The SEC's 2006 Soft Dollar Guidance: Law and Economics
82 Pages Posted: 29 Apr 2008
After some two years of deliberations, in July 2006 the SEC released its long-awaited Guidance on the scope of the soft dollar safe harbor. Passed as part of the Securities Acts Amendments in May, 1975, the safe harbor has protected fund advisers and other money managers for over 30 years from criminal actions and civil suits for breach of fiduciary duty when they use client assets to pay more than the lowest available brokerage commissions in exchange for brokerage and research services. During this time the SEC has interpreted and re-interpreted the safe harbor's scope, largely owing to the public controversy soft dollars engender as a form of illicit kickback designed to subvert advisers' loyalty. The SEC's 2006 Guidance attempts to dramatically narrow the permissible use of soft dollars by prescribing a laundry list of protected and unprotected services. Yet the SEC is now considering further interpretation, and its chairman has petitioned Congress for an outright repeal of the soft dollar safe harbor. This paper shows that soft dollars are an innovative and efficient form of economic organization that benefits fund investors. According to economic theory now well-established in antitrust law, the SEC's Guidance is hopelessly misguided. Were the Guidance to come under the scrutiny of a federal court, the SEC would very likely experience another in its recent string of embarrassing legal defeats.
Keywords: adverse selection, advisory contract, bundling, conflicts of interest, fiduciary duty, institutional brokerage, incentive alignment, investor welfare, kickback, payola, performance bond, quality assurance, safe harbor, SEC, transaction costs, unjust enrichment, vertical arrangements
JEL Classification: D23, D53, K21, K23, K31, L14, L22, L42, L60, M21
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