Section 28(e) Safe Harbor: Conditions, Research, and Brokerage

The Section 28(e) safe harbor is a provision of the Securities Exchange Act of 1934 that lets an investment manager pay a broker-dealer more than the lowest available commission without being treated as having breached fiduciary duty, so long as the extra commission buys qualifying research or brokerage services and the manager makes a good-faith judgment that the price is reasonable for what the client accounts receive.¹ The protection is narrow. It answers one specific claim, leaves every other fiduciary duty in place, and evaporates the moment any of its conditions fail.

The Three Conditions You Have to Meet

Three requirements have to be satisfied together. Miss one and the safe harbor is gone, which exposes the manager to fiduciary breach claims under both state and federal law.²

First, investment discretion. The manager must have authority to decide what securities are bought or sold for the account, usually through a written advisory agreement that lets the manager trade without prior client sign-off on each transaction. The statutory definition also reaches situations where someone actually makes investment decisions while another person holds the formal responsibility, or exercises enough influence over trades that the SEC treats the role as discretionary.¹

Second, the goods or services purchased with client commissions have to qualify as research or brokerage under the statute. Firm overhead cannot be routed through soft dollars no matter how useful it is to the business.²

Third, the manager must determine in good faith that the commission is reasonable relative to the value of the research and brokerage received. That judgment can be made trade by trade or across the manager’s overall responsibilities for all accounts.¹ It is not a one-time checkbox. Managers are expected to evaluate execution performance periodically and systematically, weighing execution capability, commission rates, financial responsibility, and responsiveness alongside the value of research provided.³ The question is whether the total package delivers the best qualitative execution for the client account, not whether the commission is the cheapest number available.

What Qualifies as Research

Research under Section 28(e) has to reflect the “expression of reasoning or knowledge” on the subject matter the statute identifies: advice on the value of securities, analysis of specific issuers or industries, and recommendations to buy or sell particular instruments.² The content must be substantive enough to help the manager select and monitor securities for client portfolios.

Analyst reports on specific companies, portfolio strategy recommendations, financial models, and quantitative analytics all qualify. Market data feeds delivering real-time pricing qualify when they carry the kind of analytical content that feeds investment decisions. Specialized financial newsletters and technical trade journals can qualify if they are marketed to a narrow professional audience. Mass-marketed publications for the general public, including newspapers and consumer magazines, cannot; those are overhead.⁴

Format is not the test. A technical journal on medical devices aimed at physicians and biotech analysts can qualify even when accessible online, because its marketing targets a specialized readership and its subscription cost is typically high. A general financial news site aimed at retail investors does not, whatever its delivery method.⁴

What Qualifies as Brokerage

Brokerage services cover functions tied to executing a trade, running from the moment the manager communicates the order to the point where securities or funds land in the account. Clearance, settlement, and custody in connection with executed trades are explicitly identified as eligible incidental brokerage services, and communication systems used to route orders directly to execution venues also qualify as functional components of the trading process.²

Which Trade Types Are Covered

The safe harbor originally applied only to agency transactions where the broker-dealer earns a disclosed commission. In 2001, the SEC expanded its interpretation to include certain riskless principal transactions in equity markets, where a dealer receives an order, buys or sells the security in a matching transaction, and charges a separately disclosed markup or markdown.⁵ The fee and the transaction price must be fully and separately disclosed on the trade confirmation, and the transaction must be reported under conditions providing independent price verification through self-regulatory organization oversight.

The expansion does not reach the debt markets. Riskless principal transactions in bonds are not currently subject to the confirmation and reporting requirements the SEC considers necessary for adequate price transparency, so they fall outside the safe harbor.⁵ Managers who trade heavily in fixed income cannot rely on Section 28(e) for those trades and have to pay for research separately.

What Soft Dollars Cannot Pay For

The SEC has been explicit. Office furniture, rent, utilities, accounting fees, website design, email software, internet service, legal expenses, personnel management costs, and marketing are firm overhead the manager pays from its own funds.² Staff salaries, including those of dedicated research analysts, are also ineligible.

