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

An asset manager discovers that portfolio managers can both place trades and amend the allocation of executed block trades to client accounts after the trading day closes. Which control change most directly addresses the risk that favourable trades are steered to preferred accounts?

Requiring allocation instructions to be recorded before execution, with any later change independently approved, best addresses cherry-picking. It removes the ability to assign trades after seeing results and creates an audit trail. Disclaimers, reporting frequency or same-day reallocation leave hindsight discretion intact.

  1. ARequire pre-trade allocation instructions to be recorded before order execution, with post-trade changes needing independent approvalCorrect
  2. BIncrease the frequency of client performance reports to quarterly
  3. CAllow portfolio managers to reallocate trades only within the same day
  4. DAdd a disclaimer to client agreements about allocation practices

Explanation

Cherry-picking arises when allocation can be decided after seeing trade outcomes. Recording allocations before execution and requiring independent approval of any change removes the discretion and creates an audit trail. Same-day reallocation still lets managers observe intraday price moves, and disclaimers or reports do not prevent the behavior.

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