Fixing Soft Dollars Is Not That Hard: A Consent and Reporting Framework for Regulating Client Commission Arrangements

by Brendan Biffany

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Abstract

Under soft dollar arrangements, investment advisers promise portfolio trades to participating brokers in exchange for investment research or other benefits. Recently, some academics, financial regulators, and practitioners have scrutinized such arrangements, arguing that they provide an avenue for advisers to unjustly enrich themselves at the expense of their clients. However, others defend soft dollar arrangements, seeing them as a mechanism for binding advisers to clients and increasing client returns.

A safe harbor currently protects advisers’ use of soft dollars, so long as certain minimum requirements are met. Critics argue that soft dollars should be banned outright, contending that advisers should be required to pay for all investment research and advisory benefits out of their own pocket rather than by using clients’ commissions. Supporters recommend maintaining the status quo, arguing that the safe harbor promotes access to diverse research that, ultimately, benefits clients.

This Note analyzes the benefits and drawbacks of soft dollar arrangements, the original rationales for the development of the soft dollar safe harbor, and the agency costs and conflicts of interest inherent in maintaining the safe harbor. This Note advocates a middle ground between maintaining the status quo and banning soft dollars outright: a consent and reporting framework for the use of soft dollars that is consistent with general principles of agency and the fiduciary duties that advisers owe their clients.

Fixing Soft Dollars Is Not That Hard: A Consent and Reporting Framework for Regulating Client Commission Arrangements

by Brendan Biffany

Click here for a PDF file of this article

Abstract

Under soft dollar arrangements, investment advisers promise portfolio trades to participating brokers in exchange for investment research or other benefits. Recently, some academics, financial regulators, and practitioners have scrutinized such arrangements, arguing that they provide an avenue for advisers to unjustly enrich themselves at the expense of their clients. However, others defend soft dollar arrangements, seeing them as a mechanism for binding advisers to clients and increasing client returns.

A safe harbor currently protects advisers’ use of soft dollars, so long as certain minimum requirements are met. Critics argue that soft dollars should be banned outright, contending that advisers should be required to pay for all investment research and advisory benefits out of their own pocket rather than by using clients’ commissions. Supporters recommend maintaining the status quo, arguing that the safe harbor promotes access to diverse research that, ultimately, benefits clients.

This Note analyzes the benefits and drawbacks of soft dollar arrangements, the original rationales for the development of the soft dollar safe harbor, and the agency costs and conflicts of interest inherent in maintaining the safe harbor. This Note advocates a middle ground between maintaining the status quo and banning soft dollars outright: a consent and reporting framework for the use of soft dollars that is consistent with general principles of agency and the fiduciary duties that advisers owe their clients.