Knight's future in balance after trading disaster

NEW YORK (Reuters) - Knight Capital Group Inc was fighting for its survival on Thursday after a trading glitch that had roiled markets wiped out $440 million of the firm's capital, forcing it to seek new funding as its shares plunged more than 70 percent in two days.

Some of the company's biggest customers, including TD Ameritrade, the No. 1 U.S. retail brokerage by trading volume, and Fidelity Investments are not routing orders through Knight. Smaller customers also were taking business elsewhere.

The company, one of the largest U.S. market makers, said it is "actively pursuing its strategic and financing alternatives," raising the possibility Knight could be sold or even face bankruptcy.

The troubles at Knight have spooked investors about a potential failure for the firm, which in 2011 was the No. 1 market marker in retail U.S. equity shares traded in NYSE and NASDAQ stocks.

"They have about 48 hours to shore up confidence," said James Koutoulas, chief executive of Typhon Capital Management and lead lawyer for Commodity Customer Coalition, an advocacy group for former customers of MF Global and Peregrine Financial.

The incident and subsequent collapse in the company's stock has cast more doubt on the inner workings of financial markets increasingly driven by electronic trading that regulators and firms are struggling to control.

They include the troubled Facebook IPO in May, the failed IPO of exchange venue BATS Global Markets in March and the Flash Crash in May 2010.

TD Ameritrade, which averaged just over 355,000 trades a day last quarter, is currently not sending orders through Knight as it tests its systems to make sure everything runs smoothly, said Joe Kinahan, chief derivatives strategist at TD Ameritrade.

The company routs about 4.5 percent of its orders through Knight.

"We are monitoring the situation," Kinahan said, adding that as long as Knight remains in good standing with the exchanges, TD Ameritrade will resume sending orders through it.

He said that every client trade that TD Ameritrade sent on Wednesday was filled, because Knight was quick to tell the brokerages to reroute their orders.

Fidelity Investments' brokerage arm on Thursday was not routing customer orders through Knight, according to people familiar with the situation, who also said Fidelity is not having any trouble routing orders as it moves the Knight traffic to other market makers.

Knight is in talks with Silver Lake Partners-backed trading firm Virtu Financial LLC about a possible deal, according to the Wall Street Journal. Knight has approached JPMorgan Chase & Co for financing, according to a report on Fox Business Network. A spokesman for JPMorgan declined to comment. A spokeswoman for Knight Capital also declined comment.

Wednesday's technology breakdown roiled the prices of some 140 stocks listed on the New York Stock Exchange, undermining fragile investor confidence in the stability of U.S. stock markets.

From the opening bell on Wednesday, traders across the market noticed something wrong, which Knight later attributed to software problems that caused little-traded shares to rise sharply, some gaining more than 100 percent within seconds. It took 45 minutes to resolve the problems, again pointing to the inability of individuals to contend with out-of-control computer based trading.

"We're losing the human control in our business," said Joe Anastasio, a founding partner of financial services consulting firm Capco who specializes in stock trading issues. "We've been so focused on automated throughput of orders and high-volume execution with no human intervention that we have lost the human logic factor when things go wrong."

Knight's shares were down 54 percent at $3.09 in afternoon trading after hitting a 13-year-low of $2.97 a share.

A SYSTEMIC RISK FOR MARKETS?

Although Knight opened for trading on Thursday there were questions about how the firm's possible failure might affect the vast network of brokers that rely on it to process orders and whether a failure could cause serious market stress.

"Knight is the one franchise that has built a network of over well over 800 broker-dealers throughout the country," said Chris Nagy, a market structure consultant.

"Many of those 800 broker-dealers, although they have very small amounts of order flow, in aggregate, represent a significant amount of volume. That's the concern, because quite frankly, those firms have no other options."

Knight's daily market-making volume was $19.5 billion in June, down 12 percent from a year ago as overall equity trading volumes have declined.

Street One Financial, a Huntington Valley, Pennsylvania-based firm that executes trades for institutional investors, on Thursday got calls from seven new asset management firms wanting to place trades because they did not want to trade with Knight due to concerns over the firm's viability.

"They have heard the reports that Knight is asking JPMorgan for an emergency loan and they don't want to risk it," said Scott Freeze, chief executive of Street One Financial.

TRADING GLITCH

The U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority are looking into Knight's trading error, according to William Brodsky, CEO of top U.S. options market CBOE Holdings Inc.

"It's obvious that it appears that there was a technology glitch in the trading algorithm," Brodsky told analysts on Thursday. "All markets have rules to address these types of situations."

While securities regulators are looking into what went wrong on the trading side, the focus from the futures industry is on the estimated $411 million in customer funds that were part of Knight's purchase in May of floundering futures brokerage Penson Financial Services.

Confidence in the futures industry's ability to safeguard customer funds has been shaken after two financially pressed futures brokers in less than a year have been accused of improperly raiding customer accounts for as much as $1.8 billion, despite regulatory oversight.

Speaking on Bloomberg Television Thursday morning, Knight Capital Chief Executive Officer Tom Joyce said the firm had "excess capital right now." On Tuesday night, it had put in new software that had a bug, he said.

The firm said it was in compliance with capital requirements, and Financial Industry Regulatory Authority, which oversees broker-dealers, confirmed Knight was in compliance.

"This issue was related to Knight's installation of trading software and resulted in Knight sending numerous erroneous orders in NYSE-listed securities into the market," Knight said. "This software has been removed from the company's systems."

On July 18, Knight reported second-quarter earnings of $3.3 million, down 81 percent from a year earlier after recording a $35.4 million pretax trading loss from the Facebook initial public offering. The company has not yet filed its second-quarter report with regulators.

Longview Capital Management, LLC, a Wilmington, Delaware-based registered investment adviser with $200 million in assets under management, is holding off from trading with Knight until "it gets its act together and tell us where they stand," said Christian Wagner, chief executive and chief investment officer of the firm.

"They are simply out of rotation right now until we are satisfied that they are back on their feet."

(Additional reporting by Jed Horowitz, Angela Moon, Jessica Toonkel, Chuck Mikolajczak, Lauren LaCapra, Sam Forgione, John McCrank, and David Henry in New York, Tim McLaughlin in Boston and Ann Saphir in Chicago; Editing by David Gaffen, James Dalgleish, Lisa Von Ahn and Kenneth Barry)

Source: http://news.yahoo.com/knight-seeks-financing-440-million-trading-loss-124602408--finance.html

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