Stuffing (Securities Trading) - Explained
What is Stuffing in Securities Trading?
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Table of ContentsWhat is Stuffing in a Sale of Securities?How Does Stuffing in Securities Trading Work?Stuffing vs. Quote StuffingOther Forms of Stuffing
What is Stuffing in a Sale of Securities?
In the trade of securities, stuffing refers to an act of trading an unpleasant security. It is a situation in which a broker dealer sells an undesirable security to a client. Once the security is moved from the broker dealer's account to the client's account, all losses and risks associated to the security are transferred to the client. Broker dealers tackle illiquidity in securities through stuffing.
How Does Stuffing in Securities Trading Work?
Although, many people tag stuffing as an unethical act, it cannot be proven. It is quite difficult to ascertain whether broker-dealers use stuffing as a means to defraud clients or perpetrate an unfavorable act. In certain situations, especially for discretionary accounts, broker-dealers can buy or sell securities without any knowledge or approval of the client. This is legal, broker-dealers can buy and sell securities for the client's account on the ground of suitability. Despite that broker-dealer's have that much power on discretionary accounts, professional accountants and financial advisors are often of the opinion that clients give consent before certain transactions are done in their accounts.
Stuffing vs. Quote Stuffing
Quote stuffing is different from the plain stuffing. Quote Stuffing is manipulative and done with the intention of perpetrating fraud. In quote stuffing, traders or broker-dealers who trade frequently in the market make a quick entrance and withdrawal of huge orders just to flood the market and make it impossible for a normal market flow to occur. In this situation, there is confusion in the market in such a way that other competitors have no time to process the quotes that have been flooded into the market. The category of traders that use quote stuffing often is the high-frequency traders (HFT). It is a fraudulent act which involves the use of algorithmic trading tools to manipulate the market.
Other Forms of Stuffing
Channel stuffing is another form of Stuffing that entails the act of a salespersons deliberately sending buyers excess inventory more than they need with the sum of inflating their sales figures. These people engage in channel stuffing in order to benefit from incentives attached to sales. Stuffing can also occur when a broker-dealer's quote is incorrect and he is obliged to complete the transaction at the quoted price. For instance, if the broker makes a quote that is unfavorable and he is obligated by the other party in the transaction to fulfill the order, stuffing will occur.