17 Mar 2020

What is a Block House?

A block house is a particular type of brokerage firm that deals in large trades. In particular it specializes in locating potential buyers and sellers for the large trades. A block house typically deals with institutional clients rather than individual investors, since a single large trade may represent millions of dollars.

KEY TAKEAWAYS

  • A block house, like any brokerage firm, facilitates transactions between buyers and sellers, who pay the firm commissions and other transaction fees. Unlike most brokerage firms, block houses deal primarily in so-called block trades, which, by definition, exceed $200,000 worth of bonds, or 10,000 shares of stock, not including penny stocks.
  • Because of the potential impact that large-volume trades can have on the market value of the securities being traded, block trades usually go through block houses. Block houses can break up the trade into several smaller chunks and channel them through separate brokers to keep market volatility to a minimum.
  • Block houses’ institutional clients include corporations, banks and insurance firms, as well as mutual funds and pension funds that assume significant security positions.

How a Block House Works

A block house, like any brokerage firm, facilitates transactions between buyers and sellers, who pay the firm commissions and other transaction fees. Unlike most brokerage firms, block houses deal primarily in so-called block trades, which, by definition, exceed $200,000 worth of bonds, or 10,000 shares of stock, not including penny stocks. In practice, block trades tend to be much larger. These transactions occur off exchange, or outside of the open market.

Because of the potential impact that large-volume trades can have on the market value of the securities being traded, block trades usually go through block houses. Block houses can break up the trade into several smaller chunks and channel them through separate brokers to keep market volatility to a minimum. That said, even well-executed block trades can significantly impact the market, and some analysts watch block trade activity to anticipate market trends.

Block houses’ institutional clients include corporations, banks and insurance firms, as well as mutual funds and pension funds that assume significant security positions.

The Block House Alternative

Institutions seeking to avoid brokerage fees and commissions also may conduct block trades directly, without employing a block house as an intermediary, on the fourth market. While primary, secondary and third markets are public markets accessible to every kind of investor, the fourth market is more exclusive and less transparent. Fourth-market trades are restricted to institutions and are only made public after the transaction is complete.

It’s this last feature of the fourth market that offers another advantage to institutions initiating block-size trades besides low transaction fees. Because the trade is conducted with less transparency, there is less risk that the market will shift before the transaction is complete.

The fourth market also precludes the possibility that a block house trader will use knowledge of an impending block trade in a fraudulent practice known as front running. In 2013, a senior equity trader at Dallas-based Cushing MLP Asset Management, was caught conducting his own trades just before block trades from his firm’s clients that were likely to boost the stock’s price. Not only did his scheme unethically benefit him by at least $532,000 over the course of 132 transaction; it set his own interests in opposition to those of his clients, who specifically relied on him to manage price exposure.

Example of Block House Trading

Let’s assume a hedge fund is long 1,000,000 shares of ABC stock and they are looking to sell a block through Cantor Fitzgerald (a block house). They want to use a block house because ABC typically trades 200,000 shares a day on average. So, a large trade of this size would greatly impact the price of ABC.

The trader at the hedge fund will call up or send an instant message to their dedicated saleswoman at Cantor Fitzgerald looking for buyers of ABC. The hedge fund will not divulge that they are looking to sell 1 million shares, instead they will say 100,000 shares in an attempt to bring out buyers. The saleswoman will alert the other sales traders that she is a seller of 100,000 shares of ABC. The other salespeople will reach out to their relationships and even those that hold positions in ABC, in an attempt to see if they are interested in buying shares of ABC. Because ABC is rather illiquid, it trades by appointment.

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