Cool

“From educational success to financial scams”

On May 11, 2007, the stock price was $7.95. Four months later, the price was closed at $0.28 on September 26, 2007. Investors have lost approximately 96% of their asset value in a less-than-six-month period. The name of the company was China Expert Technology (OTC Symbol: CXTI). Finally, on November 28, 2007, a class action lawsuit was filed in the United States District Court for the Southern District of New York. So, what takes the investors so long to realize they have fallen into a financial scam? First of all, the company has been following the United States accounting rules, instead of choosing a more straightforward and less strict Chinese rule, since it was first set up. Second, the company had hired one of most famous international accounting firms to audit its own books. Third, the headquarter of this company was located at one of the most well-developed and famed financial centers in Asia, which is Hong Kong. In other words, the company had come under the scrutiny of a more complete and civilized laws for years. At last, it had widely announced tens of projects and contracts which worth over $300 million and would generate revenue $20-35 million a year. Under such “perfect” conditions for a publicly traded company, everybody saw this as a bargain. And even вЂ?one American hedge fund manager amassed a 20 percent stake in the company’ (Norris). But in reality, tons of news had been published right before the scandal began. At the end of May, its chief operating officer had resigned from the office due to mutual agreement. And two months later, its chief financial officer also quitted his job for personal reasons. Finally, the company was late in filing its quarter earnings report in August. However, the price of the stock was still selling at $7.08 on July 13. It was only about a 10% change in price compared to its aforementioned peak value. According to the Efficient Market Hypothesis which was developed by Eugene Fama in 1970, “securities were extremely efficient in reflecting information about individual stocks and about the stock market as a whole”. (Malkiel, P.1) Applied it to my case study, I start to doubt about the theory’s effectiveness and adaptability in today financial world. In this paper, I will focus on the roles of human psychology and behavioral finance being played in financial scams together with flaws of the Efficient Market Hypothesis. At the end, I would say that Investor Education is an insufficient or inadequate solution to the problem of investor fraud.

Human traits are ugly, especially when it comes to their own interests. Out of thousands of human disgusting behaviors, greediness, overconfidence and reliance on professionals always come in the first place for all time. In one of my required readings, these human uglinesses have been totally revealed in that particular financial scam. It was published in Wall Street Journal under the name “Confession of a Scam Artist”. It was an interview of a con artist who was the founder of this specific case; he had taken about two thousands investors for almost 34 million dollars. So, how could this happen in related to human psychology? First of all, the swindlers obtained their lists of targets from the mall intercepts and internet surveys. What I mean by mall intercept is the questionnaire that the people fill out just because they think they are going to get a prize after that. The prize is usually a car or a vacation trip. Under the influence of human greediness, people give out information completely in an honest way. Additionally, the free merchandizes that some websites claim to give out to the people who provide their personal information to them were just one of the sources that the company used to look for their targets. Therefore, there is no way for the company to locate their “customers” without their rapacious behavior. When the con artist recalled the scandal, he also mentioned that the victims “are timed around things that are current in the marketplace, and everybody wants to be a winner”. (Ruffenach, P.5) Since everybody is eager to feel more superior to others, he/she would take measures which allow him/her to distinguish itself. At the end, these measures turn out to be some sorts to scams and “winners” become victims. Besides, overconfidence can also be one of the attributes of falling into a scam. When the swindler was questioned about the nature of his targets, he recalled that “the majority of clients that I (the interviewee) dealt with over the years were white-collar types of people” (Ruffenach, P.6). People who fell for his traps tend to work in professional fields such as dentistry, law and business. They were well-educated, wealthy and being summarized as “risk takers” (Ruffenach, P.6). A huge discretionary income would somehow turn these professionals into losers because they had too much to lose. Moreover, people who were being self-absorbed would rather rely on other professionals when it came to issues that did not belong to their fields. Nice pictures, detailed proposals and self-explanatory numbers would easily make others to believe. And the person who presented these materials usually held a high-rank position in the office such as office manager, sales manager and vice president of marketing. Such an authoritative figure would clear all the doubts and suspicions in their clients’ minds automatically. Therefore, those con men are “playing the psychological aspect as well as the financial aspect” (Ruffenach P.6). Since income plays a major role in determining human social status and supremacy, people who make the higher income tend to get more respect than their poor neighbors and friends. But human always tend to have an unsatisfied appetite for money. So, even if there is positive relationship between income and education, falling into a financial swindle becomes unavoidable.

Another reason for the inevitability of financial frauds is the rise of behavioral finance. Behavioral finance is an economic theory to study investors’ behaviors with the integration of human psychology. This theory was first arisen by Kahneman and Tversky in their paper named “Prospect theory: Decision Making Under Risk” in 1979. It was