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

Madoff's feeder funds charged investors fees while the Madoff firm itself earned only brokerage commissions on the trades. From a governance perspective, what does this fee arrangement most plausibly indicate to a diligent investor?

The arrangement signals economics that do not make sense for a supposedly valuable strategy. Madoff gave up performance fees and left them to feeder funds, so his true motive was unclear. A diligent investor should question unexplained fee structures rather than treat them as alignment.

  1. AStrong alignment because the manager's costs were low
  2. BAn economic structure inconsistent with the strategy's claimed value, since the manager forwent performance fees and so the true profit motive was unclearCorrect
  3. CA tax-driven arrangement common in all split-strike strategies
  4. DEvidence of superior execution quality

Explanation

Madoff forwent the typical hedge fund fees, leaving profits to feeders, which is economically puzzling for a supposedly skilled and capacity-constrained strategy. The unexplained economics should prompt questions. It is not evidence of alignment or execution quality.

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