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

A risk manager at an allocator reads that regulators examining Madoff's firm accepted documents supplied by the firm itself and did not independently confirm trades. Which control would most directly have addressed this weakness?

Obtaining trade and position confirmations directly from independent third parties, such as the clearing house or custodian, addresses the weakness. The failure was reliance on documents supplied by the firm under review. Independent verification removes that dependence, whereas more self-reported material or index comparisons does not confirm trades actually occurred.

  1. AObtaining trade and position confirmations directly from independent third parties such as the clearing house or custodianCorrect
  2. BRequesting longer written descriptions of the strategy from the manager
  3. CIncreasing the frequency of the manager's self-reported performance statements
  4. DComparing the manager's returns with a broad equity index each quarter

Explanation

The core weakness was reliance on information controlled by the subject. Independent confirmation from a custodian or clearing agent breaks that dependence and would have shown that no trades existed. Self-reported statements or index comparisons still rely on or only hint at problems.

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