When it comes to financial transactions, commission sharing agreements (CSAs) and soft dollars are two terms that often come up. Both are used to pay for research and trading services, but they have different rules and regulations governing them.
A commission sharing agreement is an arrangement between a buy-side firm (such as a pension fund or hedge fund) and a broker-dealer. In a CSA, the buy-side firm pays the broker-dealer a commission for executing a trade, and the broker-dealer then shares a portion of that commission with a third-party research provider.
This arrangement allows the buy-side firm to pay for research without violating regulations that prohibit them from accepting research for free. The broker-dealer is responsible for ensuring that the research provider delivers valuable research in return for the commission they receive.
In contrast, a soft dollar agreement is an arrangement where a buy-side firm pays a broker-dealer commissions that can be used to pay for research and other services. Soft dollars have been around for decades and were originally designed for institutional traders to purchase market data. Today, they are used for any research, software, or other services that are directly related to trading.
One key difference between CSAs and soft dollars is that CSAs are subject to explicit regulatory guidance, while soft dollars are not. The Securities and Exchange Commission (SEC) has issued guidance on CSA arrangements, including requirements for disclosure and transparency. In contrast, soft dollars are governed by a more general set of rules that rely on the buy-side firm to ensure the services they are paying for are directly related to trading and benefit their clients.
Another difference is that CSAs are more commonly used by larger buy-side firms, while soft dollars are used by both large and small firms. This is because CSAs typically require a minimum volume of trading to be cost-effective, and smaller firms may not have enough trading activity to meet this threshold.
Ultimately, both commission sharing agreements and soft dollars provide a way for buy-side firms to pay for research and other services without violating regulations that prohibit them from accepting research for free. The choice between the two will depend on the specific needs and resources of the buy-side firm. For large firms with significant trading activity, CSAs may be the better option, while smaller firms may find soft dollars more accessible and cost-effective. Regardless of the choice, it is essential for buy-side firms to fully understand the regulations and guidelines surrounding these agreements to ensure compliance.