Most mutual funds charge investors small fees for administrative operating costs, advisory fees and management expenses. However, for years, many investors have been paying even higher hidden fees due to mutual funds’ use of “soft dollars.”
Here’s how soft dollar kickback fees work. Instead of paying the lowest possible commission on trades to a brokerage house, mutual funds will agree to pay a higher commission to a brokerage with the understanding that the brokerage will provide extra services to the fund free of charge. These soft dollars allow mutual funds to pass on their operating expenses to investors under-the-radar.
Brokers simply provide extra services free of charge in exchange for the fund’s future business and trading commissions.
From an investor’s standpoint, these hidden fees are not recorded on the mutual funds’ books and are not reported in the funds’ fee disclosures. Instead, they are simply recorded as part of the fund’s trading costs.
Either way, investors pay commission fees and administrative costs. But soft dollars are not factored into a fund’s expense ratio, which is the main metric that investors use to evaluate and compare fund fees.
Soft dollar kickbacks are not illegal as long as the dollars are spent to benefit the fund and not the fund’s employees. However, since many soft dollar kickback agreements are not explicit, it can be difficult for the SEC to police soft dollar spending.
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