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

A feeder fund places all client assets with one investment manager, and its own staff perform no independent trade reconciliation, relying instead on trade confirmations and statements issued by that manager. Which governance failing does this best describe?

This is delegation of monitoring without independent verification, a failure of fiduciary due diligence. The feeder relied solely on documents produced by the manager it was supposed to oversee, as Madoff's feeders did, rather than reconciling trades and holdings with independent third parties.

  1. AOver-diversification of manager risk
  2. BDelegation of monitoring without independent verification, i.e., failure of the feeder's fiduciary due diligenceCorrect
  3. CExcess liquidity management
  4. DOverly frequent rebalancing

Explanation

Feeder funds marketed their own oversight, yet simply relied on documents from Madoff. A fiduciary should independently verify, for example through third-party custodians and reconciliations. Concentration with one manager is the opposite of over-diversification.

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