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This is not necessarily how it works.

While my explanation was simplified, in the end this is exactly how it works. Portfolio managers have a tendency to overpay for commissions to get comps. There is clearly a moral hazard here.

More often than not, Vanguard will do much more business with Goldman Sachs above and beyond the $288,000.

It may or may not (you have no idea), but regardless I want my fund manager to pay the lowest transaction costs on each trade, not be tied down to fulfilling soft dollaring obligations.

Vanguard "owes" Goldman Sachs

Precisely.

To me, soft dollars are not such a horrible thing.

I'm not sure "horrible" is the right word, but "sneaky", "unethical", and certainly "undesirable" come to mind.

Imagine you've hired a contractor to build your dream house on a Time & Materials basis. There are two lumber yards in town. Yard A charges $2 per board foot and offers no soft dollaring. Yard B charges $4 per board foot and has signed a soft dollar arrangement with your contractor, who must buy $10,000 of lumber from the yard in return for a new toolbox and a subscription to Contractor's Digest. Now, as you say, maybe our contractor was going to do $10,000 worth of business with Yard B anyway, and all this isn't going to cost you a penny. But I have a feeling your house is going to end up costing more than it should have.

Then there's the issue of abuse of the soft dollared goodies themselves. To reprint the quote above:

"...1998 report found one fund manager who spent soft dollars to buy a computer that was operated exclusively by his family, which used it to play video games. Other advisers, the SEC said, used soft dollars to pay telephone bills, rental-car costs, to install anti-static carpeting and to buy theater tickets."

Nick
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