The term “soft dollars” is generally used to describe a transaction in which a broker-dealer provides a hedge fund manager with research or other services or products in return for commission dollars paid for executing transactions rather than charging a separate fee for the research, services or products.

A typical soft dollar transaction is structured as follows:

The manager directs a broker-dealer to execute trades on behalf of the hedge fund;

The broker-dealer may charge a higher commission or, in some cases, the manager may direct a high volume of transactions to the broker-dealer at a normal commission rate;

The broker-dealer, in addition to executing the transaction, provides the manager with goods and services or engages a third party to provide the goods and services to be utilized by the manager.

As set forth below, Section 28(e) of the Securities Exchange Act of 1934 (the “Safe Harbor”), has several elements. Managers who comply with the Safe Harbor may take into consideration the products and services received in connection with soft dollar arrangements when selecting a broker-dealer. Managers that enter into soft dollar arrangements, regardless of whether such arrangements fall within the Safe Harbor, should obtain client consent after full and fair disclosure. The elements of the Safe Harbor include:

The services or products paid for with soft dollars must be “brokerage” or “research” related;

The manager must make a good faith determination of the value of the services or products provided;

The brokerage services or research products must be provided by the broker-dealer;

The soft dollars must be generated in connection with securities transactions; and

The securities transactions must be executed on an agency basis.

Managers should exercise extreme caution when engaging in soft dollar transactions as the staff of the U.S. Securities and Exchange Commission has regularly expressed concerns over the legality of soft dollar arrangements. Among other things, the SEC is concerned with whether:

The soft dollar arrangements are within the Safe Harbor;

The products and services received by the manager or its affiliates have been adequately disclosed to investors; and

Investors have consented to the soft dollar arrangements.