According to the new book Outliers by Malcolm Gladwell, countries that have high PDI’s (power-distance index) respect authority more and are less likely to speak up to or challenge superiors. The evidence cited is the case of a Korean Air flight where the first officer (the co-pilot) knew the plane was in serious trouble, but out of  perceived ‘respect’ for the pilot, was slow to suggest otherwise. The result of the first officer’s lack of speaking up was the plane crashing into the side of Nimitz Hill.

So how does this relate to the markets? According to the same study, Americans are supposed to have one of the lowest PDI’s, meaning that in order to avoid catastrophe, we aren’t afraid to speak up to authority in order to ring the alarms. Gladwell refers to this as “The Ethnic Theory of Plane Crashes”.

Apparently, when it comes to speaking up about potential fraud in the markets, we aren’t so ‘American’. How else can you explain the rampant fraud on Wall Street the last few years? Surely someone, somewhere inside the investment banks knew they were leveraged to the point of collapse. Until the day of reckoning, no alarms were sounded.

How about the situation at Madoff Securities? They were alerted to the situation as far back as 1999. As recently as 2005, they were told by Harry Markopolos that it was ‘highly likely’ that Madoff was running a giant Ponzi scheme. But every time the SEC looked at Madoff’s books, they couldn’t find anything.

Really? The government entity that’s sole responsibility is to find this type of thing was fooled into overlooking one of the simplest frauds known to man?

I find that hard to believe. More likely, those ‘investigators’ didn’t dig too deep for fear of ruining their lucrative Wall Street careers after working at the SEC. Why ruin a huge payday down the road investigating one of the most respected individuals on Wall Street? He was the former chairman of the NASDAQ after all. A pillar of the community. Easier to just slap a few minor penalties on the company and go about your business. Which is exactly what they did, as they found Madoff guilty of a “violation of the registration requirements of the Advisers Act.”

Let’s hope in the future that those tasked with protecting individual investors learn how to speak up. Otherwise, Gladwell may have to add another chapter to his book, entitled “The Promotion Theory of Wall Street Careers”.

Source: The Ethnic Theory of Plane Crashes

Last 5 posts by Christian Hill

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