Over the counter, into the bucket – Buyer be aware.

Background information

Although perhaps misleading, the title draws attention to the explosive combination of trading in derivatives, and big bets using excessive gearing.

The so-called bucket shops that flourished at the turn of the twentieth century in the US were a form of derivative trading catering to  small retail speculators who wished to have a flutter on the stock-market. No share transaction occurred. The certificate issued was usually promptly dispatched to the waste bucket, as the operator conspired to make sure that the client lost. The system was so open to abuse that Congress outlawed bucket shops in the USA in the 1920’s, after many years of disquiet.

Many regard “Over the Counter” (OTC) Contracts for Difference (CFD) trading as a sophisticated reincarnation of the old bucket shop business model. The purchaser enters into an agreement with the provider to trade in almost any global market on the basis of conditions set by the provider. There is no exchange transaction, and for this reason CFD trading is not yet legal in the US. They consider with some justification that on-market derivative trading is safer for consumers.

Exchange traded derivatives such as Futures, Options, Warrants, and Exchange Traded Funds (ETFs) are preferred. In recent years,  high-frequency equity trading has blurred the distinction between on and off-market transactions. The latter are usually executed faster and at still competitive prices, despite the wider spread. These so-called ‘dark pools’ are opposed not so much on a basis of inefficiency or rorting of the system, but because millions of dollars in revenue are diverted from the regulated exchanges to unregulated merchant banks.

How is it then that the US has sanctioned other less regulated and more risky forms of derivative trading such as Credit Default Swaps, (CDOs) ? When these went wrong they endangered the financial stability of the world.

It required an act of Congress when Bill Clinton was President, passed December 21 2000 called the Commodity Futures Modernization Act of 2000. It repealed the prohibition of the bucket shops.  Furthermore the Act ensured that “credit default swaps” and similar agreements were not forbidden by the SEC. This effectively deregulated the derivative market.

The Ugly side of Derivative Trading

The Global Financial Collapse made the world all too painfully aware of the risks of the clever new derivative products spawned in the wake of this deregulation. But have the world’s great financial institutions modified their affairs to improve the integrity of their trading? It would seem that little has changed for the better if JP Morgan Chase is an example.


US bank JP Morgan Chase has agreed to pay four regulators $920m (£572m) relating to a $6.2bn loss incurred as a result of the “London Whale” trades.

The settlement is the third biggest banking fine by US regulators, and the second largest by UK regulators.

As part of the deal JP Morgan admitted violating US federal securities laws.

Traders at JP Morgan’s London office built up huge losses in derivatives trades at the beginning of last year.

Two former JP Morgan traders face criminal charges in the US relating to the case.

Separately, JP Morgan was fined $309m by the newly-created US Consumer Financial Protection Bureau (CFPB) for illegal credit card practices.

According to the CFPB, between October 2005 and January 2012, JP Morgan Chase customers were charged monthly fees ranging from $7.99 to $11.99 for “identity theft protection” and “fraud monitoring” services which were never actually performed.

Some customers exceeded their account limits due to these fees, and thus were fined double.

Approximately 2.1 million customers of the bank are expected to get refunds.

JP Morgan has a track record of financial misdemeanors.


Controversies in which the bank has been embroiled, are listed in this Wikipedia article:

  • In 2012 it was charged with failing to disclose risky and speculative trades that resulted in significant losses.
  • In 2002 it paid $80 million settlement as one of ten banks who deceived investors with biased research.
  • It paid over $2 billion in fines and legal settlements for financing, and thus abetting Enron Corporation‘s energy and securities fraud.
  • In 2005 it had to pay a $2 billion underwriting shortfall over a bond float for WorldCom, an amount that could have been $630 million less if it had agreed to accept an investor offer.
  • In Nov 2009 in paid a $722 million settlement with the US SEC to halt a probe into sales of derivatives that pushed the Jefferson County, Alabama, to the brinK of bankruptcy.
  • In June 2010 the UK Financial Services Authority was fined US$49.12 million for failing to protect clients’ money in separate accounts from the risk of corporate insolvency.
  • In Jan 2011, they admitted to wrongly overcharging several thousand military families for their mortgages, and had improperly foreclosed on some mortgages.
  • In July 2013 their energy subsidiary JP Morgan Ventures Energy Corporation paid $410 million in penalties for allegations of market manipulation, and unjust profits.
  • On August 25 2013, they agreed to settle fines issued for violations of sanctions by the Office of Foreign Assets Control.

Greed is never good. Derivative trading appeals to our innate greed.

To assiduously work to make money is legitimate. To my way of thinking  greed can be defined as the pursuit of wealth by the unfair exploitation of others.

Derivative transactions are revenue neutral. For every winner there is a loser. Providers have an obligation not to unfairly disadvantage their clients. Contracts should be vetted by neutral authorities.

My gripe with some self-serving monolithic financial institutions of the world is three-fold:

  • they all too frequently use their superior clout to deny their clients fair deals
  • they themselves endanger global stability by engaging in risky, highly leveraged derivative trading, with inadequate trader supervision, and risk control.
  • derivative products are heavily advertised and promoted for the use of retail clients, with insufficient disclosure of the extent of the risk.

Markets will never be completely sanitized, nor greed eliminated. All that can be hoped for, is that all participants will be risk aware, and that a culture of integrity and accountability is fostered. Gearing is a dangerous lever and the exuberance of Individual traders must be curtailed.

My Advice for retail investors:

Invest in the Equity Markets. Obtain professional advice to set up a balanced portfolio suitable for your requirements, and risk profile.

The stock-market enables share-holders to participate from the profits of industry. It can be a win-win-win situation for shareholder, company, and the financial intermediary. Shareholder wealth is created as the economy prospers. Reverses do occur but those of catastrophic proportions are infrequent, and sooner or later are likely to recover. Total loss is unlikely compared with derivative trading.

Categories: Business, Financial News, Market Regulation

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1 reply


  1. My CFD experience « Technically Speaking

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