Brokerage generically refers to commission expenses or fees generated by the execution of a trade; this expense belongs to the client and not the investment firm.
Broker entities typically offer other services beyond trade execution, such as research.
A soft dollar transaction takes place when the investment management firm uses client generated commissions instead of firm cash to purchase services from a broker.
In general, soft dollar arrangements are allowable, so long as the services purchased with client commissions are used by the investment manager to support investment decision-making.
CFAI Soft Dollar Standards are voluntary. However, for a firm to claim compliance, it must minimally adhere to certain mandatory practices and is encouraged to follow certain additional recommended practices.
The standards intend to facilitate: full and fair disclosure to clients by investment firms, consistency in presentation so stakeholders can understand firm brokerage practices, standard disclosure and record keeping, and an industry model for ethical brokerage use by investment firms.
An investment firm seeking to publicly claim compliance must define services purchased with brokerage, confirm that these services are used in the investment decision making process, and isolate mixed use products.
Analyzing Soft Dollar Transactions
Level 1 – Ask, is the product truly research?
Level 2 – Is the primary use of the research product to support the investment decision making process?
Is 100% of the research product’s use involved in the investment decision making process?
Example - Elaborating on mixed-use products. Say a firm wants to acquire a software package that will be used 50% of the time to perform research for 50% of the time for access to clients and prospects for the purpose of attracting and retaining business, then the firm must pay for half of the software out of its own cash and can only use soft dollars to cover 50% of the expense.
