Financial Fraud: A Game of Cat and Mouse

Abstract

This thesis models rational criminals and regulators with flawed incentives. In it we develop a rational model of crime and regulation that we use to show the SEC's current incentive structure is ineffective at preventing fraud. Under our model, criminals balance the monetary rewards of larger frauds against an increased chance of being apprehended; and regulators design regulations to minimize either the damage caused by fraud or some other metric. We show that under this model, the SEC's focus on 'stats' and 'quick hits' leads to large frauds and a large social loss. We argue that regulators need to focus not just on successful prosecutions, but also on harm reduction and deterrence.