FRM Part II · FRM Exam Part II · Case Study: Financial Crime and Fraud
A fund administrator, auditor and custodian for an investment fund all rely on statements supplied by the fund manager, who is also the sole signatory on custody confirmations. Returns have been unusually smooth for many years. Which combination of findings best explains why a Ponzi-type fraud could persist, and which action would most directly test it?
The fraud persists because there is no independent verification: everyone depends on information from the manager, who controls custody confirmations. The most direct test is obtaining trade and asset confirmations straight from an independent third-party custodian to confirm that assets actually exist.
- AAbsence of independent verification; obtain trade and asset confirmations directly from an independent third-party custodianCorrect
- BExcessive diversification; reduce the number of funds held
- CHigh fees; negotiate a lower management fee
- DCurrency mismatch; hedge the fund's exposure
Explanation
The fraud persists because every party relies on information controlled by the manager, with no independent source of assets or trades. Smooth returns without explanation are another red flag. Direct confirmation from an independent custodian tests whether assets and trades exist. Fee, diversification or currency changes do not address verification.
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