The SEC’s Enduring Rulemaking Masterpiece: The Argument for Soft Dollars in the US


The following guest article was written by Allan Goldstein, CEO Euronext Market Services, Managing Director Commcise Software, a leading technology provider for investment managers, investment research providers and broker dealers supporting optimization of investment research funding and investment research evaluation.

The SEC’s SIFMA No-Action letter will expire next month. Re-bundling is a hot topic in the UK and EU. Globally, there is increased focus on research funding reflecting on matters such as the impact of MiFID II unbundling on the availability of investment research, and the bundled research construct that remains intact in the US, Asia and Canada.

As the SEC’s William Birdthistle said in his comments last summer, the “No Action” letter “was not intended to be a permanent solution to the issue.”  SEC Chair Gary Gensler commented just last week that not extending relief “would result in permanently foisting a foreign law, soon to be dramatically changed, on the US market”. In the original 2017 letter, the SEC commented that staff would “monitor and assess the impact of MiFID II’s requirements on the research marketplace and affected participants in order to ascertain whether more tailored or different action, including rule making, is necessary and appropriate in the public interest.” Finally, in its comments when issuing the 2019 extension, the SEC notes that the extension “will allow additional time for market-based solutions with respect to payments for research in the US and Europe to evolve further, and for greater transparency regarding research payments and practices to develop.”

Market-based solutions have indeed evolved and transparency has developed. The letters also mentioned that the extension would allow further evaluation by authorities in the EU of the effects of MiFID II. In December 2022, the European Commission commented that unbundled research has failed to achieve all of its objectives, and commented that “unbundling rules might have impaired the overall availability of research”.

It seems clear that in the end, the SEC is quite comfortable with the long-standing soft dollar construct that exists in the US, and for good reason. There is no lack of regulatory guardrails requiring investment managers to act solely in the best interest of their clients. Finally, there is no lack of competition for investment assets, which by nature, the free market is designed to weed out those managers not fully committed to eliminating conflicts of interest and elevate those who are committed to transparency.

The Investment Advisers Act of 1940 and its interpretive releases stipulate an adviser’s fiduciary obligation to its clients, a duty of care and loyalty intended to eliminate or illuminate all conflicts of interest. Simply put, advisers must act solely for the benefit of the client in all matters connected with the relationship. Does the use of soft dollars inherently violate this duty? Is unbundling by decree a solution in search of an actual inducement problem? Some argue that bundling execution and commission dollars directly and implicitly impacts an adviser’s ability to carry out its obligations of best execution. In fact, the soft dollar construct was deliberately and thoughtfully designed to enable and encourage optimal order routing without consideration of inducement.

The Birth of Soft Dollars 

May 1, 1975 (“May Day”) marked the end of fixed execution commissions at the New York Stock Exchange, ushering in the birth of discount brokers and establishment of brokerage branding as household names (think “Merrill Lynch”). But one lingering nugget of gold since then remains the establishment of Section 28(e) of the Securities and Exchange Act of 1934.

In this new era of competitive commission rates, “full service” brokers kept their commissions higher than the lowest rates available, with the argument that they offered bundled services, execution and research. Advisers however found themselves at risk of violating their fiduciary duty by not paying the lowest available commission rates.  The SEC responded with Section 28(e) of the Securities and Exchange Act of 1934. Advisors needed assurance that if the paid a commission higher than the lowest competitive market rate in return for a package of services beyond execution, they would not be considered breaching their fiduciary duty. It also allowed brokers to compete on service, not just price. Bundling research and execution took center stage. 

28(e) was designed as a safe harbor, not a set of rules. Under 28(e), an adviser could not be viewed as breaching its fiduciary duty if it paid a higher commission rate than the lowest available, so long as it “determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided”. 

Best Execution 

The SEC is currently and contentiously proposing an overhaul to existing best execution regulations for brokers. This is not relevant to our discussion here, which is focused on whether or not an adviser is induced to direct its orders based on something other than trying to achieve the best quality execution outcome from its brokers. The SEC’s proposal and FINRA’s existing Rule 5310 govern in great detail a broker dealer’s obligation of best execution. Brokers who actively engage in a trading function are examined frequently and their practices are highly scrutinized.

However, advisers in the US are not regulated by FINRA but by the SEC. So what are advisers’ obligations under the Investment Advisers Act of 1940? Further, what does quality of execution mean? It is not simply about the “best price”. The SEC’s formal guidance is that advisers “must execute securities transactions for clients in such a manner that the client’s total cost or proceeds in each transaction is the most favorable under the circumstances“, a highly subjective directive given the complex facts and circumstances of each transaction. The SEC understands this, which is why it also guides that optimizing a client’s cost or proceeds should include not only a broker’s execution capability but the “full range” of its services, including, but not limited to, commission rates, research capabilities, and responsiveness. Most importantly, an adviser must have a procedure to periodically review the execution performance of all brokers executing the adviser’s transactions. 

