Soft Dollars: How Funds Pay for Research

Behind every 13F filing is a manager who spends money to find ideas — Wall Street research, data feeds, expert networks, analyst calls. A surprising amount of that spending never comes out of the manager's own pocket. Instead it is paid for with "soft dollars," one of the oldest and most quietly debated arrangements in the asset-management business. Understanding it tells you something about the incentives of the institutions whose holdings you track.

What soft dollars are

When a fund manager places a trade, the fund pays a commission to the executing broker. Soft dollars are the practice of bundling extra value into that commission: the broker charges a little more than the bare cost of execution, and in exchange provides the manager with research and related services. The manager gets the research; the manager's clients — the investors in the fund — pay for it through the commissions charged to the fund.

The contrast is with "hard dollars," which is the manager paying for research directly out of its own revenue. With soft dollars, the cost is shifted onto the fund's trading bill. That single fact — the person choosing the research is not the person paying for it — is the source of everything interesting and contentious about the arrangement.

Why it is legal: the 28(e) safe harbor

Soft dollars would look like a conflict of interest, and in a sense they are, which is why Congress carved out a specific protection for them. Section 28(e) of the Securities Exchange Act of 1934 provides a "safe harbor" that lets a manager pay more than the lowest available commission in exchange for "brokerage and research services," without that decision being treated as a breach of fiduciary duty — as long as the manager makes a good-faith determination that the commission is reasonable relative to the value of the services received.

In practice, that covers a wide range of inputs: written investment research, market data, analytics, and access to analysts and industry experts. It does not cover ordinary overhead like office rent or salaries. The line between "research" and "general business expense" is exactly where regulators and compliance officers spend their energy.

The conflict at the center

The problem soft dollars create is straightforward. Because the manager gets the research while the fund pays the commissions, a manager has an incentive to trade more than strictly necessary — every trade generates commissions that can be steered toward soft-dollar research budgets. Excessive trading purely to generate those credits is a recognized abuse, related to the broader concern about "churning" a portfolio.

This connects directly to how you read a fund's activity. A manager that turns its book over rapidly is generating a lot of commission flow, some of which may be funding its research through soft dollars. It is one more reason to look past raw trading volume and focus on whether the positions themselves — the stake a fund takes in a name like Nvidia or CrowdStrike — reflect genuine conviction or simply activity.

How the rules have shifted

Soft dollars are an American survivor. In Europe, the MiFID II rules that took effect in 2018 forced "unbundling" — managers there generally must pay for research separately and explicitly, rather than burying it in trading commissions. That reform was designed to make research costs transparent and to stop clients from subsidizing a manager's research bill without knowing it.

The United States kept the Section 28(e) safe harbor, so soft dollars remain common here. But the global split has created friction: a manager operating on both sides of the Atlantic has to reconcile two different regimes for paying for the same research. The trend, even in the U.S., has been toward more disclosure and scrutiny of how research is paid for and whether clients are getting fair value.

Why it matters to you

You will never see soft dollars on a 13F — they are a cost arrangement, not a holding. But they are part of the machinery that produces the holdings. Soft dollars help explain how even small managers afford expensive research, why transaction costs quietly drag on fund returns, and why a manager's trading frequency is not a neutral fact. When you study a disciplined, low-turnover manager like Tweedy, Browne, part of what you are seeing is a firm that generates relatively little commission flow — and a research process that is not propped up by constant trading. The next time a fund's activity looks frenetic, it is worth asking who is paying for all that research, and why. The insights and research on 13F Insight focus on the positions themselves for exactly that reason.

FAQ

What are soft dollars?

Soft dollars are an arrangement in which a fund manager pays for research and related services by directing a portion of the trading commissions the fund pays to brokers, rather than paying for the research with the manager's own cash. The fund's investors effectively bear the cost through higher commissions.

How are soft dollars different from hard dollars?

Hard dollars means the manager pays for research directly out of its own revenue. Soft dollars shift that cost onto the fund's trading commissions. With soft dollars, the manager chooses the research but the fund's clients pay for it.

Are soft dollars legal?

Yes, in the United States. Section 28(e) of the Securities Exchange Act of 1934 provides a safe harbor allowing managers to pay more than the lowest commission in exchange for brokerage and research services, provided they determine in good faith that the cost is reasonable relative to the value received.

What is the conflict of interest with soft dollars?

The manager receives the research while the fund pays the commissions, so a manager has an incentive to trade more than necessary to generate soft-dollar credits. Excessive trading to fund research budgets is a recognized abuse and a reason to scrutinize high-turnover funds.

Do soft dollars appear in 13F filings?

No. Soft dollars are a cost and commission arrangement, not a security, so they never appear in a 13F. The filing shows what a fund holds, not how it pays for its research or executes its trades.

Why are soft dollars banned in Europe but allowed in the US?

Europe's MiFID II rules, effective in 2018, forced managers to unbundle research from execution and pay for research transparently and separately. The United States retained the Section 28(e) safe harbor, so soft dollars remain common here, creating two different regimes for global managers.