The panel … More »

  • HP Inc beats estimates, weak printer demand weighs on forecast
    HP Inc beats estimates, weak printer demand weighs on forecast Reuters - 28 minutes ago

    By Aishwarya Venugopal (Reuters) - HP Inc, the hardware business of the former Hewlett-Packard Co, reported higher-than-expected quarterly revenue and profit as demand recovered for its notebooks. However, ... … More »

  • The Latest: Authorities say quake death toll at 159
    The Latest: Authorities say quake death toll at 159 Associated Press - 39 minutes ago

    The Latest on the earthquake in central Italy (all times local): __ 00:30 Among the victims of an earthquake in Italy was an 18-month-old girl whose mother survived the deadly earthquake of 2009 in nearby ... … More »

  • Ex-Comverse CEO pleads guilty to fraud, a decade after fleeing to Africa
    Ex-Comverse CEO pleads guilty to fraud, a decade after fleeing to Africa Reuters - 47 minutes ago

    The former chief executive officer of Comverse Technology Inc pleaded guilty to securities fraud on Wednesday and was ordered detained a decade after fleeing the United States for Namibia to avoid prosecution. Jacob "Kobi" Alexander, the Woodbury, … More »

  • 'SNL' star Leslie Jones' personal site offline after hacking
    'SNL' star Leslie Jones' personal site offline after hacking Associated Press - 50 minutes ago

    The personal website of Leslie Jones has been taken offline after it appeared hackers posted personal photos in the latest online attack on the black "Saturday Night Live" and "Ghostbusters" ... … More »

  • Weak petroleum, pharma hit US stocks
    Weak petroleum, pharma hit US stocks AFP News - 57 minutes ago

    Weakness in petroleum-linked shares and pharmaceuticals pushed US stocks lower Wednesday as global markets awaited a speech this week by Federal Reserve Chair Janet Yellen. The declines by US pharma companies came as mounting criticism of drugmaker … More »

  • China’s Power Play in Asia May Be Emboldened by U.S. Politics Bloomberg - 1 hour 18 minutes ago

    Beijing is boosting its military presence in the area unabated, in the face of stepped-up U.S. patrols and a recent arbitration court ruling that invalidated its claims to most of the waterway. After decades of U.S. dominance in the western … More »

  • Canada takes tougher line with China over canola export dispute
    Canada takes tougher line with China over canola export dispute Reuters - 1 hour 19 minutes ago

    Canada hardened its line with China on Wednesday in a dispute over Canadian canola exports, saying bilateral relations could not improve until Beijing took action to settle the matter. Trade Minister Chrystia Freeland made the remarks in an … More »

  • Stocks Decline on Emerging-Market Risk as U.S. Drugmakers Tumble Bloomberg - 1 hour 35 minutes ago

    Developing-nation shares slid after Turkey launched a military operation in Syria, while North Korea conducted a missile test. South Africa’s rand sank as the nation’s finance minister refused to report to police amid a probe. Drugmakers dragged … More »

  • Wall Street stocks retreat, oil tumbles on oversupply concerns
    Wall Street stocks retreat, oil tumbles on oversupply concerns Reuters - 1 hour 40 minutes ago

    Wall Street stocks retreated on Wednesday led by health care and materials stocks, while oil prices tumbled about 3.0 percent on worries about oversupply. Mylan (MYL.O) slumped 5.4-percent to $43.15 after U.S. presidential candidate Hillary Clinton … More »

  • Oil pipeline: The legal challenges and protests
    Oil pipeline: The legal challenges and protests Associated Press - 1 hour 44 minutes ago

    A federal judge has heard testimony in the Standing Rock Sioux Tribe's request to temporarily block the construction of a four-state oil pipeline near their reservation, which straddles the North Dakota-South ... … More »

  • Business Highlights Associated Press - 1 hour 54 minutes ago

    ___ The hidden risk to the economy in corporate balance sheets America's debt problem is showing up in an unexpected place: Corporate America. Of the $1.8 trillion in cash that's sitting in U.S. corporate ... … More »

  • U.S. banking regulators focused on cyber security after SWIFT attacks
    U.S. banking regulators focused on cyber security after SWIFT attacks Reuters - 1 hour 56 minutes ago

    U.S. banking regulators said on Wednesday they are focused on cyber security risks and controls for U.S. financial institutions after attacks earlier this year involving the global financial network known as SWIFT. In a letter responding to … More »

  • Dismal time for Gulf oil = record low lease bidding
    Dismal time for Gulf oil = record low lease bidding Associated Press - 2 hours 8 minutes ago

    The federal government's annual sale of oil and gas leases in the Gulf of Mexico attracted hardly any interest on Wednesday, reflecting a dismal outlook for offshore drilling. Only three oil companies ... … More »

  • Australia's Luxury-Car Binge Belies Its Drop in Living Standards Bloomberg - 2 hours 18 minutes ago

    "A lot has been made of softer economic conditions over the first half of 2016, however the same cannot be said for the luxury car market,'' said Savanth Sebastian, an economist at CommSec. "Higher home prices are boosting wealth levels and … More »

  • How the Dow Jones industrial average fared on Wednesday Associated Press - 2 hours 28 minutes ago

