FRM Part II · FRM Exam Part II · Madoff: A Riot of Red Flags
A feeder fund invests all of its assets with a single master fund manager who also acts as investment adviser, custodian and executes all trades. Which control weakness does this arrangement most directly create?
The arrangement removes segregation of duties. Because the same manager advises, holds the assets and executes trades, no independent party can verify that securities exist or that trades occurred, which makes undetected fraud far easier.
- ALack of segregation of duties, so no independent party can confirm that assets exist and trades occurredCorrect
- BExcessive diversification across underlying strategies
- CHigher management fees due to multiple service providers
- DInability to calculate a Sharpe ratio
Explanation
When one party advises, holds assets and executes trades, there is no independent check on custody or trade records, enabling fraud to go undetected. The arrangement concentrates rather than diversifies and reduces rather than increases service-provider fees. Sharpe ratios can still be computed.
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