Soft dollar compensation
Also known as: soft dollars, soft dollar arrangement
Soft dollar compensation is research, analysis, and other services an investment adviser receives from a broker-dealer in exchange for directing client trades to that firm, rather than paying for those services in cash.
Soft dollar compensation is a non-cash arrangement between an investment adviser and a broker-dealer. Instead of paying cash ("hard dollars") for research and brokerage services, the adviser directs client trades — and the commissions those trades generate — to the broker-dealer, which provides research and related services in return.
For example, an adviser might route its clients' equity trades to a broker-dealer that supplies the adviser with research reports, analytical software, and market data. The clients' commissions effectively pay for services the adviser would otherwise buy itself — which is why soft dollars create a potential conflict of interest.
Regulators permit soft dollar arrangements within a safe harbor under Section 28(e) of the Securities Exchange Act of 1934, but only for services that benefit clients through improved investment decision-making. Eligible items include research reports, analytical software, and seminar or conference registration. Ineligible items include office rent, employee salaries, travel and entertainment, and computer hardware — these benefit the adviser, not the client. Advisers must also disclose soft dollar practices to clients and cannot sacrifice best execution just to collect soft dollar benefits.
The Series 63, Series 65, and Series 66 exams all test soft dollar compensation as an ethics topic. Expect questions asking you to sort eligible from ineligible services under the safe harbor and to identify the disclosure obligations that come with these arrangements.
Key takeaways
- Soft dollars are research and brokerage services an adviser receives in exchange for directing client trades to a broker-dealer, instead of paying cash.
- The Section 28(e) safe harbor permits soft dollar benefits that aid investment decision-making, such as research reports and analytical software.
- Rent, salaries, travel, entertainment, and hardware fall outside the safe harbor because they benefit the adviser rather than clients.
- Advisers must disclose soft dollar arrangements and still seek best execution for client trades.
- The Series 63, 65, and 66 exams test which services qualify under the safe harbor.