Irresponsible journalism from the Harvard Business Review

As a business school student from 2007-2009, I was subjected to a staggering amount of "research" from the Harvard Business Review. On balance, their articles are overly dense, poorly edited, self-congratulatory snoozefests that would be easily discreditable as satire if they didn't take themselves so seriously. It's too bad, because there's actually some very solid stuff in the HBR, but it gets lost in a sea of ridiculous "Top 5 things you need to do to succeed in business" checklists and overly simplistic 2x2 matrices.

So suffice it to say, I'm a little bit biased against HBR articles, and I've got a fairly strong visceral response when I see the HBR byline. But this article (to be fair, it's a blog post and not a standard published article) took my disdain for HBR to a new level--it just might be the most dishonest and irresponsible piece of "journalism" I've read this year (emphasis mine).

Hedge funds are playing the role of Wall Street villain again. This time, the charge is rampant insider trading. First came the 2009 arrest of Raj Rajaratnam, founder of the Galleon Group. Then came the November 22, 2010 raids of three hedge fund headquarters by FBI agents who seized documents and confiscated BlackBerries. Now authorities are serving subpoenas on other, larger hedge and mutual funds. Attorney General Eric Holder has announced the government's widening investigation is "ongoing" and "very serious"...

These events raise suspicion that many hedge fund traders may have succeeded at beating the market not through careful research and original analysis but by breaking the law. The question, then, is, 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.

Wow. First of all, a dozen or so funds in a sea of thousands is far from a "large slice". Demonizing hedge funds has become a popular political strategy of late, since it's much easier to scapegoat a small (and easily misunderstood) group of people than to be honest and admit that our economic ills are the result of a broader societal trend toward overextension of credit and an unsustainable consumerist attitude. Eric Holder's "widening investigation" is a witch hunt, plain and simple. Hedge fund managers today might as well be communists in the 1950s--the rhetoric surrounding them has gotten just that one-sided.

Furthermore, lumping "hedge and mutual funds" into the same bucket (as Ms. Stout does in her article without a second thought) is not only disingenuous, it is patently wrong. There are fundamental differences between the two, and these differences must be understood in order to arrive at a proper attitude (or regulatory approach) with respect to hedge funds, mutual funds, or both. Blaming a hedge fund for the sins of a mutual fund is a very dangerous act, and only adds to the irresponsibility of Ms. Stout's article.

Let us not forget that fraud and other economic bad behavior existed long before the term "hedge fund" entered the public lexicon in any meaningful way. But why let facts get in the way of a perfectly slanderous argument? I'll go ahead and edit the core of Ms. Stout's argument for her, if only to show how little sense it makes (all crossouts and bold print mine):

Hedge funds Large companies, both individually and as a group, can send at least three powerful social signals that have been repeatedly shown in formal experiments to suppress prosocial behavior:

Signal 1: Authority Doesn't Care About Ethics. Since the days of Stanley Milgram's notorious electric shock experiments, behavioral science has shown that people do what they are instructed to do. Hedge fund traders Employees of companies in nearly all lines of business are routinely instructed by their managers and investors to focus on maximizing portfolio returns profits. Conversely, instructions to conform to federal insider trading laws are given only in passing, if at all. Thus it should come as no surprise that not all hedge fund traders people put obeying federal securities laws at the top of their to-do lists.

Signal 2: Other Traders People Aren't Acting Ethically. Behavioral experiments also routinely find that people are most likely to "follow their conscience" when they think others are also acting prosocially. Yet in the hedge fund business environment, traders people are far more likely to brag about their superior results paychecks than their willingness to sacrifice those results paychecks to preserve their ethics. Indeed, some may even brag about their ability to profit from breaking the law. The result is a moral race to the bottom in which traders people conclude it's okay to trade on illegally-obtained nonpublic information make money while behaving unethically because everyone else is doing it, too.

Signal 3: Unethical Behavior Isn't Harmful. Finally, experiments show that people behave act less selfishly when they understand how their selfishness harms others. This poses special problems for enforcing laws against insider trading aggressive lending practices, which is often perceived as a "victimless" crime that may even contribute to social welfare by producing more accurate market prices increasing home values and creating a money-making real estate bubble. Of course, insider trading aggressive lending isn't really victimless: for every trader bank or title insurance company who reaps a gain using insider information aggressive lending, some investor homebuyer on the other side of the trade must lose. But because the losing investor is distant and anonymous, hedge fund managers banks, insurance companies, and even homebuilders can convince themselves their insider trading promotion of a real estate bubble isn't really doing harm.

Fixed. Yes, my edits (especially in "Signal 3") are absolutely bitter. But this article was entitled "How Hedge Funds Create Criminals", and not one piece of evidence or argument in Ms. Stout's piece describes ANYTHING that is unique to the hedge fund world. All of her major points can easily be taken out of context and used to describe any business in any industry in the entire history of the capitalist world--they are, in essence, universally true about human nature in general.

To make these kinds of "points" and pretend that they are in any way unique or representative of the hedge fund industry is the absolute epitome of slander and libel. The same three dynamics that she cites as evidence of hedge funds' "criminogenic environment" have been seen at companies such as Tyco, WorldCom, Enron, and, yes, General Motors. But to accuse the manufacturing, telecommunications, energy, or auto industries of being inherently flawed "criminal" organizations in light of these incidents would be absolutely laughable. We do indeed have problems in our society and how we relate with one another, but hedge funds are no more to blame than any other companies, nor are they any more or less likely to produce fraud and bad behavior.

Ms. Stout's argument is almost entirely baseless. She has so far taken a fair beating in the "Comments" section of the HBR blog, which is absolutely warranted. For someone with as impressive a resume as she has, more is expected of her. This is bad journalism in every way, and the HBR should be ashamed to publish something so brutally biased and one-sided. If you want to slander a whole community, you better make sure you've got a defensible argument. Not good, HBR. Not good at all.

[Harvard Business Review]