A recent FINRA arbitration ruling has cast new light on the risks of recommending private-equity feeder funds to retail clients. Merrill Lynch has been ordered to pay nearly $3.7 million in damages to two clients who alleged they were misled about the performance and structure of private-equity investments tied to major sponsors such as Apollo, Blackstone, and KKR.
The case underscores a growing concern for wealth advisors and RIAs looking to incorporate private equity into client portfolios: transparency and suitability remain paramount, particularly as demand for alternatives rises among high-net-worth households seeking diversification.
The award, handed down by a FINRA arbitration panel in Los Angeles, directs Merrill Lynch to repurchase feeder fund securities worth $2.73 million from clients Haihui Zhang and Qun He. Additionally, Merrill must pay $954,000 in legal fees. The arbitration stemmed from a November 2023 complaint alleging that Zhang and He were misled by their former advisor, Chelsea Deng, into allocating capital to private equity feeder vehicles that substantially underperformed expectations.
While Deng was not named as a respondent in the arbitration, she is central to the case. She had recommended the clients invest in Merrill-administered feeder funds linked to portfolios managed by prominent private equity firms. Deng, now registered with Morgan Stanley, denies the allegations. According to her BrokerCheck record, Deng maintains that the investments were appropriate and generated positive returns aligned with expectations.
However, the clients’ counsel, Michael Bixby, paints a different picture. He argues that the feeder funds returned less than 3% annually over a 10-year period—far below the 15% to 20% annualized returns the clients claim were initially represented to them. “The investments were described as outperformers with above-market return potential,” Bixby says. “But what they got instead was a high-cost, low-return product.”
One of the key points raised in arbitration was the impact of embedded, multi-layered fees. According to Bixby, the combination of Merrill’s administrative fees and the private equity firms’ management and performance charges reduced overall returns significantly. In some years, total fees exceeded 5%, he says. “These products were effectively designed to benefit the distribution and sponsor layers at the expense of the end client,” he adds.
In their complaint, Zhang and He asserted that a more suitable investment allocation over the same period would have resulted in $3.5 million in gains—highlighting what they saw as a material opportunity cost from the private equity feeder strategy.
“This was not just about miscommunication,” Bixby says. “It was about how these products are built—and how difficult it is for a typical investor to penetrate the actual fee structures, liquidity risks, and true performance assumptions.”
The panel did not offer an explanation for its ruling, consistent with standard FINRA arbitration procedures, but the outcome reinforces a message that many fiduciary advisors already take seriously: private equity products, especially feeder structures, come with substantial complexity and often misaligned incentives.
The case also arrives at a time of heightened scrutiny of private equity’s expansion into the retail space. Fund sponsors are actively pushing to lower the barriers to entry, including lobbying for the inclusion of private assets in 401(k) plans and promoting tokenized, tradable versions of private fund interests. Meanwhile, evergreen fund structures with lower minimums—sometimes as low as $5,000—are gaining traction in an effort to attract mass affluent investors.
But with that democratization comes added responsibility, Bixby warns. “These products are being sold to people who don’t have the resources or expertise to vet them,” he says. “They’re often presented as diversified, high-return, low-volatility investments—but the liquidity terms alone should give most advisors pause.”
One issue Bixby highlighted in the arbitration is the lack of sufficient disclosure on liquidity terms and duration. “Feeder funds can lock clients in for 10 to 15 years,” he says. “Even when disclosure documents exist, they’re often so dense and jargon-filled that clients don’t actually grasp what they’re agreeing to.”
Although the SEC has not weighed in on this particular arbitration case, it has shown increasing interest in the growing retailization of private markets. In June, the SEC’s Office of the Investor Advocate announced a year-long study examining whether the inclusion of private equity in retirement accounts serves the public interest. That effort is likely to include a closer look at how products are marketed and whether disclosures meet the standard expected for long-dated, illiquid investments.
For wealth advisors and RIAs considering private equity exposure for clients, the Merrill ruling offers a cautionary tale. While access to institutional-quality managers may sound appealing, the delivery mechanism—particularly feeder structures—can introduce additional friction, costs, and fiduciary risk.
“There is a major disconnect between how these products are being pitched and how they actually behave,” Bixby says. “This case is a clear reminder that if you can’t explain the risks and fees plainly to your client, you probably shouldn’t be recommending it.”
The advisor at the center of the dispute, Deng, remains registered with Morgan Stanley. She maintains that the investments were in line with her clients’ risk profiles and that any claims of losses or unsuitability are unfounded. Merrill Lynch, for its part, declined to comment on the arbitration ruling.
While the award is final and binding, it is also non-precedential. Still, the outcome is expected to resonate throughout the industry, especially among firms accelerating their push into private alternatives for accredited investors.
As interest in private equity continues to grow, the challenge for fiduciary advisors will be to strike a balance between innovation and accountability. Understanding the true economics behind feeder fund structures—and communicating that clearly to clients—will be essential.
“This wasn’t a case of a market turning against the investor,” Bixby concludes. “It was a case of the investor never having a fair shot in the first place.”
