Getco to Consider Buying Knight Shares, Evaluate Investment

Getco LLC will consider transactions with Knight Capital Group Inc. (KCG) such as buying or selling shares of the market-making firm that dodged bankruptcy in August.

Getco said it may evaluate its investment in Knight, according to an amended 13D filed yesterday with the Securities and Exchange Commission. Chicago-based Getco owns convertible securities representing a 23.8 percent of Knight’s outstanding common stock after helping rescue the company following its $457 million trading error. The new language is similar to passages in filings by Blackstone Group Inc. and Stephens Inc., two other Knight investors that helped save the firm three months ago.

“They may be contemplating or signaling to the market that they may be more open to acquisition-type transactions,” William J. Tuttle, a Washington-based lawyer who focuses on corporate and securities matters at Dechert LLP, said in a phone interview. “This language is still very flexible but it sends a slightly stronger statement to the market.”

Knight shares rallied 6.6 percent to $2.52 as of 2:03 p.m. in New York, poised for the biggest advance in almost two months. Getco’s stake represents 23.8 percent of the 181.9 million shares of common stock outstanding on Nov. 5, according to the filing. It would own 15.6 percent of Knight’s 364.7 million shares of common stock if all the preferred stock holders converted their shares, the filing said.

Getco and Knight are market-making firms whose rise paralleled the explosion in electronic and individual trading since the 1990s. Control of the Jersey City, New Jersey-based company was transferred from public shareholders to six Wall Street firms including Getco in August after they provided cash to preserve its solvency.

Jefferies Investment

Getco didn’t mention evaluating its Knight holdings or the possibility of buying or selling shares in its filing on Aug. 6.

“As a matter of policy, Knight does not comment on shareholder activities including filings,” Kara Fitzsimmons, a spokeswoman, said in an e-mail. Sophie Sohn, a spokeswoman for Getco, declined to comment.

Getco, the automated trading firm founded in 1999, was one of six investors that acquired stakes when they bought $400 million of convertible stock. Others included Jefferies Group Inc. (JEF), the investment bank that agreed last week to be taken over by its largest owner, Leucadia National Corp. (LUK), for $2.8 billion.

Knight’s capital was depleted after it bombarded U.S. equity exchanges with erroneous orders on Aug. 1 in the wake of improperly installed software that malfunctioned, according to Chief Executive Officer Thomas Joyce. The trading caused volume to surge and prices to swing in dozens of securities listed on the New York Stock Exchange and NYSE Arca.

Market Makers

Getco and Knight are automated market makers. While Getco operates across asset classes mainly on exchanges and similar platforms around the world, Knight is also a wholesale market maker that services retail brokers including Fidelity Investments and TD Ameritrade Holding Corp. by executing buy and sell orders for individuals.

Knight has expanded its operations beyond equities and market making to areas such as foreign currency and fixed-income trading. It owns the Hotspot FX and BondPoint platforms, provides research and asset management and got into the reverse mortgage business in 2010. Knight had more than 1,400 employees at the end of last year, it said in a filing.

More Control

The change in Getco’s filing “would suggest to me that they might now be thinking that they want to expand their holding and go for more control,” Elizabeth Nowicki, a mergers and acquisitions professor at Tulane University Law School, said in a phone interview.

In an Aug. 6 interview, Daniel Coleman, chief executive officer of Getco, said Knight’s disappearance wouldn’t have yielded a “better world” for Getco. Without Knight’s ability to provide liquidity, “it would be more expensive for everyone to trade,” he said in a phone interview.

“In some ways Knight’s a competitor, in some ways they’re a client, in some ways we’re their client,” Coleman said. “But at the end of the day the liquidity they provide and I think the liquidity we provide probably makes both of us better. This is in our strategic interest to make sure Knight stays viable.”

SEC Investigation

The SEC began a formal investigation into Knight’s compliance with a rule governing risk-control procedures in its trading operation and other regulations, the company said in a filing with the commission on Nov. 8.

Knight’s stock plunged after the computer malfunction, which accelerated an industrywide assessment of how to improve controls in electronic trading. From a price of $10.33 on July 31 the shares fell 75 percent over the next two days and haven’t traded above $3 since Aug. 10. Its market capitalization bottomed at $253 million in August and has climbed back above $420 million as stock has been converted by its rescuers.

Joyce said on a conference call accompanying the firm’s earnings release on Oct. 17 that he had no plans to split apart the electronic business, the market-making unit and the institutional sales and trading segment, or reallocate resources between them.

“We are better off having them all than becoming a siloed kind of one-product firm,” Joyce said. “We came back as well as we came back because of the broadness of our organization.”

Richard Repetto, a New York-based analyst at Sandler O’Neill & Partners LP, said Knight is stronger now than it was in early August when retail brokers reduced the number of orders they sent the firm.

“Knight’s business is more stable now,” Repetto said in a phone interview. “I don’t think Knight needs to do an acquisition but it may help speed a recovery after the technology mishap that occurred.” He said he considers Getco a “possible partner, especially once they participated in Knight’s recapitalization.”

To contact the reporters on this story: Nina Mehta in New York at nmehta24@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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