Financial Fraud and Investor Awareness

Abstract

Financial fraud refers to firms taking deceptive actions to exploit investors, such as Ponzi schemes and running away with the money. The existence of many financially “illiterate” investors opens the door for financial fraud because these investors are likely to be attracted by products that offer too-good-to-be-true returns. Our experiment and survey suggest that some investors are unaware of the possible financial fraud of high-return products, justifying policy intervention. A simple eye-opening education program can reduce the proportion of naive investors which helps them make better decisions and also reduces, if not eliminates, the firms’ incentive to commit financial fraud. Competition makes offering normal products less profitable and thus discourages firms from behaving honestly. Policy instruments such as interest rate ceilings, legal punishment, and public education programs, may trigger honest firms to strategically shroud information. Consequently, these policies cannot ensure an improvement in investors’ welfare.