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This episode aired on BloombergTV on Jul 27, 2012

Soft Dollars

Soft dollars are benefits brokers provide money managers who bring them good business. They are a reward brokers dole out to loyal customers, and often take the form of research, but can include software or infrastructure as well. While soft dollars are allowed by the SEC, the regulation surounding them have been tightening since the ’70s, and soft dollar benefits must be disclosed on the form ADV.

Q. So, much to my disappointment, this is not a FX term at all, is it? No relation to “weak dollar”?

A. No relation. “Soft dollars” refers to a kind of frequent flyer program that brokers offer to money managers. In exchange for business, brokers often provide benefits back to the money manager without cash compensation. Of course the reason is that they’re making great money on the brokerage commissions and want to keep the manager as a client. So the expression is that those benefits are “soft dollared” back to the money manager. The opposite is that the money manager pays cash for the benefits, which are called “hard dollars”.

Q. So you mean that the broker is effectively rebating some of its commissions to the asset manager in the form of benefits? These are benefits the asset manager would otherwise have to pay real cash for?

A. Right. The most common soft dollar arrangements relate to research. The brokerage house may create its own proprietary research for use only by its clients, and the investors in the fund supposedly benefit as a result. But the broker might also offer software, infrastructure, or even conference attendance for soft dollars.

Q. But nothing’s really free, right? Maybe the manager is paying more than the bear minimum in brokerage commissions to get those soft dollar benefits.

A. Exactly right. Indeed, that’s the explicit understanding. Investors in the fund are really paying for the soft dollar benefits. In fact, there’s a term for brokers who don’t offer soft dollar arrangements; they’re called “execution only” brokers.

Q. Does the SEC limit these sorts of practices?

A. Yes. Soft dollar deals have been allowed ever since fixed commissions were eliminated back in the 70s, but the rules have gotten progressively tighter. The important thing for investors to know is that money managers, from mutual fund managers to hedge fund managers, have to disclose their soft dollar arrangements on a form, called an ADV. And that form is available to current and prospective investors… you can see, essentially, how much more than bear minimum the fund is paying to brokers, and what it’s getting back as part of its soft dollar deal.