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

A pension fund's investment committee is reviewing lessons from the Madoff fraud. Which feature of the Madoff case best illustrates a failure of regulatory oversight, as opposed to a failure of investor due diligence?

The best example of regulatory failure is that credible, detailed whistleblower tips were received repeatedly but not investigated effectively. The regulator did not verify trading with independent third parties. The other choices describe shortcomings by investors or feeder funds, which are due diligence failures rather than supervisory ones.

  1. ARepeated credible whistleblower submissions to the regulator were not investigated effectivelyCorrect
  2. BInvestors accepted returns that were unusually smooth relative to the stated strategy
  3. CFeeder funds charged fees for access without verifying the manager's trades
  4. DInvestors did not question the use of a small, unknown auditor

Explanation

The regulator received detailed, specific complaints over many years and its examinations did not follow them up to the point of verifying trades with third parties. The other options describe investor or feeder-fund diligence lapses, not regulatory conduct.

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