Soft Dollar Arrangements: Section 28(e), Disclosure, and ERISA

Soft dollar arrangements let an investment adviser use client trading commissions to pay for research and certain brokerage services instead of paying for them out of the firm’s own revenue. The practice is legal under federal law, but only inside a defined safe harbor that limits what those commissions can buy, requires the adviser to seek best execution, and demands specific disclosure to clients. Miss any of those pieces and the adviser is exposed to SEC enforcement, fiduciary breach claims, and in retirement plan accounts, ERISA liability.

Here is how the money moves. The adviser routes client trades to a broker-dealer, the client pays a commission on each trade, and a portion of that commission becomes a credit the broker-dealer holds for the adviser’s benefit. The adviser then directs the credits toward research reports, market data, analytical tools, or other qualifying services. The broker-dealer either provides those services itself (proprietary research) or pays a third-party vendor on the adviser’s behalf. Either way, the client is the one funding the research, which is why every step is governed by fiduciary rules on disclosure, cost, and execution quality.

The contrast is with “hard dollars,” which come from the adviser’s own pocket. Because clients pay for soft dollar research through their commissions, the arrangement carries a built-in conflict: the adviser has a financial incentive to steer trades to whichever broker-dealer offers the most useful research, not necessarily the best execution.

The Section 28(e) Safe Harbor

Section 28(e) of the Securities Exchange Act of 1934, codified at 15 U.S.C. § 78bb(e), is the statute that makes these arrangements defensible. Without it, an adviser who paid commissions above the lowest available rate to obtain research could be sued for breaching the duty to minimize client costs. The safe harbor says the adviser will not be deemed to have “acted unlawfully or to have breached a fiduciary duty” solely because client accounts paid higher commissions, provided three conditions are met.¹

First, the adviser must exercise investment discretion over the accounts generating the commissions. That means authority to decide what to buy and sell without asking the client first. An adviser who only recommends and lets the client approve each trade does not qualify.

Second, the products or services received must be “brokerage and research services” as the statute defines them, and they must provide lawful and appropriate assistance to the adviser’s investment decision-making. The statute lists three eligible categories: advice about the value of securities and whether to buy or sell them; analyses and reports on issuers, industries, economic trends, and portfolio strategy; and the execution of trades along with related functions like clearance, settlement, and custody.¹

Third, the adviser must make a good-faith determination that the commissions paid are reasonable relative to the value of the services received. That judgment can be made trade by trade or across all discretionary accounts as a whole. The burden of showing good faith rests on the adviser.²

The 2006 SEC guidance confirmed the safe harbor covers both proprietary and third-party research, as long as the executing broker-dealer is involved in effecting the trades and takes responsibility for keeping the research payments within the statutory limits.²

What Client Commissions Can Pay For

To qualify as research under the safe harbor, a product or service must reflect “substantive content,” which the SEC defines as the expression of reasoning or knowledge. It also has to relate to the statutory subject matter: securities valuation, issuer analysis, industry conditions, economic data, or portfolio strategy.³ A database that just organizes information without any analytical layer does not clear that bar.

Traditional research products sit comfortably inside the safe harbor: analyst reports, financial models, and economic forecasts. Market data qualifies too. Stock quotes, trading volumes, last-sale prices, company financial data, and macroeconomic indicators like unemployment and GDP figures all contain substantive content about securities and are eligible.²

Meetings and consultations can qualify when reasoning or knowledge about issuers or securities is actually being shared. A meeting with a company executive to discuss financial outlook is eligible. A consultant advising on portfolio strategy is eligible. A consultant advising on the adviser’s own business operations is not.²

Mixed-Use Products

Many tools do more than one job. A software platform might combine portfolio analytics with back-office accounting. A management information system might handle both trading and recordkeeping. When a product has eligible and ineligible uses, the adviser has to allocate the cost. Only the portion supporting investment decision-making can be paid with soft dollars. The rest comes from the firm’s own funds, and the allocation itself must be documented.⁴

Computer hardware works the same way. A machine running exclusively research software that benefits client accounts can be paid for with commission dollars. A machine that also handles bookkeeping or email has to be split proportionally.⁴

What Client Commissions Cannot Pay For

The SEC has drawn a clear line around general business overhead. None of these can be paid with client commissions, no matter how loosely someone frames them as supporting the investment process:

Office costs: rent, furniture, equipment, utilities, and supplies
Personnel expenses: salaries (including research staff), professional licensing fees, and personnel management
Administrative software: back-office tools, operating systems, word processing, and equipment maintenance
Business services: accounting, legal expenses, web design, email software, and internet service
Marketing and membership: marketing costs, membership dues, and lobbying fees

These fail the statutory test because they do not reflect reasoning or knowledge about securities, issuers, or portfolio strategy.²

The Seminar Trap

This one catches advisers off guard. The cost of attending a research seminar or conference can be paid with soft dollars, because the seminar content is research. The travel, hotel, meals, and entertainment costs of attending cannot. Those are personal or overhead expenses and have to come out of hard dollars. The line is between the intellectual content of the event and the logistics of getting there.⁴

Advisers also cannot inflate commissions to disguise payments for ineligible services like shelf space or client referrals. If commissions are pumped up to cover those costs, the adviser cannot credibly claim the total was reasonable relative to the eligible research received.²

Best Execution Still Applies

The safe harbor does not suspend the adviser’s fiduciary duty to seek best overall execution. What it does is clarify that best execution is not just the lowest commission. Advisers can weigh a broker-dealer’s full range of capabilities: execution speed and reliability, commission rates, financial stability, responsiveness, and the value of any research provided.⁴

The SEC expects advisers to periodically and systematically evaluate execution quality. That includes soliciting input from traders and portfolio managers, comparing results across broker-dealers rather than relying on a single relationship, and keeping documentation showing the evaluation actually happened.⁵

