What are soft dollars and when are they acceptable under CFA Institute standards?

Soft dollars (or "soft commissions") are the practice of using client brokerage commissions to pay for research and other services beyond pure trade execution. This is a significant ethics topic on CFA Level III.

How Soft Dollars Work

Instead of paying a broker $0.01/share for execution only, the manager pays $0.03/share and receives research services in addition to execution. The extra $0.02/share is the "soft dollar" payment — it comes from the client's assets, not the manager's pocket.

What's Permitted (CFA Institute Standards)

Under CFA Institute Standard III(A) — Loyalty, Prudence, and Care, and the Soft Dollar Standards:

Permitted uses of soft dollars:

• Third-party research reports and analysis
• Financial databases and analytical software
• Economic and market data services
• Quantitative models and performance analytics

Key requirement: The research must benefit the client whose commissions are used to pay for it.

Not Permitted:

• Office rent, utilities, or general overhead
• Personal travel or entertainment
• Hardware (computers, servers — with limited exceptions)
• Marketing materials or client entertainment
• Admin software (accounting, CRM systems)

The "Mixed-Use" Problem

Some products have both research and non-research uses. For example, a Bloomberg terminal provides market data (research) but also email and messaging (administrative). The manager must:

1. Make a reasonable allocation between research and non-research usage
2. Pay for the non-research portion out of the firm's own funds ("hard dollars")
3. Document the allocation methodology

Disclosure Requirements

• The manager must disclose soft dollar practices to clients
• Clients should understand that they are paying above-market commissions
• The manager must explain what services are obtained and how they benefit the portfolio

Example: Caldwell Asset Management directs $2M in annual commissions to Brentwood Securities at $0.04/share (market rate for execution-only is $0.015/share). In return, Brentwood provides:

• Third-party equity research ($400K value) — permitted
• A Bloomberg terminal ($24K/year) — partially permitted (must split research vs. admin use)
• Office supplies and printer ink — not permitted
• Conference attendance for marketing purposes — not permitted

Caldwell must use hard dollars for non-research items and disclose the entire arrangement to clients.

CFA Level III Exam Application

Exam questions typically present a scenario where a manager uses soft dollars and ask you to identify violations. Watch for:

• Using commissions for non-research benefits
• Failing to disclose soft dollar arrangements
• Directing trades to brokers who don't provide best execution, just because they offer soft dollar services
• Not allocating mixed-use items properly

Practice identifying soft dollar violations in our CFA III ethics materials.