Net Capital Implications Regarding Soft Dollar Arrangements – Are you a $5,000 Broker-Dealer or a $250,000 Broker-Dealer?

In July, 2006 the SEC issued additional interpretative guidance regarding the use of “soft dollars” to pay for research and brokerage services. This latest interpretative guidance allows broker-dealers to continue to pay for research offered by third-party providers on behalf of money managers under the “safe harbor” of 28(e) provided that the broker/dealer pays the research preparer directly; reviews the description of the services to be paid for with the commissions to ensure that they fall within the definitions of research under the safe harbor of 28(e) and that they agree with the money managers assessment that they fall with the safe harbor; and the broker/dealer develops procedures so that the research payments are documented and paid promptly. If these conditions are met, the services being paid for are considered to be “provided by” a broker dealer under the requirements of the 28(e) safe harbor.

However, there could be potential net capital implications in such arrangements since payments made by a broker-dealer on behalf of its clients, where the firm is not obligated to make the payment, could be viewed as a rebate of commissions by regulators and, under an interpretation issued by the NASD, subject the broker/dealer to a $250,000 net capital requirement.

The key to this issue is determining if the firm is or is not legally obligated to pay for the research and the potential impact on your net capital. We recommend contacting your NASD liaison or a securities attorney regarding your specific business model to determine if you are legally obligated under any contractual arrangements with the money managers for the payments and the potential implications to your net capital requirements, if any.