CFM Fund Administration & Operations 5 — Questions and Answers
Question 1: A fund administrator discovers a NAV calculation error from three days ago that overstated NAV by 0.15%. What is the standard industry approach?
- Correct the error silently going forward without notifying investors
- Assess the materiality of the error against the fund's error policy and compensate affected investors if the threshold is breached (Correct answer)
- Immediately suspend all redemptions and subscriptions
- Report the error to the SEC within 24 hours regardless of materiality
Correct answer: Assess the materiality of the error against the fund's error policy and compensate affected investors if the threshold is breached
Most funds apply a materiality threshold (commonly 0.5% for retail funds); errors below this threshold may be absorbed, while errors above require investor compensation and disclosure.
Question 2: What is 'in-specie' transfer in the context of fund operations?
- Transferring cash between fund share classes
- Delivering actual securities rather than cash to satisfy a redemption or subscription (Correct answer)
- Converting a fund from onshore to offshore domicile
- Allocating securities across multiple sub-funds
Correct answer: Delivering actual securities rather than cash to satisfy a redemption or subscription
An in-specie transfer involves the delivery of securities (rather than cash) to fulfill a large redemption or to seed a fund at launch, avoiding the costs and market impact of selling and repurchasing assets.
Question 3: Which regulatory framework specifically governs the custody of assets for U.S. registered investment advisers managing client funds?
- Investment Company Act of 1940, Rule 17f-2
- Investment Advisers Act of 1940, Rule 206(4)-2 (the 'Custody Rule') (Correct answer)
- Securities Exchange Act of 1934, Rule 15c3-3
- Dodd-Frank Act, Section 619 (Volcker Rule)
Correct answer: Investment Advisers Act of 1940, Rule 206(4)-2 (the 'Custody Rule')
Rule 206(4)-2 under the Investment Advisers Act imposes specific custody requirements on registered investment advisers, including use of qualified custodians and annual surprise audits.
Question 4: In a master-feeder fund structure, where does portfolio management and trading primarily occur?
- In each feeder fund independently
- In the master fund, with feeder funds investing as limited partners (Correct answer)
- At the administrator level for operational efficiency
- In the largest feeder fund by AUM
Correct answer: In the master fund, with feeder funds investing as limited partners
In a master-feeder structure, all feeder funds pool their assets into the master fund, where all portfolio management, trading, and investment decisions are made centrally.
Question 5: What is the purpose of a 'subscription document's representations and warranties' section?
- To describe the fund's investment strategy in detail
- To have the investor affirm their eligibility, accredited status, and understanding of risks (Correct answer)
- To specify the fee schedule for the investment
- To establish the governing law for disputes
Correct answer: To have the investor affirm their eligibility, accredited status, and understanding of risks
Representations and warranties require the investor to confirm they meet eligibility criteria (e.g., accredited investor status), have reviewed risk disclosures, and have authority to invest—creating legal accountability.
Question 6: How does a 'clawback provision' protect investors in a private equity fund context?
- It prevents the manager from withdrawing management fees mid-year
- It requires the general partner to return previously paid carried interest if overall fund returns fall below the hurdle rate (Correct answer)
- It allows investors to demand early return of capital if the manager underperforms
- It caps the total performance fee payable over the fund's lifetime
Correct answer: It requires the general partner to return previously paid carried interest if overall fund returns fall below the hurdle rate
A clawback ensures that if early profitable exits cause the GP to receive more carried interest than they are entitled to based on total fund performance, the GP must return the excess to limited partners.
Question 7: Which of the following best describes 'operational due diligence' (ODD) conducted by institutional investors before allocating to a hedge fund?
- Reviewing the fund manager's investment thesis and track record
- Assessing the fund's back-office processes, controls, technology, service providers, and risk management infrastructure (Correct answer)
- Analyzing the fund's portfolio for concentration risk
- Reviewing the fund's audited financial statements only
Correct answer: Assessing the fund's back-office processes, controls, technology, service providers, and risk management infrastructure
ODD focuses specifically on non-investment risks—how the fund processes trades, safeguards assets, values positions, manages counterparty relationships, and maintains internal controls.
CFM Fund Administration & Operations 5
A fund administrator discovers a NAV calculation error from three days ago that overstated NAV by 0.15%.
What is the standard industry approach?