    Stocks closed lower on Wednesday, led by sharp declines in health-care companies as outrage over the steep price hikes for Mylan's EpiPens escalates. On Wednesday: The Dow Jones industrial average fell ... … More »

  • Stocks end lower as health-care companies decline
    Stocks end lower as health-care companies decline Associated Press - 2 hours 29 minutes ago

    Stocks closed lower on Wednesday, led by sharp declines in health-care companies as outrage over the steep price hikes for Mylan's EpiPens escalates. Trading remains quiet overall with many investors still ... … More »

  • Pharma shares under fire as US stocks fall AFP - 2 hours 32 minutes ago

    US stocks fell Wednesday with pharmaceutical shares tumbling as controversy over the sky-high price of Mylan's EpiPen prompted rebukes from the White House and Democratic presidential candidate Hillary ... … More »

  • Williams-Sonoma meets 2Q profit forecasts Associated Press - 2 hours 55 minutes ago

    On a per-share basis, the San Francisco-based company said it had net income of 58 cents. The results matched Wall Street expectations. The average estimate of 15 analysts surveyed by Zacks Investment ... … More »

  • Wall St. falls as healthcare, materials stumble
    Wall St. falls as healthcare, materials stumble Reuters - 2 hours 57 minutes ago

    Wall Street retreated on Wednesday, pulled lower by weakness in the materials and healthcare sectors as investors continued to weigh the possibility of an interest rate hike in the coming months. The market is awaiting Federal Reserve Chair Janet … More »

  • Markets Right Now: US stocks close lower Associated Press - 3 hours ago

    The latest on developments in global financial markets (all times local): 4:00 p.m. Stocks are closing lower, led by drops in health care companies, more than erasing a modest gain from the day before. ... … More »

  • One Tiny Ski Town Is Defying Japan’s Scary Population Collapse Bloomberg - 3 hours ago

    The area’s booming economy has spurred investment in luxury hotels, restaurants, and shops--and attracted local and expat workers who’ve become full-time residents. Niseko’s population grew 2.9 percent last year to 4,952 compared with 2010 levels, … More »

  • Grain lower, livestock lower Associated Press - 3 hours ago

    Grain futures were lower Wednesday on the Chicago Board of Trade. Wheat for Sept. declined 3.75 cents at $4.04 a bushel; Sept. corn fell 1 cent to 3.2750 a bushel; Sept. oats was off 2.25 cents at $1.6925 ... … More »

  • Oil slides on surprise jump in US crude stockpiles AFP - 3 hours ago

    Oil prices slumped Wednesday as a surprise jump in US crude stockpiles added to lingering concerns over a global supply glut. The US Department of Energy said commercial inventories of crude grew by 2.5 ... … More »

 
Recent Quotes
Symbol Price Change % Chg 
Your most recently viewed tickers will automatically show up here if you type a ticker in the "Enter symbol/company" at the bottom of this module.
You need to enable your browser cookies to view your most recent quotes.
 
Sign-in to view quotes in your portfolios.

MARKET MOVERS

  • Most Actives
    Most Actives
    NamePriceChange% Chg
    0.1290.0000.00%
    N21.SI
    0.250.00-1.96%
    5ME.SI
    0.60+0.04+6.57%
    5TP.SI
    0.99-0.02-1.98%
    Y92.SI
    0.156+0.007+4.70%
    AFC.SI
  • % Gainers
    % Gainers
    NamePriceChange% Chg
    0.30+0.06+22.45%
    T18.SI
    0.15+0.02+15.38%
    5TI.SI
    0.225+0.025+12.50%
    Y35.SI
    0.51+0.05+12.09%
    BHU.SI
    0.162+0.017+11.72%
    QS9.SI
  • % Losers
    % Losers
    NamePriceChange% Chg
    0.011-0.115-91.27%
    QF6.SI
    0.23-0.17-42.50%
    AWI.SI
    0.205-0.055-21.15%
    I06.SI
    0.45-0.10-18.18%
    BFK.SI
    0.385-0.085-18.09%
    E8Z.SI

Market Data

  • Currencies
    Currencies
    NamePriceChange% Chg
    1.3538+0.0001+0.01%
    USDSGD=X
    1.5257+0.0008+0.05%
    EURSGD=X
    1.7914+0.0008+0.04%
    GBPSGD=X
    74.1920+0.049+0.07%
    SGDJPY=X
    5.7242+0.0006+0.01%
    SGDHKD=X
    2.9765-0.0004-0.01%
    SGDMYR=X
    9,781.6260-1.6152-0.02%
    SGDIDR=X
    4.9125-0.0008-0.02%
    SGDCNY=X
    1.0310+0.0003+0.03%
    AUDSGD=X
  • Commodities
    Commodities
    NamePriceChange% Chg
    1,329.20-0.50-0.04%
    GCZ16.CMX
    18.53-0.03-0.14%
    SIU16.CMX
    95.34-8.55-8.23%
    ^XAU
    2.080.00+0.17%
    HGU16.CMX
    46.83+0.06+0.13%
    CLV16.NYM
  • Bonds
    Bonds
    TreasuryYield (%)Yield Change
    1.140.00
    ^FVX
    1.56+0.01
    ^TNX
    2.24+0.01
    ^TYX