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2012-08-07 11:39:38
Aug 6th 2012, 15:24 by T.E. | NEW YORK
IT MAY be the slowest trade Knight Capital, a firm known for high-speed
financial transactions, has executed since its inception. Between August 2nd
and 6th, its management has been involved in hectic negotiations to conclude a
distress sale of a big stake of its own equity to well-capitalised investors.
The aim was to ensure Knight s survival after a devastating software glitch on
August 1st which cost the firm $440m.
The deadline was the start of trading in New York on Monday, the 6th. And sure
enough, not long after the echo of the opening bell subsided, a press release
was posted on Knight s website. It announced an injection of $400m in equity
from a consortium of firms: Jefferies Group, a bank, which took the lead;
Blackstone, a private equity firm; GETCO, a Chicago-based competitor; and two
brokers, Stifel Financial and TD Ameritrade.
Knight, which prior to the trading disaster was known for its IT skills, plays
a key backstage role executing trades for retail brokerages. This meant that
even in Knight s darkest moments, other Wall Street firms had an interest in
some sort of bail-out. During the negotiations cost was the most important
question, though failure was certainly a possibility.
Critical details were missing in this morning s press release, but it is widely
reported that in exchange for the cash infusion, the investors will ultimately
receive 70% of Knight s equity, along with seats on Knight s board. A higher
price would have probably meant the end of the firm s independence, which may
have been the limiting factor.
The company s stock price fell to $3 a share, down from just over $4 at the
close of trading for the weekend, but up from $1.50 early Friday morning. Prior
to the crisis, it traded above $10, suggesting the glitch cost the firm more
than $700m in value.
The evisceration of net worth resulted from a faulty trading algorithm embedded
in new software. Yet critical details remain unknown, notably who gained from
Knight s losses, and what, specifically, went wrong. It appears that the prices
at the opening of more than 100 securities might have been directly affected,
with a particularly large impact on a half-dozen.
In a matter of minutes, Knight was left with a vast portfolio of stocks
acquired at unfavourable prices. The position was reportedly sold in bulk and
at some discount to Goldman Sachs, capping Knight s losses at $440m. That may
have capped the disaster, but nonetheless left the firm reeling. Knight is not
in the category of too big to fail and as soon as the firm s trading problems
became known, customers stopped sending any business. After the announcement of
the capital injection, there were indications that key customers would begin
sending business to Knight once again.
Emphatic message
The firm emerged in the 1990s as an alternative trading venue to the
established firms. In the midst of a crisis in 2002, Thomas Joyce became its
chief executive, moving over from Merrill Lynch where he had run one of the
largest trading platforms in America. He is broadly thought to have done a good
job at Knight. The head of a trading desk at one firm said that he believed
there was a good possibility that lost business could be largely recovered over
the course of a year, though probably not sooner.
The boss of one firm that competes and works with Knight said the experience
shows that trading algorithms are potential weapons of mass destruction for the
firms using them, and the broader financial system. Knight s problems follow
costly trading disasters tied to the public offering of Facebook on the NASDAQ
stock exchange and the BATS Global Market on its own electronic exchange.
Not surprisingly, the Securities and Exchange Commission has issued the
expected statement of outrage ( unacceptable , says the commission s chairman
Mary Shapiro). Other brokers and exchanges were rattled as well. In its
security filings Knight is clear about the risk it faces from exactly the kind
of problem it encountered. But its realisation, and Knight s struggle to
survive, has sent an emphatic message. For all but the too-big-to-fail
institutions, survival requires making the system work better.