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

Which feature of a hedge fund's governance would an investor most reasonably view as a red flag in the context of the Madoff case?

An unusual fee arrangement with commissions only, combined with no independent oversight of operations, is a red flag because it indicates opacity and concentrated control. Independent administrators, independent boards, and reputable auditors are positive governance features that provide checks.

  1. AFees charged only as brokerage commissions with no management or performance fee, and no independent oversight of the manager's operationsCorrect
  2. BAn independent administrator that calculates the net asset value
  3. CA board with a majority of independent directors
  4. DAnnual audits by an internationally recognized firm

Explanation

Unusual fee structures that forgo standard fees, combined with no independent oversight, signal opacity and concentrate control with the manager, as in Madoff's case where feeders captured the fees. The other options are positive governance practices that provide independent checks.

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