Situation #1: A company which aims at being a major global player in its industry adopts an aggressive growth-by-merger-and-acquisition strategy, which is largely fueled by the price of the company's stock. This strategy makes the company an important client of its investment bank, which is paid lucrative up-front fees for handling the transactions behind the mergers and acquisitions. The price of the company's stock is largely driven by the glowing opinions of the investment bank's industry analyst, which are expressed worldwide despite the analyst's knowledge that the company's business is floundering.

The dynamic of this relationship is thus framed: The investment bank is desperate for the company's mergers-and-acquisitions business, so it is willing to abandon objectivity in its research. As a result, the bank gets rich on up-front fees and thousands of investors lose billions of dollars.

This is the story of Worldcom, Citigroup and Jack Grubman.

Situation #2: A hedge fund aims to bet that several different pools of mortgages will default. This strategy makes the hedge fund an important client of its investment bank, which is paid lucrative up-front fees to locate someone to take the other side of these bets. The investment bank knows the mortgages will default but does not tell those who are betting the mortgages will not fail.

The dynamic of this relationship is thus framed: The investment bank is so desperate for the up-front fees that come with the hedge fund's bets that it covers up how bad the bets are to its own clients. As a result, the bank gets rich on up-front fees and unsuspecting investors lose billions.

This is the story of Goldman Sachs, collateralized debt obligations and credit default swaps.

A common thread in these two situations is the perverse financial incentive. In each instance, the investment banks favored huge up-front fees over other legal obligations (to tell the truth in its analyst reports, to disclose the doomed nature of the mortgages behind the CDOs to its investors).

My advice is this: When making any investment, financial or otherwise, always be cognizant of the other side's incentives and how much you really know, versus how much you think you know. Trust nothing but the facts and no one but yourself.