Merrill Lynch Ordered to Pay $3.6M Over Alts Feeder Funds’ ‘Layers of Fees’

The Financial Industry Regulatory Authority announced that an arbitration panel has ordered Merrill Lynch to pay nearly $3.6 million to two retail clients whose private-equity feeder-fund investments performed far below expectations and broad-market benchmarks due to what their attorney labeled as “layers of fees.”

The three-arbitrator panel awarded Qun He and Haihui Zhang $2.73 million in compensatory damages for the diminished value of their securities, plus $955,000 in attorneys’ fees and related costs.

According to the investors’ counsel, Michael Bixby of Sarasota-based Bixby Law, his clients were steered into a series of private placement and non-traded alternative strategies, structured as Merrill-sponsored feeder funds, that generated about 3% annualized over roughly 10 years. Bixby said his clients had been guided to expect double-digit performance and ultimately allocated more than 10% of their assets to the products.

Bixby attributed the shortfall largely to multiple layers of fees. He stated that the underlying private equity vehicles, managed by sponsors such as Apollo, KKR and Blackstone, may typically charge about 1.5%, or 150 basis points, of management fees. On top of that, the Merrill feeder funds levied administrative fees that could reach 125 basis points annually, plus one-time placement fees of roughly 250 basis points.

“You have layers of fees on top of layers of fees,” he said, noting that the structure saddled clients with illiquidity and risk without commensurate return.

The structure of feeder funds is often marketed as a way to lower the high entry thresholds of traditional alternative investments. Merrill’s own asset-allocation guidance can recommend alternative exposures of up to 40% for aggressive portfolios, according to Bixby, but he warned that internal-rate-of-return metrics used in marketing materials may not align with real-world returns.

According to Bixby, the anticipated return for the products was 15% to 20%, but the actual returns were 3% or less. Over the same period in question, the S&P 500 delivered annualized gains of more than 10% despite volatility.

The panel’s award also noted that ownership of the disputed securities remains with Merrill Lynch, leaving the firm free to resell them.

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