Custody-Only Trading

Electronic trading in stock shares and bonds are facilitated via depository transfer check (DTC), which serves as the repository and record-keeping clearinghouse for negotiable securities. However, there are circumstances when shares or bonds are held in physical certificate form, i.e. custody-only trading.

Often, in the past, people would buy and hold the certificates with the intention of passing them down to heirs in their wills. Early buyers of Walt Disney Co. stock often framed their certificates, which were inscribed with a photo of Walt Disney surrounded by Mickey Mouse, Donald Duck, and other beloved characters. These have since become collectibles, with a certificate for a single share of stock worth a few hundred dollars.

The other reason to keep securities in physical certificate form is to prevent illegal short selling, which still is practiced regularly in spite of a 2008 SEC ban. The unavailability or limited supply of stock that can be “loaned” for legitimate short sales allows for companies to forensically track which market makers may be in violation. This is a tactic that Pink Sheet and small cap public companies may need to deploy to avoid predatory speculation and manipulation of stock prices by market makers.

True story: a Market Maker naked shorted about 20,000 shares of stock at $2. It subsequently dropped to about $0.65, where it stayed for over 9 months. The Market Maker had a $27,000 positive carry on his P&L for so long that he forgot to follow the position for news. One day he saw that he had a -$10,000 position, and was shocked to see the stock at $2.50. There had been a tender offer to go private, and 94% of the stock had been purchased. The Market Maker had to bid on the Street and try to locate any shareholders without stock in Street Name, i.e. certificate form. Every electronic purchase of 10 shares increased the price by 25-50 cents. They wound up paying an average of over $38 per share, after finding several certificate owners to sell to them to cover the rest of the short. Expensive lesson, but the alternative could have been to possibly lose their NASD trading authorization.