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FRM Part II · FRM Exam Part II · Madoff: A Riot of Red Flags

A feeder fund manager charges investors a 1.5% management fee on assets while the master manager charges only trading commissions. A due diligence analyst notes the feeder earns its fees for 'monitoring' the master manager but performs no independent verification of assets or trades. What is the most appropriate conclusion?

The feeder is collecting fees for a monitoring service it does not deliver, which is both a conflict of interest and a failure of fiduciary duty. Its incentive is to keep assets flowing rather than challenge the master manager, so stable returns or lower master fees do not justify the arrangement.

  1. AThe fee is justified because the feeder provides diversification across strategies
  2. BThe fee is justified as long as the master manager's reported returns are stable
  3. CThe feeder is paid for due diligence it does not perform, creating a conflict of interest and a failure of its fiduciary duty to investorsCorrect
  4. DThe arrangement is low risk because the master manager is paid less than the feeder

Explanation

Feeder funds charge for selection and monitoring. If they do not verify the master, they collect fees without delivering the service, and their incentive is to retain assets rather than question the manager. Stable returns do not justify the fee, and the feeder invests in a single master, so there is no diversification benefit.

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