Conflict within Commission on Soft Dollars


New York, NY – This past week the SEC voted unanimously to issue guidance to mutual fund directors on what type of oversight boards should provide on soft-dollar arrangements used by a fund’s advisers.  The release of the proposed guidelines will be followed by a public comment period which ends on October 1st.  Besides the actual guidance provided, we were also interested in the fact that comments by senior SEC members revealed that a deep conflict currently exists within the commission over this topic.

Changing the Balance?

In comments regarding this guidance, SEC Chairman Christopher Cox noted that some fund boards might opt to instruct their advisers to eliminate the use of soft dollars altogether.  He also suggested that the forthcoming guidance might “change the balance between board and adviser”.  These comments are consistent with the Chairman’s comments in the past suggesting that soft dollars should be banned altogether. 

However, Andrew Donahue, the director of the SEC’s Division of Investment Management explained that the purpose of this guidance would be to “promote a dialogue on best execution” – rather than focus on soft dollars in isolation.  Donahue also disagreed with Chairman Cox’s characterization that the coming guidance would change the balance between board and adviser.

Purpose of the Guidance

Despite the obvious conflicts, what everyone does agree on is that mutual fund directors are being overwhelmed by the sheer volume of transaction data, and they need help and directions on how to better handle this deluge.  The SEC’s guidance is meant to recommend information that mutual fund boards should request from advisers instead of trying to monitor each trade.  This information is likely to include how advisers are using client commission dollars to pay for execution and research services.

Integrity’s Take

It is clear to us that Chairman Cox is continuing to wage his own personal war on that “witches brew” called soft dollars.  However, it is also clear that few others are willing to jump on his bandwagon due to the severe consequences that eliminating soft dollars could have on the entire financial services industry.

What Chairman Cox seems to surprisingly miss is that soft dollars are not merely the $1.0 billion in commissions that money managers “pay up” for third-party services.  Instead, soft dollars are the $5 to $6 billion in client commission dollars that is currently being spent over and above the lowest cost of execution for both sell-side and independent research.  This distinction was made clear by the Commission in their 2006 Interpretive Guidance.

“Section 28(e) applies equally to arrangements involving client commissions paid to full service broker-dealers that provide brokerage and research services directly to money managers, and to third-party research arrangements where the research services and products are developed by third parties and provided by a broker-dealer that participates in effecting the transaction. Today, it remains true that, if the conditions of the safe harbor of Section 28(e) are met, a money manager does not breach his fiduciary duties solely on the basis that he uses client commissions to pay a broker-dealer more than the lowest available commission rate for a bundle of products and services provided by the broker-dealer (i.e., anything more than “pure execution”).”

Consequently, the elimination of “soft dollars” would mean that investment advisers would be forced to pay for all sell-side and independent research out of their own pockets.  We suspect this would cause buy-side investors to slash a significant amount of what they currently spend on external research – a move that would obviously cause tremendous pain for sell-side and independent research providers.  In addition, we think that money managers, faced with higher research expenses, would probably raise fees to investors.  And these consequences don’t include the cost of lower investment returns caused by more limited research.

Fortunately, many others in the industry, including senior staffers at the SEC, and the lobby for the money management and the broker-dealer communities, all get the joke. As a result, we expect they all will continue to fight off Chairman Cox’s efforts to ban soft dollars.


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  1. Bill George on

    In the early 1970’s in an effort to foster competition the U.S. Government attempted to end “price fixing” in several industries. The government soon noticed that the U.S securities exchanges and the exchange member firms had a long history of collusion to “fix” brokerage commissions at artificially high rates. The government mandated that as of May 1st 1975 all brokerage commissions must be “fully-negotiated”.

    As May 1st 1975 approached the brokerage industry and its lobbyists worked hard to get an exemption from the mandated fully-negotiated brokerage commissions. The brokerage industry and its lobbyists argued that fixed price commissions enabled the industry to offer valuable additional services, such as investment research, to clients.

    Within weeks after May 1, 1975 the U.S. Congress favored the brokerage industry and its lobbyists’ argument (conditionally) by passing an amendment to The Securities Exchange Act of 1934. This amendment is known as Section 28(e). Section 28(e) offers a limited safe harbor for investment advisors to “pay-up” from their fully-negotiated execution only commission rate, and in exchange for the paid-up commissions receive investment research from brokers. Congress gave the responsibility of interpretation and enforcement of Section 28(e) to the U.S. Securities and Exchange Commission.

    Soon after Section 28(e) was passed the term “soft dollars” became the term-of-art used to describe the excess commissions paid-up above the advisor’s fully-negotiated execution-only brokerage commission rate. And over time (and with a seemingly intense public relations effort by the full-service brokerage industry) the term soft dollars has misinterpreted to relate exclusively to commissions paid-up and used to purchase investment research produced by independent research providers.

    In the context of current discussions, and the context of SEC’s proposed interpretive guidance for 1940 Act directors and fund boards it seems important that the original intent of Section 28(e) and the accurate history of the term “soft dollars” be very carefully reviewed.

    It might also be important for regulators and fund directors to realize that:

    (1) Prior to May 1, 1975 there was almost no third-party (independent) research available. After May 1st 1975 and the passage of Section 28(e) independent research could effectively compete with brokerage firms “free” proprietary research because under section 28(e) execution-only boutique brokers could be used to pay independent research providers.
    (2) Full-service brokers have no motivation to distribute independent research or give independent research credibility; because truly independent (unbiased) research cannot be trusted to consistently fulfill the sales and marketing objectives of the full-service brokerage industry.
    (3) Independent research can provide an objective alternative to the sometimes conflicted and self-serving motivations of full-service and investment banking brokerage firms’ proprietary investment research.

