Hedge fund use of soft dollars

While many hedge fund activities have attracted more scrutiny recently, the use of soft dollars by hedge funds has been a source of regulatory concern for years. A fund manager’s decision under a classic soft dollar arrangement to pay more than the lowest commission in return for research or brokerage services is expressly protected by the safe harbor in Section 28(e) of the Securities Exchange Act of 1934 (“1934 Act”). Many hedge fund managers use commissions to obtain not only research and brokerage services, but also a number of services that may be outside the Section 28(e) safe harbor. Whether or not a particular service constitutes “research” is generally a fact‐specific determination. A key element of such determination is whether the product or service aids the investment manager’s investment decision‐making responsibilities rather than the manager’s marketing or general administrative activities. Where proposing to use client or fund commissions for non‐research or non‐brokerage services, the fund manager must be very careful to ensure that such use is both fully disclosed and permissible under applicable law and documents.