So, if an adviser uses soft dollars, does this inherently create a conflict with its fiduciary duty and its obligation to execute transactions most favorably, such that its clients’ total cost or proceeds in each transaction is most favorable under the circumstances? 28(e) will guide us to the answer, but first there is one more historical point of reference to look at: the SEC’s 28(e) 2006 interpretation, and the SEC as the primary regulator of investment advisers.  

As discussed above, 28(e) originally provided an important construct for advisers in carrying out their fiduciary obligations, but a much more consequential move by the SEC came in 2006 when it released a formal interpretation after significant industry feedback and collaboration. The 2006 interpretation helped define in great detail what is considered as eligible brokerage and research and, of particular importance, asserted an obligation to affirmatively determine if the amount of client commissions paid is reasonable in light of the value of products and services provided by the broker. Secondly, it considered and provided very clear guidance on arrangements made among advisers and brokers in carrying out the provision of brokerage and research in exchange for soft dollars. It is this specific guidance in the 2006 release that in fact provides the comprehensive regulatory construct allowing best execution and soft dollars to co-exist harmoniously. 

Under the discussion of arrangements, the SEC detailed two important concepts, effecting and provided by. With this distinction, the SEC essentially created a segregation of execution expertise and research quality. This allowed an adviser to direct trades to one broker for execution, but use commissions on that trade to pay for research from another provider. The ‘effecting’ guidance defined exactly what it meant to execute a trade, allowing brokers to divide the four pillars it defined under a commission-sharing agreement. It then provided three pillars under which a broker effecting a trade could provide research services using a portion of commissions (soft dollars) to pay a third party. 

The brilliance of 28(e) is underappreciated. It allows a highly detailed guided methodology under which advisers can receive a “full range” of services from brokers without compromising best execution. Very simply, an adviser can choose a broker with a singular focus on delivering execution quality (i.e., the best price), pay a bundled or full-service commission, and use the excess to pay a third-party provider for research. The methodology used to allocate value to each of the execution and research services is highly subjective from one adviser to another and is partially driven by competitive forces. Therefore, a thoughtful and documented procedure for doing so is required. 

Commission Consolidation or Aggregation 

A unique outcome of the 2006 28(e) interpretation is the emergence of soft dollar consolidation. The compliance burden of the 28(e) “provided by” guidance is considerable for most executing brokers, as is the operational overhead of onboarding third-party vendors and processing payments from soft dollar pools. Therefore, any broker that wants to compete as an agency broker has to build the capacity to manage this. Additionally, because the 2006 interpretation defined what is required to “effect” a trade, commission-sharing agreements provide a mechanism for some brokers to build a dedicated capacity with scale to consolidate or pool the excess research commissions an adviser accrues across all its brokers, and provide a single point of reconciliation and processing for third-party research payments from this single pool. 

Aggregators (among whom, Commcise and Euronext now compete) play a vital role in facilitating the efficient functioning of research funding and payments in the US, Asia and Canada. As data and technology proliferate in trading, and as investors demand accountability for commission spending, the ability to leverage technology for precision and transparency in managing the commission wallet is essential and available. Where once a monthly spreadsheet email dump of soft dollar trades was adequate to determine and agree on research credit balances, today, daily trade-by-trade reconciliation helps capture every eligible soft dollar and facilitates budget tracking more accurately. 


Existing regulation in the US requires advisers to comply with a fiduciary duty of care and loyalty, and a standard of best execution. The regulation effectively provides a highly detailed construct that advisers must follow to prove their compliance. Section 28(e) and the 2006 interpretive release skillfully provide the contours for segregating optimal execution and research choices while funding both with commissions to secure the best outcome for the investor.

By some counts, there are over 15,000 SEC registered investment advisers (RIAs) in the US. Do many of them fail in their obligations to investors? Is this a result of inadequate regulations? The SEC does not have the capacity to maintain the connection with its advisers that FINRA has with its registrants. In 2022, an SEC report suggested only 15% of RIAs were examined. Anecdotally one hears of advisers not speaking to a regulator over a ten-year span. In contrast, each of the 3,400 broker dealers registered with FINRA is examined on a cycle varying from annually to once in four years, with those posing the highest risk on an annual cycle.

Could additional disclosure and enforcement for advisers help? Yes indeed; but an appreciation of the robustness of US regulation, particularly Section 28(e) in light of the non-renewal of the SEC’s “SIFMA “No Action” letter and MiFID II unbundling reforms is long past due.


About Author

Mike Mayhew is one of the leading experts on the investment research industry. In addition to founding Integrity Research, Mike is on the board of directors of Investorside Research Association, the non-profit trade association for the independent research industry, and a frequent speaker on research industry trends and developments. Mike has over thirty years of research industry experience. Email:

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