What is a Bucketshop?

It Sells What It Does Not Own The many failures of stock brokerage firms in recent years has brought to the fore the old problem of driving the "bucketshops" out of business. Before headway can be made the public must know exactly what a bucketshop is. Legitimate brokerage houses should not, of course, be driven out of existence in prosecuting the bucketshops.

The legitimate brokerage firm acts as an agent for public customers in the purchase and sale of securities. It also obtains credit for such customers, thus enabling them to buy "on margin." If, for example, an investor buys through a brokerage house 100 shares of U. S. Steel stock at $100 per share, he can either pay the purchase price of $10,000, or he can deposit with the broker $2,000, say, as "margin" and let the broker obtain the remaining $8,000 for him. This the broker does by paying the seller the $10,000 due, and then borrowing the $8,000 from a bank upon the collateral of the stock certificate. Thus most of the stock certificates bought "on margin" by customers, they never actually see. Nor does the legitimate broker usually keep them in his office, for he may in the manner suggested above put them in a "loan envelope" and deposit them with a bank to obtain a loan upon them. The customer sees only his statement from his broker, upon which he is credited with the securities he has bought.

This practice with regard to "margin" stock is unavoidable and is in every way legal and legitimate. But owing to the fact that most brokerage customers do not fully understand the business, it permits unprincipled brokers to sell out their customers' stock as fast as it is purchased& -which is "bucketing." If the customer asks where his stock is, he is told that it is at a bank in a "loan envelope," and he has to take the broker's word for it. The "bucketing" broker profits from this illegal and underhanded practice in two ways. In the first place, he charges interest on $8,000 to the customer, when he is not actually borrowing money to carry his stocks at all, since he has already sold them out. This "interest" is, of course, all pure profit. In the second place, if the market declines, either the customer, discouraged by the decrease in his margin which this causes, orders the stocks sold, or else the bucketeer sells him out when his margin has become exhausted. If, for example, the customer buys 10 shares of Steel at 100 on a $500 margin, his margin or equity in the stock amounts to only 5 points in its price. If the price of Steel falls to 97, and he orders the stock sold, the bucketing broker, who has secretly sold it already at about 100, makes about $300, while if the. price of Steel falls to 95, the broker pretends to "sell the stock out," to avoid loss himself; actually he has already sold it, and thus simply pockets the customer's $500. Most people who speculate, and particularly amateurs, are always buyers. Hence the bucketshops can flourish only when the stock market is declining. During the long decline in the stock market from November, 1919, to August, 1921, bueketshops posing as brokerage houses in Wall Street made huge sums of money. But the business becomes immediately unprofitable on a rising stock market. That is why so many bucketshop failures occurred between August, 1921, and the peak of the high market last Fall. Rising prices did vastly more than any other factor to bankrupt these pretended brokerage concerns.

There is a law in New York State which compels a stock broker to give, on his customer's demand, the name of the other party from whom or to whom the customer's stock was bought or sold. For this reason the bucketshops, which originally never bought or sold anything at all, must legitimately purchase for their customers, and this they almost always do. But the deception which they practice consists in at once selling the same amount of the same stock at as near the same price as possible, for some "dummy" or imaginary account on his books. Thus, while the customer thinks his stock is being "carried" for him, actually the bucketshop keeper has sold it out.

It is consequently most important, especially during declining or "bearish" markets, for customers to most carefully investigate their brokers' methods of doing business. In this respect, if the broker is a member of the New York Stock Exchange it is a great indication that his business will be honestly handled because of the severe rules of that institution regarding business conduct. Moreover, the customer cannot afford to take the letters of recommendation issued by banks regarding stock brokers too seriously, for the big bucketshops sometimes keep larger sums of money on deposit with a bank than a legitimate brokerage firm. They can afford to do this, since they do not carry stocks and therefore do not need their money in their business, as an honest house does. Oftentimes the banker knows little of practical stock brokerage; he sees simply a large deposit of his books, and judges the depositor accordingly.

One check against the extension of bucketing has been provided by the New York Stock Exchange in refusing to give one of it's stock tickers to any firm not of the right character. Without a stock ticker the bucketeer finds it all but impossible to do business. In this work the Stock Exchange has made few mistakes; very few of the bucketshops which have failed in recent years had a New York Stock Exchange ticker. The latter instrument must not, however, be confused with the very similar looking ticker machine of the Consolidated Stock Exchange, so many of whose members have recently failed under distinctly peculiar circumstances. It must not be presupposed, however, that every failing brokerage firm has necessarily been "bucketing" its customers' orders. Brokerage failures can, of course, occur like failures in other lines of business, because of too heavy overhead or shrinkage in the value of the assets, which brokers usually keep invested in securities.

It is a noteworthy fact that the 100 odd failures of supposed brokerage houses in New York occurred during the long rise in stock prices during 1921-22, while the recent insolvencies of prominent Curb houses have occurred during a temporary rally after a severe decline in stock prices this Spring. The latter were consequently due rather to the step taken by Curb authorities (under the vigorous leadership of John W. Curtis, President of the New York Curb Market Association) to investigate and check wrongful practices by its members, than merely to the change in security values.