The Ostrich Defense By: Gabriel PotterMBA, AIFA® 2013.09.25
I recently got back from Africa. While watching Ostriches stride across the grasslands, our guide reminded us that the Ostrich does not actually stick its head in the ground when threatened; that’s just a myth. Actually, ostriches are fast enough to outrun most predators, and they have strong clawed legs to defend themselves. It simply makes no evolutionary sense for an animal to willfully ignore a problem and hope it goes away. Despite this common sense realization, the myth persists – at least for the animal kingdom – but humanity is better than that, right?

As it turns out, humanity is not always as directly logical as our counterparts in the animal kingdom. In our litigious society, we will attribute the responsibility of our actions based on our information at the time. The argument goes, “we can’t be liable for information we don’t have.” In other words, by not understanding the dangers, we have avoided our responsibility for managing them.

There have been several high profile court cases which featured defendants arguing their ignorance of the law, or the truth, as a way to lessen their responsibility. Wikipedia lists these cases under the subject “The Idiot Defense”, and highlights their outcomes here: Pointedly, they remark “no major instances of the idiot defense being successful in criminal proceedings have been reported in American jurism to date.”

One might think, given such a weak track record, the Ostrich Defense would lose all credibility. It doesn’t make sense in the animal kingdom. It hasn’t had success in practice. By contrast, acknowledging a threat and working directly to address it just makes common sense.

By contrast, I remember a classroom discussion about the Martha Stewart insider trading scandal. One of my Finance professors tried to argue that the primary reason Martha Stewart went to prison was because she didn’t adequately assert her ignorance about the law. To review the incident, Martha Stewart was warned by her broker that one of her stocks (ImClone) was going to lose a lot of value after learning a key drug patent failed to get FDA approval. The information about the FDA disapproval was private information; acting upon material, non-public information is called insider trading, and it is illegal. So, when Martha Stewart made trades based upon insider information, she would have warranted, at minimum, a fine, or penalty, or an official reprimand of some sort. However, my professor’s argument was that Martha Stewart ultimately went to prison not because of the insider trading, but because she lied to the investigators about her actions. She was ultimately convicted on conspiracy and obstruction of justice for her attempts to conceal the crime. If she had simply plead ignorance of the law – something like, “My broker told me the company was going to go down and so I sold the stock. Is this a problem, officer?” – she might have avoided jail time. However, because she tried to destroy evidence, she demonstrated an understanding that she broke the law and a willingness to lie to maintain her innocence, the legal system was obliged to give her a stronger penalty. So, for Martha Stewart, maintaining a position of willful ignorance might have saved her from some culpability.

I’m not a legal expert and I certainly can’t go back to time to ask to Martha Stewart and get her to change her strategy, so I can’t test my professor’s theory. In the, admittedly hypothetical, scenario in which Martha fesses up to the insider trading immediately, why might she avoid some of guilt of her action? I might argue that a LOT of common law depends on the role assumed. In other words, what would a typical member of the community do, presuming an prudent standard of understanding and care. After all, who would have expected a domestic maven like Martha Stewart to know the intricacies of securities law? Certainly, Martha Stewart is less liable for these actions compared to her NASD registered stock-broker: securities professionals are supposed to know better. Martha Stewart never put herself forward as an expert in legal or investment requirements. (By contrast, if Martha Stewart started out patently horrendous recipes in her magazine, she would be subject to greater criticism than an amateur chefs, since she has put herself forward as an expert in the field.)

In other words, the role you adopt helps to determine your responsibility. If you have accept a role with greater responsibility, like a stock-broker, you must maintain the higher standard, act according to the law, and accept higher penalties for failures.

Most importantly, once you’ve accept a role with more responsibility, you can no longer maintain ignorance as a defense.

Therefore, we have a final question: do your plan fiduciaries understand the responsibilities they accepted by adopting that role? Logically, once a fiduciary has accepted that title, they have a duty to understand what they are now responsible for. In other words, they can no longer stick your head in the sand and pretend that they are safe from responsibility by claiming ignorance.
Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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