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Lynn Stout, a law professor at UCLA, says yes:

Why does a large slice of the hedge fund industry seem to have succumbed to illegal behavior?

I would argue that it’s not so much about misaligned incentives, as we might guess from standard economic theory, but rather because, from a behavioral perspective, hedge funds are “criminogenic” environments that can turn even ethical people into conscienceless sociopaths.

What does this environment look like?  Stout highlights three environmental features of Hedge Funds:

  1. Authority Doesn’t Care About Ethics
  2. Perception that Other Traders Aren’t Acting Ethically
  3. Perception that Unethical Behavior Isn’t Harmful

To some extent I can buy all three of these as creating criminogenic environments, but what I fail to see is how any of these three apply disproportionately to Hedge Funds versus other investment houses.  The emphasis placed on profit and returns; the perception that other traders are acting unethically–beating the market through aggressive information gathering; the distance between the traders and the investors harmed by insider trading.  Stout fails to demonstrate that these things take place disproportionately in the Hedge Fund world versus the trader community at large.  If there is little variation between Hedge Funds and other investor firms on these three variables something else must be responsible for the rash of illegal behavior.  It’s also possible that the clustering of Hedge Fund troubles could be random, or a function of the Department of Justice’s selection of cases to pursue.  It isn’t that other dogs didn’t bark–we just haven’t heard them yet.

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