SEC Sanctions Broker-Dealer for Improper Soft Dollar Payments

Investment Management Update

Date: March 24, 2014


On December 26, 2013 the Securities and Exchange Commission announced sanctions against a New York-based brokerage firm for ignoring red flags and paying more than $400,000 in soft dollars for expenses that an investment adviser had not properly disclosed to clients.1


After Congress abolished fixed commission rates in 1975, it enacted Section 28(e) of the Securities Exchange Act of 1934,2 which provides a safe harbor with respect to arrangements in which an investment adviser pays more than the lowest available commission rate when it receives valuable products or services from a broker-dealer.3 These arrangements, commonly known as “soft dollar” arrangements, allow an investment adviser to take into account the totality of the brokerage and research products and services it receives from a broker-dealer related to its clients’ securities transactions, rather than considering only the broker-dealer’s commission rates. Nonetheless, this safe harbor is subject to various conditions including a requirement that the investment adviser has “… determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided.…”4 While many soft-dollar-related administrative proceedings focus on an investment adviser’s improper conduct, this proceeding implicated the broker as aiding and abetting violations of the Investment Advisers Act of 1940.

SEC Position on Broker-Dealers as Gatekeepers

The SEC’s actions seem to be sending a warning to broker-dealers. In announcing the sanctions, Marshall S. Sprung, co-chief of the SEC Enforcement Division’s Asset Management Unit, stated:

Brokers perform a crucial gatekeeper function in approving soft dollar payments, and they cannot turn a blind eye to red flags that investment advisers may be breaching their fiduciary duty to clients.5

In this case, the red flags may have been particularly hard to ignore, as payments included residential rent payments and alimony payments thinly disguised as consulting agreement fees.

Outlook and SEC Guidance

While most of the SEC guidance over the last 20 years has focused on defining brokerage and research services that are eligible for soft dollars,6 the present enforcement action points to the need for common-sense vigilance by broker-dealers when reviewing soft dollar payment requests. This is particularly important in client commission arrangements, where an investment adviser is using client commissions to pay for research produced by someone other than the executing broker-dealer. The SEC believes these arrangements are covered by the Section 28(e) safe harbor provided, among other things, that the broker-dealer reviews the services to be paid with client commissions for red flags that indicate the services do not fall within the safe harbor.7


To learn more about our investment company legal services and investment advisory legal services, please contact:

Parker D. Bridgeport

Michael V. Wible


This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

This document may be considered attorney advertising in some jurisdictions.


1; SEA Rel. No. 71191, Dec. 26, 2013 (Release).

2 Securities Exchange Act of 1934, as amended; June 4, 1975, Pub.L. 94 29, § 21, 89 Stat. 160.

3 Investment advisers have a fundamental obligation under the Investment Advisers Act of 1940, as amended (15 U.S.C. 80b-1), and state law to act in their clients’ best interests, see, e.g., SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 189-191 (1963). This includes the obligation to seek “best execution” of clients’ transactions under the circumstances of the particular transaction, see, e.g., Exchange Act Release No. 23170 (Apr. 23, 1986), 51 FR 16004, 16011 (Apr. 30, 1986). The adviser’s fundamental obligation to act in his client’s best interest also generally precludes the adviser from using client assets for his own benefit or that of his other clients without client consent.

4 Section 28(e)(1), Securities Exchange Act of 1934.

5 Release at para 5.

6 See, e.g., “Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934,” Rel No. 34-54165, July 24, 2006.

7 Id.