Travel and entertainment get the same treatment. Meals at conferences, flights to meet corporate executives, and hotel costs for seminars where research might be discussed orally all sit outside the safe harbor.² The line is functional: if the expense keeps the business running rather than directly generating investment insight or executing trades, it belongs to the firm.

Mixed-Use Allocation

Most modern research platforms and software tools serve eligible and ineligible purposes at the same time. When a product has mixed uses, the manager has to split the cost by the share of value that comes from research or brokerage functions versus administrative or operational ones. Only the eligible portion can be paid with client commissions.¹

If a software package is used 60% for portfolio analysis and 40% for client billing, only the 60% share is eligible. The allocation has to be reasonable and well-documented. SEC examiners will ask for the documentation, and a sloppy or unjustifiable allocation can turn into a fiduciary breach.⁶ Document the methodology before you buy the product, not after the exam notice.

Computer hardware follows the same logic. If the hardware is dedicated exclusively to software used for investment research, its cost can be paid with client commissions. If the same machine handles bookkeeping, email, or other administrative tasks, only the research-attributable share qualifies.¹ Almost no computer is used exclusively for research, so hardware purchases almost always require a mixed-use allocation.

Commission Sharing Agreements

Commission Sharing Agreements (also called CSAs or Client Commission Arrangements) let a manager execute trades through one broker-dealer and use accumulated commission credits to pay a different firm for research. That unbundling lets the manager seek best execution from a strong trading desk while sourcing specialized research from an independent provider.⁴

Two statutory requirements have to be met for the arrangement to sit inside the safe harbor. The broker-dealer must be considered to be “effecting” the trade by performing at least one of four core functions: taking financial responsibility for customer trades until payment is received, maintaining required trade records, monitoring and responding to customer comments about the trading process, or generally monitoring trades and settlements.² And the research must be “provided by” the broker-dealer even if a third party created it, which requires the broker-dealer to pay the research provider directly, review service descriptions for red flags suggesting the content falls outside Section 28(e), and maintain procedures ensuring research payments are documented and paid promptly.⁴

Best Execution Still Applies

The safe harbor does not replace or weaken the duty to seek best execution. It answers one specific claim, that paying above the lowest commission rate is itself a breach. Every other fiduciary obligation stays fully in force, including the duty to execute trades so the client’s total cost or proceeds are the most favorable under the circumstances.¹

A manager who routes trades to a broker offering generous research credits but mediocre execution quality is not protected. Section 28(e) does not shield anyone from antifraud liability or from allegations of failing to seek the best price.¹ Evaluate broker-dealer execution performance regularly and systematically, not just when an examiner asks.

What You Have to Disclose

Form ADV Part 2A is the primary vehicle for soft dollar disclosures. Item 12 requires investment advisers to describe their brokerage practices in enough detail that clients can evaluate the conflicts these arrangements create.⁷

The disclosure has to describe the types of research products and services obtained with client commissions during the last fiscal year with enough specificity that clients understand the conflicts involved. A vague reference to “various research reports and products” does not meet the standard.³ Several specific points have to be covered:

The conflict itself: receiving soft dollar benefits creates an incentive to pick broker-dealers based on research offered rather than on the client’s interest in best execution.⁸
Paying up: if the manager may cause clients to pay commissions higher than those available from other brokers, the disclosure has to say so explicitly.⁸
Account allocation: the disclosure has to state whether soft dollar benefits serve all client accounts or only those whose commissions generated the credits.⁸
Directed brokerage: if the manager routinely recommends or requires clients to direct trades through a specified broker, the disclosure has to describe the practice and acknowledge that it may prevent achieving best execution.⁸

Products or services that fall outside Section 28(e) require even more detailed description. Failure to maintain accurate disclosures can lead to SEC enforcement, including monetary penalties, disgorgement of commissions improperly obtained, censure, and mandated engagement of an independent compliance consultant.⁹

