Thoughts About Soft Dollars

Brokerage commissions are not paid by the fiduciary managing funds; they are debited directly from funds’ assets when trades settle.  The advisor directs each transaction to the broker/dealer of his choice, and the fund holder pays a commission that bundles brokerage and research fees together into a per-share rate.  Just as there is no statutory definition of “hedge fund”, there isn’t one for “soft-dollars”.  A common definition is that it is the difference between the commission rate paid by the fund and the lowest rate available for a specific transaction.

Regulators’ Position
Section 28e of the 1975 Amendments to the Securities Act (28e) provides a safe harbor for a fiduciary to pay more than the minimum commission rate available if it is:
determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided…”

In 2005 Fidelity Investments wound down the practice of paying dealer bundled commissions based on the observation that if they did not know how much they were paying for brokerage services vs. research,  they could not determine in good faith whether or not the fee was reasonable.

Past interpretations of 28e expressed skepticism that “market data” qualifies as research.  

One can argue that vendors like Bloomberg and Thomson Reuters that produce analytics and proprietary news are much closer to “research” than it is to “market data”.  Columnists, financial models, relative value & comparative analytics, portfolio risk reports are all examples of services that, if provided by a broker, would certainly be categorized as research.   

It should be easy for a fiduciary to determine in good faith whether or not $n per month for an analytics and news package is reasonable.  ECNs charge explicit rates for brokerage services.   Are these services excluded from being classified as research because we charge an explicit fee?

The SEC should issue interpretive guidance that:
A) Refines the definition of “research” to include a description of the Professional Service.
B) Emphasizes safe harbor protection for fiduciaries who unbundle services paid for with soft dollars.