SEC Inspection Report on the Soft Dollar Practices

Soft Dollar Arrangements are agreements between broker-dealers and their clients where the broker-dealer provides, in addition to other services, research to the client, in addition to execution services. The research, which includes reports, access to analysts, or third party reports is provided to the client by the broker-dealer at the broker-dealer’s cost, and part of the execution fees paid by the client are allocated to the research component of the services.

The federal securities laws permit the practice, there are inherent conflicts. In effect, the client, which is typically an investment advisor or hedge fund, is using its clients funds, labeled commissions, to purchase research. In one view of the practice, the advisor is using his client’s money, through commissions, to benefit itself by purchasing research. Add to the mix the potential for inferior executions by the broker-dealer in order to “compensate” itself for the cost of the research, and there is potential for harm to the ultimate investor, the advisor’s clients.

The practice is permitted by Section 28(e) of the Securities Exchange Act of 1934 (“Exchange Act”) which created a safe harbor to protect advisers from claims that they had breached their fiduciary duties by causing clients to pay more than the lowest available commission rates in exchange for research and execution. The Section requires advisers to disclose soft dollar arrangements to their clients. The SEC estimates that the total value of third party research purchased annually with soft dollars exceeds $1 billion.

The SEC regularily monitors soft dollar arrangements during its inspections of broker-dealers and investment advisors, but there is a perception by some that the use of soft dollars is either inherently abusive or beneficial to clients. Because of the wide spread use of soft dollar arrangements, and the diverse perceptions regarding the practice, the SEC conducted an inspection to gather information about the current uses of soft dollars, conducting on-site reviews of 75 broker-dealers and 280 investment advisers and investment companies from November 1996 through April 1997.

The SEC found that while most of the products purchased with soft dollars were research products, it also found that a significant number of broker-dealers (35%) and advisers (28%) provided and received non-research products and services in soft dollar arrangements, and that virtually all of the advisors had failed to adequately notify their clients of the practice. This is significant, since not only does the lack of adequate disclosure violate the advisor’s fiduciary duty to its clients, it may also constitute a violation of the federal securities laws, subjecting the advisor, the broker dealer, and the individuals involved to sanctions.

The SEC also expressed its concern regarding the disclosures made by firms involved in pure research soft dollar arrangements, finding that many firms were simply using boilerplate disclosure phrases which did not adequately address the relationships, and the ultimate impact on investors.

The Report itself is an excellent overview of the SEC’s view of the scope of soft dollar arrangements, and the disclosures required by advisors and broker-dealers who make use of such arrangements. The report is available at the SEC’s web site, at

– Mark J. Astarita, Esq.

Securities Attorney at Sallah Astarita & Cox | 212-509-6544 | | Website | + posts

Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.

He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page -, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.