What You Have to Keep on File

Investment advisers have to maintain records of all brokerage transactions under Rule 204-2 of the Investment Advisers Act. For each order, the adviser must keep a memorandum showing the terms and conditions, the person who recommended the trade, the person who placed the order, the account involved, the date, the executing broker-dealer, and whether the order was placed under discretionary authority.¹⁰

All required books and records have to be preserved for at least five years from the end of the fiscal year in which the last entry was made, with the first two years kept in an appropriate office of the adviser. Written agreements relating to commission sharing arrangements have to be retained as well.¹⁰

Beyond the regulatory minimums, the SEC’s inspection report recommends that advisers keep a detailed list of all products and services received through soft dollars (especially when working with multiple broker-dealers), written records documenting the basis for each mixed-use allocation, and annual statements from broker-dealers itemizing what was provided.³ Examiners typically review commission reports, trade blotters, canceled checks, and invoices. Having them organized before the notice arrives saves weeks of scrambling.

If You Manage ERISA Plan Assets

Managers handling employee benefit plan assets face an additional layer of regulation. Soft dollar arrangements can implicate ERISA’s prohibited transaction rules, which bar fiduciaries from using plan assets for their own benefit or engaging in transactions that transfer plan assets to a party in interest.¹¹ A manager receiving research paid for by plan commissions is arguably benefiting from the use of plan assets, so the analysis matters.

The Department of Labor addressed the issue in ERISA Technical Release No. 86-1, which explains how the fiduciary responsibility provisions apply to soft dollar and directed commission arrangements involving plan assets.¹² Plan fiduciaries are responsible for monitoring how their managers use plan-generated soft dollars. Managers running both ERISA and non-ERISA accounts should be careful about cross-account allocation, since using plan-generated credits to benefit non-plan accounts can constitute a prohibited transaction.

Cross-Border Managers and MiFID II

The EU’s MiFID II directive, which took effect in January 2018, requires investment managers to pay for research separately from execution rather than bundling them into commissions. That directly conflicts with the U.S. framework, where bundled payments are protected by Section 28(e). U.S. broker-dealers who accepted unbundled research payments from European-regulated managers risked being classified as investment advisers under the Investment Advisers Act of 1940.

In October 2017, SEC staff issued a no-action letter allowing U.S. broker-dealers to accept research payments through MiFID II-compliant Research Payment Accounts without triggering investment adviser registration, provided the payments were for research eligible under Section 28(e) and all other safe harbor conditions were met.¹³ That temporary relief expired on July 3, 2023, and has not been renewed or made permanent. Legislative efforts to codify the relief have been introduced in Congress but have not been enacted as of early 2026.

Firms with operations on both sides now typically maintain parallel compliance frameworks: unbundled payments for European operations under MiFID II, bundled soft dollar arrangements for U.S. operations under Section 28(e). It adds cost and complexity, and it avoids regulatory violations on either side.

1
Securities and Exchange Commission. Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act of 1934 and Related Matters
2
Federal Register. Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934
3
Securities and Exchange Commission. Inspection Report on the Soft Dollar Practices of Broker-Dealers, Investment Advisers and Mutual Funds
4
U.S. Securities and Exchange Commission. Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934
5
Federal Register. Commission Guidance on the Scope of Section 28(e) of the Exchange Act
6
Office of the Comptroller of the Currency. OCC Bulletin 2007-7 – Soft Dollar Guidance: Use of Commission Payments by Fiduciaries
7
Investor.gov. Investor Bulletin: Form ADV – Investment Adviser Brochure and Brochure Supplement
8
U.S. Securities and Exchange Commission. Form ADV Part 2
9
Securities and Exchange Commission. SEC Charges New York-Based Brokerage Firm for Ignoring Red Flags
10
eCFR. 17 CFR 275.204-2 – Books and Records to Be Maintained by Investment Advisers
11
Office of the Law Revision Counsel. 29 U.S. Code 1106 – Prohibited Transactions
12
U.S. Department of Labor. ERISA Technical Release No. 86-1
13
U.S. Securities and Exchange Commission. No-Action Letter: Securities Industry and Financial Markets Association – Asset Management Group