Knight Loss Is $270 Million After Taxes, Joyce Tells Clients

Knight (KCG) Capital Group Inc. Chief Executive Officer Thomas Joyce estimated last week’s trading loss will be $270 million after taxes and told clients the firm is “in good standing” with clearinghouses.

The post-tax loss compares with a previously disclosed pretax loss of $440 million. The letter comes a week after Knight, one of the biggest market-making firms in the U.S., was driven to the brink of bankruptcy after a technology malfunction spewed orders into the market by mistake. Joyce told clients that the company is in talks with outside advisers as it works to prevent another error.

Knight’s relationships with the Depository Trust & Clearing Corp. and the Options Clearing Corp. remain intact, according to the letter from Joyce. Knight Capital Americas LLC and Knight Capital Europe Ltd., the firm’s broker-dealer units, have held capital above the minimum requirements and consistent with historic levels, he wrote.

“Our review of the August 1st technology issue is ongoing and we take this matter very seriously,” Joyce wrote in a letter obtained by Bloomberg News and confirmed by Knight spokeswoman Kara Fitzsimmons. “We are in discussions with external advisors in an effort to effectively assess the situation, in addition to our internal review.”

Rescue Funding

Knight was saved from collapse on Aug. 6, when it received a $400 million cash infusion through the sale of convertible securities from a consortium of investors. Getco LLC, Blackstone Group LP, brokerages Stifel Nicolaus & Co. and TD Ameritrade Holding Corp., as well as Stephens Inc. and Jefferies Group Inc. invested in the rescue funding, according to the Jersey City, New Jersey-based company. The investment will give the firms a 73 percent stake in Knight once the shares are converted into common stock.

Clearinghouses such as DTCC and OCC operate as central counterparties for all buy and sell orders executed or handled by their members, who post collateral to reduce the threat from a trader’s default. Their members are called clearing firms.

“DTCC has been in near-constant communication with Knight since last Wednesday and throughout much of the weekend to address the myriad of issues arising from this situation,” Michael C. Bodson, president and chief executive officer of the clearinghouse, wrote in an Aug. 6 letter to clients, a copy of which was attached to Joyce’s communication. “DTCC has been in close touch with our regulators and our board during this time to keep them fully apprised of our discussions with Knight and the actions we have undertaken to provide stability to the markets during this period of uncertainty.”

69 Percent

Knight’s stock rose 3.3 percent to $3.16 in New York today and is down 69 percent from its $10.33 closing price before the Aug. 1 software malfunction.

Knight rejected a $500 million rescue-loan offer from Citadel LLC on Aug. 5, said two people with knowledge of the matter. The loan terms would have given Citadel a minority stake in Knight’s stock and an interest in its HotSpot foreign- exchange subsidiary, said the people, who spoke on condition of anonymity because the talks were private. Citadel, the $12.5 billion hedge fund run by billionaire Ken Griffin, competes with Knight’s market-making and electronic-trading business.

‘Still Fluid’

Knight may have suffered additional losses outside of what it has reported so far as legal and consulting costs increase while revenue is hurt by decreased use of its services among clients, according to Christopher Allen, an analyst at Evercore Partners Inc. (EVR) in New York.

“We still await details on what other losses were incurred last week as Knight attempted to free up capital before the raise was in place,” Allen wrote in a note yesterday, adding that Evercore acted as an adviser to Blackstone in the transaction. “The situation is still fluid in our view as there are still questions to be answered around capital levels, strategic direction, and risk management capabilities moving forward.”

NYSE Euronext said in a statement yesterday that Knight will resume its duties as a designated market maker on the New York Stock Exchange on Aug. 13. The exchange said that all of the firm’s securities, staff, operations and systems will return to Knight after being temporarily reassigned to Getco earlier this week.

Knight has 18 employees and a compliance officer as part of its market-making operation at the exchange, according to Richard C. Adamonis, a spokesman for NYSE. Designated market makers are floor traders who buy and sell specific stocks to help increase liquidity in the market, performing many of the tasks of what used to be known as specialists.

Knight reported $115.2 million in net income in 2011 on revenue of $1.36 billion. The firm’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.

To contact the reporters on this story: Inyoung Hwang in New York at ihwang7@bloomberg.net; Stephanie Ruhle in New York at sruhle2@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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