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FRM Part II · FRM Exam Part II · Performing Due Diligence on Specific Managers and Funds

During due diligence, an investor learns that a hedge fund manager's chief operating officer also serves as the fund's chief financial officer, approves all wires, and reconciles the cash account. Which risk is most directly heightened?

Lack of segregation of duties is most heightened. When one person approves wires and also reconciles cash, no independent check exists, so misappropriation or errors can be committed and concealed. This is an operational control failure rather than a market, liquidity or tracking error issue.

  1. ALack of segregation of duties enabling misappropriation or concealmentCorrect
  2. BHigher market risk from concentrated positions
  3. CIncreased liquidity mismatch between assets and redemptions
  4. DGreater tracking error versus the benchmark

Explanation

One person who authorizes payments and also reconciles cash can both commit and hide misappropriation. Segregation of duties is the key control that is missing. The other risks relate to portfolio or liquidity structure, not control design.

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