What Is a Block House?

A block house is a brokerage firm that specializes in matching potential buyers and sellers for large-scale trades.

Generally, a block house deals with institutional clients rather than individual investors. A single trade may represent millions of dollars in assets.

Key Takeaways

  • Block houses are brokerages that deal primarily in large block trades between institutional investors.
  • By definition, a block trade is more than $200,000 worth of bonds, or 10,000 shares of stock, not including penny stocks.
  • Block trades are made directly between the buyers and sellers, not on the public exchanges.

How a Block House Works

A block house, like any brokerage firm, facilitates transactions between buyers and sellers. It makes money on the commissions and other transaction fees it charges to do that.

Unlike most brokerage firms, block houses deal primarily in so-called block trades. By definition, a block trade exceeds $200,000 worth of bonds or 10,000 shares of stock, not including penny stocks. In practice, block trades are typically much larger than that.

The actual transaction is made between the parties, with the brokerage house acting as a middleman, rather than on a public exchange.

The Role of the Block House

Block trades are done off-exchange by necessity. A very large order to buy or sell a particular stock will, however inadvertently, disrupt trading and artificially inflate (or deflate) its market price.

For this reason, block trades go through block houses. A block house can break up the trade into 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. For example, if a mutual fund manager moves to acquire a large amount of stock in the leisure industry, analysts may see it as a potential trend upwards for leisure stocks in the near future.

Block houses’ institutional clients include corporations, banks, insurance firms, mutual fund companies, and pension funds.

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 exchanges accessible to all investors, the fourth market is more exclusive and less transparent. Trading is restricted to institutions and transactions are only made public after they are completed.

This last feature of the fourth market is the biggest advantage to institutions initiating block-size trades. It removes the risk that the market price will rise dramatically before the transaction is complete as other investors pile on.

The Potential for Insider Trading

The fourth market also precludes the possibility that a block house trader will use knowledge of an impending block trade to engage 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 immediately before block trades from his firm’s clients went through and boosted the prices of the stocks they were buying.

His scheme benefitted him by at least $1.7 million over the course of 400 transactions. This was insider trading. Worse, it set his own interests in opposition to those of his clients, who specifically relied on him to manage their price exposure.

Example of Block House Trading

Let's assume a hedge fund owns one million shares of ABC stock and decides to sell it.

ABC typically trades about 200,000 shares a day. A block trade of this size could not go through a public stock exchange without dramatically altering ABC's trading pattern for the day. And that could be costly to the hedge fund. Instead, ABC decides to work through Cantor Fitzgerald, a block house brokerage.

The trader at the hedge fund will send a message to a sales professional at Cantor Fitzgerald looking for buyers of ABC.

The hedge fund will not immediately divulge that all one million shares are for sale. Instead, it says 100,000 shares are available. That brings out more potential buyers.

The sales professional alerts traders that 100,000 shares of ABC are for sale. The traders reach out to their contacts to gauge interest.

Eventually, the hedge fund and a buyer or buyers will make a deal.