NYSE Euronext temporarily assigned responsibility for 680 stocks that Knight Capital Group Inc. handles as a primary market maker to Getco LLC so the broker could focus on shoring up its finances after incurring a $440 million trading loss on Aug. 1.
Automated trading firm Getco, which oversees activity in 896 companies listed on the New York Stock Exchange and NYSE MKT, will use its own technology and commit its capital to trade the shares, according to Larry Leibowitz, chief operating officer at NYSE Euronext. The Chicago-based firm will be responsible for an additional 524 stocks listed on the Big Board and 156 on NYSE MKT, formerly known as NYSE Amex, until oversight returns to Jersey City, New Jersey-based Knight.
“They needed short-term funding extensions,” Leibowitz said in a phone interview. “We needed a contingency plan in case that didn’t happen at any point in time. From late Wednesday on we’ve been discussing a contingency plan. We didn’t want to walk into Monday and have there be any doubts.”
Knight received a $400 million cash infusion through the sale of convertible securities after a software malfunction last week drove the market maker to the brink of bankruptcy. Getco, Blackstone Group LP, brokerages Stifel Nicolaus & Co. and TD Ameritrade Holding Corp., as well as Stephens Inc. and Jefferies Group Inc. are investing, Knight said in a statement today.
Knight shares plunged 24 percent to close at $3.07 at 4 p.m. in New York and are down 70 percent since July 31.
The decision to use Getco’s market-making operation to handle Knight’s responsibilities wasn’t related to the equity financing arrangement for Knight, in which the rival firm invested. It was “coincidental,” Leibowitz said.
The Big Board decided to move the companies to Getco on Friday. Having the “luxury of the weekend just made life a little easier” because of the operational complexities in managing the transition, Leibowitz said. Knight cooperated with the shift, he added.
“Going into Friday it was clear that if something permanent didn’t happen, they weren’t going to be in business on Monday,” Leibowitz said of Knight. “We wanted an abundance of caution.”
The exchange operator plans to shift back the Knight companies to the market maker when it’s “operationally easy for both Getco and Knight and the Knight staff,” Leibowitz said. Knight employees working on the floor of the exchange are using Getco’s systems and capital to make markets in the companies they handle, he said.
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. Getco began talking to Jefferies about an investment on Saturday, Aug. 4, and took a “significant amount” of the Knight convertible securities, according to Coleman, who negotiated the transaction while on vacation.
Jefferies conceived and structured the equity financing, according to a statement from Knight today.
“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.”
Obtaining additional capital to fund businesses such as market making was viewed as necessary to keep Knight afloat. Analysts at CLSA Credit Agricole Securities wrote last week that bankruptcy was a possibility if the firm failed to get financing.
Knight’s trading loss was bigger than the $365 million cash balance it reported as of June 30 and exceeded its market value of $398 million as of Aug. 3, data compiled by Bloomberg show.
Getco’s investment in Knight may benefit the Chicago trading firm if it considers an initial public offering, Diego Perfumo, an analyst at hedge fund adviser Equity Research Desk LLC in Greenwich, Connecticut, said in a phone interview.
“If Knight fails, Getco’s chance to have an IPO decreases,” Perfumo said. “Knight has been in this business for so long. If it blows up and disappears, will investors want to invest in Getco? No.”
Sophie Sohn, a spokeswoman at Getco, declined to comment on speculation about an IPO. The financial investment was based on the role Knight plays in the market and her firm’s belief in the “long-term value of the organization,” she said.
NYSE Euronext received a “scatter of concerns and questions” from people at companies who wanted to know how their shares would be affected by Knight’s problems, Leibowitz said. He said the exchange would hold a webinar to explain the shift to the companies today.
Knight’s mishap spurred calls in Congress to examine whether increasing automation is damaging the integrity of the U.S. equity market, the world’s largest with $16.4 trillion in share value. Representative Maxine Waters of California, a senior Democrat on the House Financial Services Committee, said the panel should hold hearings to get to the bottom of the turmoil.