Stuffing: What It Means, How It Works, Types

What Is Stuffing?

Stuffing is the act of selling unwanted securities from a broker-dealer's account to client accounts. Stuffing allows broker-dealer firms to avoid taking losses on securities that are expected to decline in value. Instead, client accounts take the losses.

Stuffing can also be used as a means to raise cash quickly when securities are relatively illiquid and difficult to sell in the market. Stuffing is considered to be an unethical practice but it can be difficult to prove whether such transactions constitute fraud.

How Stuffing Works

Broker-dealers are meant to act in the best interest of their clients, and though stuffing is frowned upon, it can be very difficult to prove. Often, broker-dealers are given the power to buy and sell without client consent for discretionary accounts. Furthermore, the legal standard for broker-dealers buying securities for these accounts is "suitability," which can be broadly interpreted. Since discretionary accounts provide so much power to broker-dealers, many financial advisors suggest that customers insist on providing consent for all transactions in their accounts. 

If you don't have a long and trusted history with your broker-dealer, it is always best to know what is being bought and sold in your account. Not only to avoid losses but even to be aware of possible illegal practices.

Clearly, you can assume that stuffing can cause issues as it relates to brokers and customers. This is why stuffing can be quite troublesome for all parties involved. The push to have discretionary accounts give consent to all transactions is a safety protocol that is in the best interest of the client. As the world of Wall Street moves towards openness; procedures in place to avoid stuffing are widely considered a good thing.

Stuffing vs. Quote Stuffing

The stuffing of customer accounts differs from the better-known form of stock market manipulation, "quote stuffing." Quote stuffing is the practice of quickly entering and then withdrawing large orders in an attempt to flood the market with quotes, causing competitors to lose time processing them.

Quote stuffing is a tactic by high-frequency traders (HFT) in an attempt to achieve a pricing edge over their competitors. In practice, quote stuffing involves traders fraudulently using algorithmic trading tools that allow them to overwhelm markets by slowing down an exchange’s resources with buy and sell orders.

Other Forms of Stuffing

Stuffing may also refer to when a broker loses a price or quotes a price incorrectly and is obligated by another party to honor and complete a transaction at the quoted or promised price. In general, the price to cover the agreed-to transaction is a disadvantage to the individual who quoted it. However, the cost of fulfilling the order is borne by the broker; the "stuffed" party.

In channel stuffing, salespeople and companies attempt to inflate their sales figures—and earnings—by deliberately sending buyers (such as retailers) more inventory than they are able to sell. Channel stuffing tends to happen closer to the end of quarters or fiscal years to help influence sales-based incentives.

This activity can cause artificial inflation of accounts receivable. When retailers are unable to sell the excess inventory, the surplus goods are then returned and the distributor is required to readjust its accounts receivable (if it adheres to GAAP procedures). As a result, its bottom line suffers after the fact, and after bonuses are paid. In other words, channel stuffing will eventually catch up with a company that fails to prevent it.