FRM Part II · FRM Exam Part II · Madoff: A Riot of Red Flags
A fund-of-funds analyst reviewing a hedge fund notes that its multi-billion-dollar portfolio is audited by a three-person accounting firm operating from a small office, with only one active partner. In the context of the Madoff case, which assessment is most appropriate?
A tiny, single-partner audit firm for a multi-billion-dollar fund is a red flag, as in Madoff. The auditor lacks the capacity and expertise to verify such assets and trades, so an unqualified opinion offers little assurance. Auditor capability must match the fund's size and complexity.
- AThe auditor's size is a red flag because it appears incapable of independently verifying a fund of that scaleCorrect
- BThe auditor's size is irrelevant provided the audit opinion is unqualified
- CThe auditor's size is a positive sign because small firms are more independent
- DThe auditor's size matters only if the fund is registered offshore
Explanation
Madoff's feeder funds and the advisory business were audited by a tiny firm that lacked the capacity and expertise to audit a business of that size. Due diligence should compare auditor scale and experience with the complexity and assets of the fund. An unqualified opinion from an incapable auditor gives little comfort.
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