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FRM Part II · FRM Exam Part II · Case Study: Investor Protection and Compliance Risks in Investment Activities

A fund manager earns higher fees on in-house funds than on third-party funds. Its advisers have recommended in-house funds to 85% of clients, though internal analysis shows comparable third-party funds would have been cheaper and equally suitable for about 40% of them. The compliance head is designing a response consistent with investor protection principles. Which action is most appropriate?

The best response is to identify and disclose the conflict, align adviser incentives with client outcomes, and monitor recommendation patterns with escalation. Disclosure alone is insufficient, and a blanket ban is disproportionate because in-house funds can be suitable. Conflicts require layered management, not just paperwork.

  1. AIdentify and disclose the conflict, align adviser incentives with client outcomes, and monitor recommendation patterns with escalationCorrect
  2. BDisclose the fee differential in the annual report only and make no change to incentives
  3. CProhibit advisers from recommending any in-house fund
  4. DRely on clients' signed acknowledgement that they understand the firm sells its own products

Explanation

Sound conflict management combines identification, disclosure, mitigation through incentive redesign and ongoing monitoring. Annual-report disclosure and signed acknowledgements are weak, as clients may not understand them. A blanket prohibition is disproportionate because in-house funds may be suitable for many clients.

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