Where a broker-dealer sells research at an unbundled price separate from execution, that price gives the adviser a useful benchmark for the research’s market value. If the research has been copied or repackaged from another source, the adviser faces a heightened burden to justify additional commissions paid for it. And an adviser who commits in advance to generating a specific dollar amount of commissions with a broker-dealer faces what the SEC calls a “heavy burden” of proving best execution was still consistently achieved, because that kind of commitment creates an obvious incentive to overtrade or route suboptimally.⁴

Disclosures to Clients

Section 28(e) itself requires advisers to disclose their commission policies and practices in whatever manner the SEC prescribes.¹ In practice that means Item 12 of Form ADV Part 2A, which registered advisers must deliver to clients and prospective clients. The requirements are specific, and boilerplate like “we receive various research reports” is explicitly not enough.⁶

Under Item 12, the adviser has to:

State that using client commissions to obtain research benefits the firm because it does not have to produce or pay for those services itself
Acknowledge that this creates an incentive to select a broker-dealer based on research rather than the client’s interest in best execution
Disclose, if applicable, that client accounts may pay commissions higher than what other brokers would charge in exchange for soft dollar benefits
Disclose whether soft dollar benefits go to all client accounts or only those whose trades generated the credits, and whether the firm tries to allocate benefits proportionately
List the specific types of products and services acquired with client commissions during the last fiscal year, in enough detail for clients to evaluate the conflicts
Describe the procedures used to direct client transactions to a particular broker-dealer in return for soft dollar benefits

Both proprietary and third-party research have to be covered. Products that fall outside the safe harbor need more detailed disclosure than products that qualify. Examiners look closely for vague language that obscures the true scope of the arrangements.⁶

Recordkeeping

Beyond disclosure, advisers have to keep records that back up their soft dollar practices. Under 17 CFR § 275.204-2, advisers must maintain memoranda of each order placed for a client account, showing the terms, the person who recommended the transaction, the account, the date, and the broker-dealer used. Orders made under discretionary authority have to be marked as such.⁷

Advisers also have to retain written communications tied to recommendations, the receipt or disbursement of funds and securities, and the placement or execution of orders, along with any written agreements with clients or broker-dealers connected to the advisory business.⁷

For mixed-use products, the SEC expects records documenting how each cost was split between eligible and ineligible uses, including the reasoning. Advisers who cannot produce that documentation effectively lose the ability to claim the safe harbor for those transactions.²

Retirement Plan Accounts Add an ERISA Layer

If the accounts generating the commissions are retirement plan assets, ERISA piles additional fiduciary duties on top of the securities law rules. The Department of Labor’s Technical Release No. 86-1 addresses soft dollar arrangements in the plan context directly. Plan fiduciaries who delegate investment management still have to monitor the manager, and that monitoring has to confirm best execution and confirm commissions are reasonable relative to the value of services received.⁸

ERISA’s prohibited transaction rules raise the stakes. Section 406(b)(1) bars a fiduciary from dealing with plan assets in the fiduciary’s own interest. A soft dollar arrangement that falls outside Section 28(e), for example using plan commissions to pay for the adviser’s travel or office expenses, may be a prohibited transaction, which carries excise taxes and personal liability for the fiduciary.⁸

Soft dollar use is permissible in plan accounts when the goods or services benefit the plan, commissions are reasonable, and best execution is met. The plan sponsor or named fiduciary must evaluate those conditions periodically, not only at the start of the relationship.⁸

Cross-Border Firms and MiFID II

Firms with European operations face a separate constraint. The EU’s MiFID II rules, effective January 2018, require investment managers in Europe to pay for research separately from execution commissions. Under the Investment Advisers Act of 1940, a broker-dealer accepting direct cash payments for research that qualifies as investment advice can be reclassified as an investment adviser, triggering registration and compliance obligations most broker-dealers are not built for.

The SEC issued temporary no-action relief letting broker-dealers accept unbundled research payments from MiFID II-affected managers without those Advisers Act consequences. That relief was extended once and expired on July 3, 2023.⁹ The SEC has not moved to impose European-style unbundling in the United States, and the traditional Section 28(e) framework remains the domestic rule.

What Goes Wrong in Enforcement

The SEC treats soft dollar violations as misuse of client assets. Enforcement actions have targeted advisers who used client commissions to pay personal expenses, failed to allocate mixed-use costs, made inadequate disclosures, or picked broker-dealers based on soft dollar benefits without regard for execution quality. Penalties have ranged from modest fines for disclosure failures to multi-million-dollar sanctions where advisers diverted commissions to cover personal obligations like rent or divorce settlements.

Beyond fines, the SEC can bar individuals from the securities industry, order disgorgement of improperly obtained benefits, and censure firms. The safe harbor is real protection, but only for advisers who keep thorough records, run genuine best execution reviews, allocate mixed-use costs honestly, and give clients specific disclosures in Form ADV. Anything less and the protection falls away exactly when it is needed.

1
Office of the Law Revision Counsel. 15 USC 78bb – Effect on Existing Law
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. Interpretive Release – Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934
4
Securities and Exchange Commission. Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act of 1934 and Related Matters
5
U.S. Securities and Exchange Commission. Compliance Issues Related to Best Execution by Investment Advisers
6
Securities and Exchange Commission. Form ADV Part 2
7
eCFR. 17 CFR 275.204-2 – Books and Records to Be Maintained by Investment Advisers
8
U.S. Department of Labor. ERISA Technical Release No. 86-1 – Statement on Policies Concerning Soft Dollar and Directed Commission Arrangements
9
Securities and Exchange Commission. SEC Announces Extension of Temporary Measure to Facilitate Cross-Border Implementation of the European Union’s MiFID II’s Research Provisions