Soft Dollars Question

Hey guys, I haven’t really done a lot of practice yet on ethics, and have started to read through it and do some practice questions. One question I have is regarding soft dollars. I’m having a hard time grasping the whole concept, not necessarily the ethical part of it. I don’t understand why “brokerage” is property of the client. I see it as the client pays the brokerage for their services to execute the trades. After that point, why can’t the brokerage firm do whatever they want with it? Maybe I’m missing the point but I feel like its the same as saying when I go down to the local supermarket and purchase something, they must use the money I give them to benefit me?? HELP ME UNDERSTAND!!!

I see where you are going with this question. Soft dollars are execution services such as reseach, cash credit etc. Not just the price for executing the trade. As you are paying up to receive these extra services there has to be an investing benefit to them. You can see how soft dollars create a problem if an Manager uses a brokerage who would give him say World Series tickets. That’s why the brokerge (ie extra services) must have some benefit for the client.

As an alternative…say you’re giving your nanny 10$ to go to the store and buy some milk. Today’s a special offer where she gets 2 milk packs for the price of one plus a 6-pack of beer. Wouldn’t you want to have the extra milk and the beer, or at least know about it? The nanny would be your portfolio manager, investing your money that happens to lead to extra benefits, soft dollars, from the brokers, the supermarket. Oh, and the brokers basically have the same incentives. They want to lure as many trades from asset managers as possible by…you guessed it, offering an extra 6-pack of beer.

^^ good example…how people link beer, food and sex (one of smarshy’s old posts) to cfa material…if beyond my comprehension!

Lance, I think you might not be viewing brokerage as it generally pertains to this concept. Do not think of it as parking your money at a brokerage firm and executing trades through them (like Schwab, for example). Instead you should view it as opening an account with a money manager (or even a mutual fund)…the portfolio manager is making trades on your behalf, but he has the flexibility of going to virtually any broker to place the trade. Thus when the PM is looking to place a trade he has to choose the broker that is benefitting the CLIENT the most, not his own interest. I’ll give you an example. I work for an Registered Investment Advisory firm…our clients have accounts with the trust side of a large bank who is the custodian. When we go to make a trade we have the option of going to Morgan Stanley, UBS, small firms, etc…then the broker and custodian settle the trade. Therefore when I go to make a trade I have to think which broker is going to be the best choice for my clients…some brokers specialize in foreign bonds, some offer low rates for large size trades, while others may be willing to execute very small size trades without a minimum fee. The flip side to the decision would be to choose the broker that offers me the most benefit (maybe it is a friend, maybe they let me use box seats at a baseball game, etc).

because CFAI says so