Rethinking Brokerage Rebate Arrangements: The Case for Collective Cash Pass-Through Arrangements

Abstract:     
Investment advisers customarily direct brokerage - route securities transactions to broker-dealers for execution - while managing client portfolios. In directing brokerage, an adviser is constrained by fiduciary duties and under a strict obligation to secure best execution for its client's securities transactions. Subject to such conditions, however, an adviser may cause a client to pay a higher commission in return for brokerage and research services services which may benefit the adviser rather than the client. These arrangements, called soft dollar arrangements, have flourished over the last twenty-five years, becoming a central feature in the way that broker-dealers compete for orders from managed accounts. This article explores the law and economics of soft dollar and other brokerage rebate arrangements. While noting problems with existing brokerage rebate arrangements, the article questions whether repeal of the principal statutory safe harbor that insulates soft dollar arrangements from legal challenge is warranted in view of competitive realities within the securities industry. Instead, the article proposes a new form of brokerage rebate arrangement - a collective cash pass-through arrangement - as a competitive alternative to existing arrangements. To become a viable competitive alternative, the article recommends that regulators take steps to remove legal impediments to the use of collective cash pass-through arrangements and encourage affirmative consideration of such arrangements by advisers and their clients.

Keywords: soft dollars, investment advisors, investment advisers, directed brokerage, brokerage commissions

JEL Classification: G20, G23, G24, G28, K22

Accepted Paper Series