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Answer: There is not enough evidence to conclude that investors of hedge funds are compensated for fraud risk by receiving higher returns.
**B is correct.** There's no evidence that supports that investors are compensated for fraud risk through higher returns or lower fees. **A is incorrect.** Disclosures regarding past regulatory or legal violations are effective in predicting fraud. **C is incorrect.** Although certain characteristics, such as conflicts of interest, can predict fraud, we cannot infer that conflicts of interest cause fraud, or that their prohibition would deter fraud. **D is incorrect.** In the past, SEC didn't provide access to historical data (contemporaneous data has always been available) but this is not the case anymore. Up until 2007, the investing public's ability to develop and use predictive models based on Form ADV data was potentially limited because the SEC did not provide access to historical data. As a result, the realized benefits of disclosure during that time frame may have been lower. The results of the study given in the reading suggest that improving public access to comprehensive historical disclosures could increase the benefits these disclosures were meant to provide. **Learning Objective:** Explain the use and efficacy of information disclosures made by investment advisors in predicting fraud. **Reference:** Stephen G. Dimmock and William C. Gerken: Predicting Fraud by Investment Managers (2012)
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A consultant is reviewing the disclosures hedge funds are required to file with the US Security and Exchange Commission. The consultant highlights how investors can use these disclosures to identify and manage fraud risk. Which of the following statements is correct?
A
Disclosures of past regulatory or legal violations are not effective in predicting fraud because circumstances almost always change.
B
There is not enough evidence to conclude that investors of hedge funds are compensated for fraud risk by receiving higher returns.
C
Regulatory and legal prohibitions prevent fraud, and insufficient requirements on disclosure of violations cause fraud.
D
Regulatory and legal violation disclosures benefit only a small fraction of investors who have access to high-cost contemporaneous data.
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