We know about bucket shops from Jesse Livermore. They were storefront businesses that let people place directional side bets on stocks. The bets stayed within the walls of the bucket shops; the owner of a bucket shop took the opposite side of the trade of its clients and charged a commission. Naturally, some owners were more honest than others, but for the most part the small-time speculator lost money because he was a bad trader, not because the game was rigged. Richard D. Wyckoff, in Wall Street Ventures & Adventures through Forty Years, originally published in 1930 and reprinted by Traders Press in 1986, describes the transformation of bucket shops from gambling parlors that were the launching pads for future star traders to scams that entrapped the naïve retail investor. And, sadly, there were the futile attempts of the New York Stock Exchange to shut them down. In the end it was the media that sounded their death knell.
Wyckoff started his career on Wall Street in 1888 as a runner. He performed back office tasks, delivering negotiable bonds and stock certificates and collecting money. This literally meant running from building to building, “rushing wild-eyed from one house to another to complete their deliveries before the last fifteen seconds of the delivery hours were ticked off on the old Gold and Stock tickers.” (p. 15)
That was the norm. By 1890, however, he had another task. The New York Stock Exchange, desperate to shut down the bucket shops and always coming up short, resorted to an extreme measure. It simply stopped the ticker service, not only to the bucket shops but to its own members as well. The ticker tape went silent. So the runners had the hapless task of running between the exchange and their offices to provide quotes that were clearly delayed. “No one in any of the offices knew prices until his boy arrived. This could not last. Nobody wanted to trade when the ticker wasn’t ticking.” (p. 19) The bucket shops could simply have waited out this nitwit strategy of the NYSE; it lasted only several days. But they used private wire services to transmit quotes to their offices across the country. Their customers weren’t worse off than those of the NYSE.
Fast forward to 1920. In a much more insidious form the bucket shops continued to thrive. “There was a difference between the old-style bucket shop, with its two-point-margin method, and the bucket shop 1920 style. The modern shop got hold of people with substantial amounts of money and swindled them by means of alleged information, discretionary accounts and actual transactions (frequently executed on the New York Stock Exchange through dummies).” The bucketeer “got hold of a client, preferably in another city, ascertained how much money he had, induced him to put up more and more by reporting purchase for him of this or that stock at 3 or 4 points below the market and announcing that he ‘already had a profit’ of $2,000 or $3,000, etc. When the amount of margin that could be extracted from the victim had about reached the limit, he was ‘sent to the cleaner’; in other words, he was put into a fictitious transaction that cleaned him out. Often, in fact, he was left in debt to the bucket shop.” (pp. 261-62)
The authorities were powerless to stop these swindles. The bucket shop lobby saw to it that New York state laws were ineffectual, and the New York Stock Exchange just kept wringing its hands. Finally the press entered the picture. Starting with Wyckoff’s Magazine of Wall Street and continuing with such large-circulation publications as the New York Herald and the Saturday Evening Post, reporters exposed the new bucket shops for the swindling operations they were. Emboldened, New York beefed up its state laws, the NYSE figured out ways to deprive the bucket shops of their services, and-- most importantly--the public stopped handing over its hard-earned money to the bucketeers. Soon enough, one shop after the other folded; the era of the bucket shops was over.
Of course, such profitable schemes never really die. We can look at credit default swaps, for instance, as a variation on the old bucket shop idea—unregulated side bets.