Soft dollars are a—sometimes controversial—inducement brokers offer investment managers to place trades through them. A broker sets aside a portion of the commissions it receives from an investment manager. The investment manager is allowed to spend these "soft dollars" on third-party research, financial data or other services that can aide its investment decision making. Brokers have long provided investment advice, research or other services to clients—including investment managers—as an inducement for them to trade with those brokers. The extra services cost money, so brokers who provide them tend to charge higher commissions. Soft dollar arrangements are a natural extension of this. Soft dollars allow the broker to "outsource" the extra services it offers an investment manager. Rather than limiting an investment manager to using the broker's own research, soft dollars allow the broker to offer the investment manager research or other services from any third party the investment manager chooses. A problem with soft dollars is the fact that the investment manager selects the broker and directly benefits from the soft dollars while it is the investment manager's clients who pay the commissions that fund the soft dollars. Investment managers have an incentive to trade with expensive brokers who offer soft dollars while their clients might prefer they trade with less expensive brokers who don't offer soft dollars.
It is argued that clients of an investment manager benefit indirectly from soft dollars because the research or other services soft dollars buy enhance a manager's ability to make sound investment decisions. A counterargument is that clients would be better served if there were no soft dollars and investment managers simply increased their fees to cover the cost of directly purchasing the research or other services the soft dollars buy. This would provide greater transparency and eliminate opportunities for abuse. Abuses have long been associated with soft dollar arrangements, which have occasionally been used to purchase goods or services unrelated to improving investment decisions—things like office administration, carpeting, office rents, membership dues, travel and even entertainment. Critics see soft dollar arrangements as little more than kick-backs to investment managers. Efforts to regulate soft dollars tend to focus on limiting their use to purchases of services directly relevant to investment decision making—things like research and financial data.
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