'Nobody is Proud of Soft Dollars': The Impact of MiFID II on U.S. Financial Markets

Since 1975, investment managers in the United States have been permitted to pay excess brokerage commissions on securities transactions and then utilize those excess payments—commonly known as “soft dollars”—to purchase research and related services, thereby subsidizing the investment advisers’ own profit margins at the expense of their investor clients. Over the past four and a half decades, the Securities and Exchange Commission (SEC) has made fitful efforts to put guardrails around the practice and enhance the transparency of soft dollar payments. At the same time, many asset managers and brokers who provide investment research and trading services profit from soft dollars and have argued vigorously to keep the payments obscure and undiminished. In the United States, soft dollar payments have persisted despite evolving best practices and significant changes in how research is paid for in Europe. In January 2018, financial authorities in the European Union (E.U.) and the United Kingdom (U.K.) implemented MiFID II, a set of regulatory reforms that forced the unbundling of commission charges in a manner that makes this aspect of European financial markets more investor-friendly and arguably more efficient. The emergence of new international standards for the oversight of excess brokerage commissions has presented challenges to global financial services firms that increasingly need to comply with conflicting legal regimes across national boundaries. As MiFID II was coming into effect, the SEC granted the financial services industry temporary no-action relief to facilitate compliance with the Directive’s requirements, but Commission officials recently announced that this relief will expire in July of 2023, presenting an opportunity for the United States to reconsider its approach to soft dollars. This article starts with a brief and critical overview of the use of soft dollar payments in the United States as well as a summary of economic studies exploring the impact of soft dollars on investors. We then review the regulation of excess brokerage commissions in the United States, concluding with an analysis of the scale of soft dollar payments and the manner in which they were disclosed to U.S. investors as MiFID II was being rolled out several years ago. We next summarize intervening developments in the E.U. and the U.K. with respect to soft dollar payments, highlighting the extent to which those developments have created operational difficulties for financial firms operating on a global basis and have already started to influence (and, in our view, improve) soft dollar practices in this country. After offering an assessment of developments in European capital markets since MiFID II went into effect, including recent efforts on the part of European officials to reformulate the application of MiFID II’s unbundling provisions for small and medium size public companies, we close with an overview of an array of reform efforts that could improve the regulation of soft dollar payments in the United States (all short of legislation outlawing the practice). While we take a critical view of soft dollar practices, the story of MiFID II recounted here presents admittedly challenging and contested issues of policy analysis as the agency costs inherent in soft dollar payments are arguably offset by positive externalities supporting the development of robust capital markets. The article also offers an unusual and noteworthy illustration of innovations in investor protections running from foreign markets into the United States rather than the other way around, as has been the norm in the post-World War II era.