FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure
An investor is reviewing a hedge fund's organizational structure. The fund's prime broker also acts as its custodian, and the fund's sole auditor is a small unknown firm. Which change would most improve protection of investors' assets from fraud?
Using a reputable independent auditor and independent custody, or multiple prime brokers, best protects against fraud because it provides third-party verification that assets exist and are reported accurately. Co-investment, shorter lock-ups or higher hurdles do not independently confirm holdings or counter weak audit and custody arrangements.
- AUse a reputable independent auditor and ensure assets are verified by an independent custodian or multiple prime brokersCorrect
- BIncrease the manager's personal co-investment in the fund
- CShorten the lock-up period for new investors
- DRaise the performance fee hurdle rate
Explanation
Asset misappropriation and fabricated reporting are mitigated by independent verification: a reputable auditor and independent custody or diversified prime brokerage with third-party confirmation. Co-investment aligns incentives but does not verify assets, and lock-ups and hurdle rates do not address custody or audit weakness.
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