Bucketing

What Is Bucketing?

Bucketing is an unethical practice whereby a broker generates a profit by misleading their client about the execution of a particular trade. Specifically, it refers to a situation in which the broker confirms that a requested trade has taken place without actually executing that order. The broker then attempts to execute the order at a more favorable price than the one quoted to the client. The spread between these two prices is then kept by the broker as profit, without revealing this fact to their client.

A brokerage firm that engages in unscrupulous activities, such as bucketing, is often referred to as a bucket shop.

Understanding Bucketing

Bucketing is an unethical business practice because it involves placing the broker's interests ahead of those of the client, while also misleading the client into believing that their interests are being given priority.

Effectively, bucketing works by exploiting the trust held by the client toward the broker. By placing their trades through the broker, the client is acting on the belief that the broker will seek out the best available terms when executing that trade. In the case of a buy order, this means obtaining the lowest price possible, while the opposite is true for a sell order. 

Bucket Shops

Historically, the term "bucket shop" referred to any business that involved illegal or quasi-legal gambling. However, more recently the term has been used to refer to brokerage firms that engage in unethical practices, such as bucketing.

In practice, however, brokers engaged in bucketing exploit this expectation by lying to the client. When processing purchase orders, they will tell the client that they have purchased the shares at a specified price, whereas in fact they purchased the shares at an even lower price and kept the difference as profit for themselves.

In the case of a sell order, the broker will tell the customer they sold at a given price when in fact they sold at an even higher price. In both cases, the broker pockets the difference between the actual price and the one communicated to the client. In substance, this amounts to stealing from the client's own profits.

Other Uses of the Term

Bucketing also refers to a retirement strategy whereby an individual divides up their assets into different "buckets" based on when they'll need them in retirement. This is opposed to the traditional method of receiving retirement income, where a retiree receives regular distributions from their portfolio to cover expenses.

So for example, a retiree will have a near-term bucket with a specific amount of assets and only those assets will be used. The same would be for a medium-term bucket and a long-term bucket, that would be used last, if at all.

Bucketing is also a three-step process of financial planning. An individual aims to reach all three buckets step by step. The first bucket is creating an emergency fund, the second bucket is reaching financial goals, and the third bucket is for retirement.

Example of Bucketing

Steve is a broker who regularly engages in bucketing. He receives an order from his client, Linda, who expects him to place her interests first when executing her transactions.

Linda's trade request is to purchase 100 shares of XYZ Corporation at a price of $10 per share or lower. Steve responds shortly thereafter, claiming that the trade was executed at a price of $10 per share.

In reality, however, Steve lied to his client. Instead of executing the order at $10 per share, he in fact executed it at $9 per share. The difference of $1 per share was kept by Steve as his own personal profit, without disclosing this fact to Linda. At a $1 profit per share on 100 shares, Steve pocketed $100. That is $100 dollars that should have benefited Linda, from whom he stole.