  2. Bill George on

    Bill George
    Encino, CA 91426
    August 8, 2008

    Securities and Exchange Commission
    100 F Street, NE
    Washington, DC 20549-1090

    Subject: File No. S7-22-08 (Proposed Soft Dollar Guidance for Fund Directors)

    Dear Securities and Exchange Commission:

    During the July 12, 2006 Open Meeting at which Commission Guidance Regarding Client Commission Practices Under Section 28(e) of The Securities Exchange Act of 1934 was passed, the content of The Guidance and the comments made by the chairman, commissioners and some staff members about The Guidance and about the future of soft dollar regulation led many institutional investment professionals to believe the SEC intended to soon release interpretive guidance on disclosure and transparency in all institutional brokerage arrangements. Furthermore, The Guidance and the comments in this open meeting also led to the general belief that the SEC planned, in the future, to monitor and regulate soft dollars generated in bundled undisclosed brokerage arrangements, and ostensibly used to purchase brokers’ proprietary research, with the same regulatory fervor it has applied to soft dollars generated from third-party brokerage arrangements and used to purchase fully-disclosed independently produced investment research [in compliance with Section 28(e)]. Nothing the SEC has done since July 12, 2006 seems to contribute to the goals of brokerage commission disclosure and transparency, or the equal regulatory treatment of soft dollars generated in bundled undisclosed brokerage arrangements – as compared to the regulatory treatment of third-party soft dollar arrangements.

    Also, I am concerned that I continually hear very senior SEC officials state that, in recent years, soft dollar brokerage totals approximately 1 billion dollars per year, when, in fact, annual soft dollar brokerage currently costs institutional advisors’ clients closer to 10 billion dollars per year. It seems the SEC and the public can only truly appreciate the negative effect, and the magnitude of loss of account owners’ potential long term compounded investment returns, if the true magnitude of soft dollar brokerage is revealed. A careful re-reading of Section 28(e) of the Securities Exchange Act of 1934 and the SEC’s interpretation and definition of soft dollar brokerage should help to reveal a misinterpretation that has led some to significantly underestimate the true magnitude of soft dollar brokerage.

    See, Speech By SEC Chairman: Opening Statements at the Commission Open Meeting by Chairman Cox – July 12, 2006 (First Item: Soft Dollar Interpretive Release) at > and access the video record of the July 12, 2006 SEC Sunshine Meeting at >
    See, Statement on Soft Dollar Interpretation by SEC Commissioner Roel Campos July 12, 2006 at>
    See, Section 28(e) of the Securities Exchange Act of 1934, pages 235 to 238 at >
    See, Inspection Report On The Soft Dollar Practices of Broker Dealers, Investment Advisors and Mutual Funds, published September 22, 1998 Item II. A. Soft Dollars Defined at >

    Public Comment on File No. S7-22-08 by Bill George
    August 8, 2008
    Page 2

    It seems full-service brokers, investment advisors, and investment consultants are motivated to misinterpret and under report their uses of clients’ brokerage commissions paid-up above the fully-negotiated costs of execution-only brokerage. In their public announcements these investment professionals neglect to report soft dollars generated in bundled undisclosed full-service brokerage arrangements. And it seems many high level officials at the SEC use these reported figures, without question. The only senior level official at the SEC who seems to understand this issue is Lori Richards, Director of the SEC’s Office of Compliance, Inspections, and Examinations. Ms. Richards has been quoted to say:

    Many advisers do not take into account the research they receive from affiliated broker-dealers, when asked to report on their use of soft dollars. One very common misperception among investment advisers is that when they obtain research from a proprietary broker-dealer, they don’t consider that to be a soft-dollar transaction. That’s a misunderstanding. If they are acquiring research with client commission dollars, they’re engaged in a soft-dollar transaction.

    On page 14 of the proposed guidance many of the explicit costs of brokerage execution are itemized. Based upon the state of the brokerage industry in 1975 and the government’s mandate that all brokerage commissions be fully-negotiated after May 1, 1975, it seems very reasonable to conclude that the U.S. Congress’ intention, as expressed in Section 28(e), was that these explicit costs of execution would be fully-negotiated and that under the safe harbor of Section 28(e) certain qualifying investment research could be purchased with clients’ commissions “paid-up” above the advisors’ “fully-negotiated costs of brokerage execution”. It seems highly unlikely that Congress intended the amounts of commissions “paid-up” not to be disclosed, or to be obscured in bundles of unidentified and subjectively valued brokerage services.

    This proposed guidance also mentions how competition, technology, advanced processes and new trading venues have continued to reduce the costs of brokerage execution. This is undeniably true. Trading cost studies I have recently seen show that the explicit costs of institutional brokerage execution are in the range of ½ to ¾ of a cent per share. While at present institutional advisors are paying 4 to 4.5 cents per share (of their clients’ money) in brokerage commissions. It seems the single most helpful thing the SEC could do to enable fund boards and fund directors to properly discharge their fiduciary responsibilities would be to mandate the identification and pricing of the services investment advisors’ receive in these soft dollar brokerage arrangements.

    Thank you,

    Bill George

    See, InvestmentNews article, Advisors Misreport Use of Soft Dollars by Sara Hansard published July 24, 2006 at >
    See, article titled, The Seven Deadly Sins of 401K Plans Fifth Deadly Sin Excessive Fees – Disclosed and Hidden – published 9/22/2003 at >

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