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

During operational due diligence on a hedge fund with USD 800 million AUM, an analyst finds the fund is audited by a one-person accounting firm, uses an administrator affiliated with the manager, and the CFO also acts as chief compliance officer. Which conclusion is most appropriate?

These findings point to weak independent oversight: a tiny auditor for a large fund, an affiliated administrator and a combined CFO/CCO role. Together they remove independent verification and form a serious operational red flag until remedied. Stable returns do not offset this, and fixing only the auditor leaves other gaps.

  1. AThe red flags are mainly about the audit firm's size, so switching to a larger auditor would resolve all concerns
  2. BThese are independent-oversight weaknesses that compound each other and should be treated as a serious operational red flag until remediedCorrect
  3. CThe findings are acceptable because the fund's reported returns are stable and low in volatility
  4. DOnly the dual CFO/CCO role matters, as auditor and administrator affiliation are standard market practice

Explanation

An unqualified auditor for the fund size, a related-party administrator and combined finance and compliance roles each weaken checks and balances, and together they remove independent verification. Stable returns are not mitigating and can themselves be a warning sign. The Madoff case showed this pattern. Fixing only the auditor leaves the other gaps.

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