Aug. 5 (Bloomberg) -- Knight Capital Group Inc. executives are focused on negotiating an outside investment that would restore the firm’s capital and preserve its independence, said two people with knowledge of the matter.
They hoped to agree on the terms within hours, said one of the people, who requested anonymity because the discussions were private. The identity of the investors wasn’t known. One option under discussion would involve the sale of $400 million in convertible bonds, one of the people said. TD Ameritrade Holding Corp. President and Chief Executive Officer Fred Tomczyk had no comment on the negotiations as he left Knight’s headquarters in Jersey City, New Jersey.
Knight, whose market-making unit executes about 10 percent of U.S. equity volume, has been fighting for survival since a computer breakdown spewed orders through the stock market Aug. 1 and spurred a $440 million trading loss. Spokeswoman Kara Fitzsimmons didn’t respond to a request for comment.
“There’s a lot of questions about their liquidity -- do they have the money to get through the trade settlement on Monday?” Patrick O’Shaughnessy, an analyst at Raymond James & Associates Inc., said in an interview with Pimm Fox on Bloomberg Television’s “Taking Stock.” “They have to find somebody to either invest capital into the company or somebody who’s just going to buy the company outright.”
The market maker turned to Goldman Sachs Group Inc. on Aug. 1 to buy the firm out of trading positions acquired by mistake when a computer program malfunctioned, a person with knowledge of the matter said. It has until the close of business on Aug. 6 to complete the transaction.
Possible investors include Getco LLC and TD Ameritrade, CNBC reported, citing a person involved in the deal. Sophie Sohn, a spokeswoman for Chicago-based Getco, declined to comment. Kim Hillyer, a spokeswoman for TD Ameritrade, declined to comment on “rumor or market speculation” before Tomczyk was seen leaving Knight.
Knight made it to the weekend after receiving short-term financing for market making, according to a person familiar with the matter who requested anonymity. TD Ameritrade and Scottrade Inc., which sent trades elsewhere for execution after Knight’s software failure, said Aug. 3 they were routing orders back. Knight’s stock surged 57 percent to $4.05 in New York after tumbling 75 percent in the previous two sessions.
Joyce was in meetings at the company’s headquarters, according to his secretary on Aug. 4, who didn’t give her name. Joyce did not return a call seeking comment.
Citadel LLC and KKR & Co. were no longer exploring an investment, the people said.
Citadel, a hedge fund that has a market-making and electronic-trading business, walked away from talks yesterday, said one of the people, who asked not to be named because the discussions are private. Efforts to reach Ken Griffin, founder of Chicago-based Citadel, weren’t immediately successful. Kristi Huller, a spokeswoman for New York-based KKR, declined to comment.
As the company opened its books to potential saviors, people with knowledge of the matter said KKR, TPG Capital and Silver Lake were among buyout firms that had an initial interest -- although one said chances of a private-equity deal are small. Citadel had expressed interest, as has Two Sigma Securities LLC, a New York-based market maker, people with direct knowledge of the matter said.
R.J. O’Brien Report
A spokeswoman for Chicago-based R.J. O’Brien & Associates declined to comment on an Aug. 3 New York Times report that the company was among a group of potential buyers in talks about Knight’s futures brokerage.
“As a matter of policy, RJO doesn’t comment on rumor or speculation and doesn’t discuss conversations it may or may not be having with other entities,” Ellen G. Resnick of Crystal Clear Communications, said on the firm’s behalf.
David Wells, a spokesman for New York-based Goldman Sachs, said he couldn’t comment; representatives at Silver Lake, TPG, KKR, Citadel and Two Sigma declined to comment Aug. 3.
People trickled in and out of Knight’s Jersey City headquarters this morning, with polo shirts and khakis outnumbering business suits. None would comment on the record to Bloomberg News. Around noon, platters of sandwiches and salads from Vito’s Italian Deli in Hoboken were delivered.
“I seriously doubt they will go out of business,” Kenneth Pasternak, who co-founded Knight in 1995, said in a phone interview from his Ridgefield Park, New Jersey, private equity firm Kabr Real Estate Investment on Aug. 3. Pasternak bought shares in Knight during its two-day plunge. “I just hope they can maintain the innovation. My fear is they will be bought by some big bank and become consumed.”
Knight is working with Sandler O’Neill & Partners LP as advisers in the rescue talks, said one of the people, who spoke on condition of anonymity because the discussions are private.
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 Aug. 2.
“We’re talking to a lot of capable people, people who are in touch with situations like this,” Joyce said. “This was an anomaly, not one we’re proud of.”
Scottrade spokesman Whitney Ellis said the online retail brokerage began routing orders to Knight Aug. 3. TD Ameritrade resumed routing with Knight after testing its systems.
“After considerable review and discussion, we are resuming our order routing relationship with Knight,” Tomczyk, president and chief executive officer at TD Ameritrade, said in a statement. “Knight is one of many order routing destinations for us and has long been a good and trusted partner.”
John Woerth, of Vanguard Group Inc., said in an Aug. 3 e-mail that the company continued to avoid routing brokerage orders through Knight. Fidelity Investments, the second-largest mutual-fund company, is sending orders elsewhere, according to a person familiar with the matter, who asked not to be identified because the information is private.
“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. “Your confidence with a counterparty like a Knight is only as strong as their skills as well as their balance sheet.”
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 many 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 precipitated by Knight’s malfunction “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 as of Aug. 3, 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 the trading mistakes, 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.
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.
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. and failed IPO of Bats Global Markets Inc.
George Smaragdis, spokesman for the Financial Industry Regulatory Authority, said in an e-mail Aug. 3 that Finra has examiners at Knight and is working with the firm and other regulators to review the impact of the incident.
Securities and Exchange Commission Chairman Mary Schapiro, whose agency is the main market overseer in Washington, described the Knight event as “unacceptable,” and promised to issue regulations to help prevent similar mishaps.
“I have asked the staff to accelerate ongoing efforts to propose a rule to require exchanges and other market centers to have specific programs in place to ensure the capacity and integrity of their systems,” she said in a statement. The chairman also said the agency will hold a public meeting with industry participants in the coming weeks “to discuss further steps that can be taken to address these critical issues.”
The error highlighted the fragility of 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 after the company reported earnings Aug. 3. “We are understanding that speed is not always better.”
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