Legal Definitions - soft dollars

The term soft dollars has two distinct meanings, primarily used in the financial and investment sectors. The first definition is the most common and widely understood.

• 1. In the Securities Industry:Soft dollars refer to the practice where an investment manager (such as a mutual fund, hedge fund, or pension fund manager) directs client brokerage transactions (buying and selling securities) through a specific broker. In return for this trading business, the broker provides the investment manager with research, analytical tools, market data, or other services that benefit the client, rather than offering a direct cash discount on commissions. Essentially, the investment manager uses the client's trading commissions to "pay" for these valuable, non-cash services, which they would otherwise have to purchase directly.

  • Example 1: Market Research Reports
    An investment advisory firm manages a large portfolio of stocks for its individual clients. Instead of paying cash for expensive, in-depth market research reports from a third-party provider, the firm directs a significant volume of its clients' stock trades through Brokerage A. In exchange, Brokerage A provides the investment firm with a complimentary subscription to its proprietary research portal, which includes detailed company analyses, economic forecasts, and industry trend reports.

    How it illustrates the term: The investment advisory firm is receiving a valuable service (market research) from Brokerage A. This service is "paid for" not with direct cash from the firm, but by the commissions generated from the client trades directed to Brokerage A. This non-cash benefit is considered soft dollars.

  • Example 2: Financial Data Terminal Access
    A university endowment fund needs access to a specialized financial data terminal that provides real-time market data, news feeds, and sophisticated analytical tools, which typically costs tens of thousands of dollars annually. To acquire this, the endowment fund agrees to execute all its equity trades through Brokerage B. Brokerage B then provides the endowment fund with a complimentary subscription to the data terminal.

    How it illustrates the term: The endowment fund is receiving a significant non-cash benefit (the data terminal subscription) from Brokerage B. This benefit is provided in exchange for the trading commissions generated by the endowment fund's business, illustrating the concept of soft dollars where services are exchanged for trading volume.

  • Example 3: Analyst Meetings and Conferences
    A hedge fund frequently needs to connect with industry analysts and attend exclusive investor conferences to gain insights into potential investments. Instead of paying for these events and meetings out-of-pocket, the hedge fund directs its trading activity through Brokerage C. Brokerage C, in turn, arranges and covers the costs for the hedge fund's portfolio managers to attend several high-profile analyst meetings and investor conferences throughout the year.

    How it illustrates the term: Brokerage C is providing valuable access and covering expenses (analyst meetings, conferences) for the hedge fund. These services are not paid for directly by the hedge fund in cash but are compensated through the trading commissions generated by the hedge fund's business, demonstrating the use of soft dollars.

• 2. In Tax Contexts (Less Common): A less common definition of soft dollars refers to the portion of an equity investment that is immediately tax-deductible in the first year. This typically applies to specific types of investments where certain initial costs or a percentage of the investment can be used to reduce taxable income in the year the investment is made, often to incentivize particular types of investment.