I believe in the power of free markets and capitalism to create prosperity, to harness and direct human potential. But sometimes that energy can run amok, particularly if there are inadequate protections against the temptations of the weak side of human nature.

Hedge funds are a case in point: Generally privately held, lightly regulated, often based offshore, and frequently dealing in lightly-traded securities and hard-to-price illiquid investments, they provide a Petri dish for human weakness, particularly when it comes time to divvy up the pie.

Case in point: “Pricing Tactics of Hedge Funds Put to Question,” in The Wall Street Journal on October 9, 2007, Heard on the Street. Seems that when it comes time to do the monthly valuations of the performance of the fund, “’Hedge fund managers purposefully avoid reporting losses by marking up the value of their portfolios,’ according to new academic research by Nicolas P.B. Bolton of Vanderbilt University and Veronika K. Pool of Indiana University.”

The naked pursuit of profit at all cost can quickly lead one down an unethical, if not immoral, path. Business must acknowledge the social contract, its obligations to the community as a whole if not as a direct legal obligation (for god only knows how the lawyers would twist that), then certainly as a heartfelt ethical and moral obligation, to be held accountable via the bully pulpit and the court of public opinion.

Ethics should be a required course in every business school and the goal of every economic enterprise should only be “principled profit.”

This is a classic from the NSC Blog archive. Originally posted October 22 , 2007.