The term "bucket shop" is often confused with "boiler room" by the financially uneducated. Actually, the two concepts have no relationship at all.
A "bucket shop" is simply a brokerage firm that puts customer orders in a "bucket", and does not execute them in the OTC market or on the floor of any stock exchange. Rather, as principal it takes a position opposite to that of its customer every time an order is received.
For example if you're a customer of a "bucket shop" and you order 100 shares of General Motors at the market, you'll receive a ticket (a written confirmation) of the date and time you purchased the shares and the price that you paid, which may or may not also include a brokerage commission. Then at a future date when you choose to sell those shares, you'll receive a ticket showing the date and time that you sold, and the price, less the firm's "commission" on the sale.
As long as the "buy" ticket is at the same price at which GM traded on the NYSE at that date and time, and your "sell" ticket is at the correct "bid" price at which GM then traded on the NYSE, and you can collect the proceeds of your sale on the customary settlement date, do you really care if the brokerage firm ever purchased any GM shares for your account on the NYSE floor?
"Bucketing" was commonplace, and hundreds of pure bucketshops populated Wall Street, until the practice of "bucketing" was made illegal by the Securities Exchange Act of 1934. While pure bucketshops no longer exist, many brokerage firms will occasionally "bucket" a customer's order. This is somewhat more prevalent in the bond markets (especially munis) than in the equity markets today.
When operating brokerage firms outside of U.S. jurisdiction (where "bucketing" was perfectly legal at that time), I would "bucket" every order for a listed U.S. stock or bond. That meant that we always held a "naked short" position when a customer bought, and paid the customer the correct market price whenever the customer sold.
Obviously this can be very risky for the brokerage firm, especially if the stock rises substantially while the "naked short" position is open, before the custiomer decides to sell.
This is not a topic that is frequently addressed in the 21st century, so I'll be pleased to answer any reader's questions in this respect!
Neal R. Bruckman
The Tycoon Report