Knight Capital Group Inc. (KCG), struggling to stay afloat after a trading error spurred a $440 million loss and caused some clients to trade elsewhere, told brokers it secured short-term financing to fund market making, a person with knowledge of the matter said.
The Jersey City, New Jersey-based securities firm has money for today, according to the person, who requested anonymity because the conversations were private. Knight’s stock surged 64 percent to $4.24 at 2:35 p.m. in New York, extending gains after TD Ameritrade Holding Corp. said it will resume routing trades to the firm. The shares had tumbled 75 percent in the previous two sessions.
As the company opened its books to potential investors or buyers, some of the world’s biggest investment firms and electronic brokerages shunned the market maker for a third day. The software bug on Aug. 1 flooded the market with unintended trades and left Knight with a loss that threatens to exhaust its cash. U.S. stock trades settle three days after they are made.
“Knight may or may not have the ability to withstand this on a balance sheet basis, but their biggest risk is if people decide not to do business with them,” Keith Wirtz, who oversees $14.7 billion as chief investment officer for Fifth Third Asset Management in Cincinnati, said in a telephone interview. Fifth Third is a client of Knight’s. “In my 30-plus years experience, your confidence with a counterparty like a Knight is only as strong as their skills as well as their balance sheet.”
Kara Fitzsimmons, a Knight spokeswoman, didn’t return a call and e-mail requesting a comment today. The short-term financing was reported earlier by the Wall Street Journal.
Knight opened its books to private-equity firms and at least one securities-industry rival, said two people with knowledge of the matter. It’s working with Sandler O’Neill & Partners LP and Goldman Sachs Group Inc. as advisers in the rescue talks, said one of the people, who spoke on condition of anonymity because the discussions are private. The company is under pressure to strike a deal within days, the people said.
The trading fault, which caused stocks to move as much as 151 percent, left the firm with a “large error position,” Knight Chief Executive Officer Thomas Joyce told Bloomberg Television yesterday.
“We’re talking to a lot of capable people, people who are in touch with situations like this,” Joyce said yesterday. “This was an anomaly, not one we’re proud of.” Joyce declined to elaborate on the discussions during the interview, saying “you might imagine during the day-to-day activity, it’s kind of hard to comment.”
John Woerth, of Vanguard Group Inc., and Whitney Ellis, a spokesman for Scottrade Inc., said in e-mails that their firms continue to avoid routing brokerage orders through Knight. Fidelity Investments, the second-largest mutual-fund company, is routing orders away from Knight, according to a person familiar with the matter, who asked not to be identified because the information is private.
TD Ameritrade Holding said it will resume routing client trades to Knight after testing its systems.
“After considerable review and discussion, we are resuming our order routing relationship with Knight,” said Fred Tomczyk, president and chief executive officer at TD Ameritrade, in a statement. “Knight is one of many order routing destinations for us and has long been a good and trusted partner.”
About 23 percent of Vanguard’s market orders in NYSE-listed securities were routed to Knight last quarter, according to a filing. The figure was 41 percent at Scottrade, 38 percent at Fidelity’s National Financial Services LLC unit and 9 percent at TD Ameritrade.
Fitch Ratings said in a statement that it does not expect any major counterparties of Knight to suffer large losses even in a bankruptcy scenario since “numerous institutions” have already switched to other market makers. The issue still may lead to a structural change in the business, the ratings firm said.
“The events of the last two days again pose risks for equity trading volume as many investors become more concerned about seemingly unforeseeable risks related to trading technology problems and the broader market impact of high-frequency trading systems that periodically break down,” Fitch said in the statement.
The number of exchange-listed securities changing hands on average each day fell 11 percent to 6.12 billion in July from a year ago, according to data compiled by Bloomberg.
Knight’s $440 million loss compares with net income of $115.2 million in 2011 and is more than the company’s market value of $253 million at the close yesterday, data compiled by Bloomberg show. The company was worth as much as $4.8 billion in 2000 and valued at more than $1 billion before yesterday, according to data compiled by Bloomberg.
The loss represents about 40 percent of Knight’s book value and would “exhaust” the firm’s cash, according to CLSA Credit Agricole Securities. Knight had $365 million of cash as of the end of June, with about $70 million in its revolving credit line, Robert Rutschow, a New York-based analyst with CLSA, wrote in a report yesterday.
Kenneth Pasternak, who co-founded Knight in 1995 and retired in 2002, said in a telephone interview that a takeover by a big bank may slow the process of innovation that helped Knight become a leader in computerized trading.
“I seriously doubt they will go out of business,” said Pasternak, who now runs a family office, Chestnut Ridge Capital LLC, in Jersey City. “I just hope they can maintain the innovation. My fear is they will be bought by some big bank and become consumed by the CYA behavior and lose their edge.”
Knight’s market-making unit executed a daily average of $19.5 billion worth of equities in June, according to its website. The unit traded 711 million exchange-listed shares a day in June, according to data compiled by the company and Bloomberg.
The NYSE reviewed trading in 140 stocks from Molycorp Inc. to AT&T Inc. as the market’s Aug. 1 open was disrupted. Trades that occurred during the height of the volatility were canceled in six securities, where prices swung at least 30 percent in the first 45 minutes. Trades in all of the other stocks were allowed to stand.
“Technology breaks,” Joyce told Bloomberg TV yesterday. “It ain’t good. We don’t look forward to it.” He added that the problem is mainly one for his firm, and “we did not harm individual investors, we got them out of the way.”
The software malfunction was the latest black eye for the computer infrastructure of an equity market still haunted by the May 2010 market crash, the botched initial public offering of Facebook Inc. (FB) and failed IPO of Bats Global Markets Inc.
The Securities and Exchange Commission has been monitoring the situation, spokesman Kevin Callahan said in an e-mail yesterday. George Smaragdis, spokesman for the Financial Industry Regulatory Authority, said Finra has examiners on site and is working with Knight and other regulators to review the impact of the incident.
The error has fueled scrutiny that may reshape an industry spread across about 50 trading venues. The head of the New York Stock Exchange said the firm’s crisis is a “call to action” to fix a market that’s grown too complex to explain to regulators.
“The structure that has evolved over the last decade in the U.S. has led to inexorable fragmentation, really an emphasis on speed, a feeling that if something is faster than by definition it’s better,” NYSE Euronext Chief Executive Officer Duncan Niederauer said during a conference call today after the company reported earnings. “We are understanding that speed is not always better.”
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