As time was running out, Knight Capital Group Inc. Chairman and Chief Executive Officer Thomas Joyce had three choices left -- accept a $500 million bailout from his biggest competitor, take an offer from a group of clients and others that would dilute owners, or go bankrupt.
The 57-year-old former Harvard University football star chose the second, ceding most of the company to investors led by Jefferies Group Inc. The $400 million rescue staved off insolvency as well as Ken Griffin, the billionaire founder of rival Citadel LLC whose overtures to Knight were never able to penetrate the distrust between the two firms, people with direct knowledge of the matter said.
“It’s no secret that in the wholesale market-making space, firms are extremely competitive with one another,” said Christopher Nagy, president of broker consultant KOR Trading LLC in Omaha, Nebraska, who said he had no first-hand knowledge of the talks. “It’s no different between Ken and Tom.”
The rescue of Knight Capital that unfolded over 48 hours last weekend, as recounted by participants on all sides who requested anonymity because the negotiations were private, was fueled by competition, concern about job losses, misunderstandings and exhaustion. The result saved Knight from insolvency.
“As long as they are alive, that is better than being dead, right?” Alan “Ace” Greenberg, the former chairman of Bear Stearns Cos., which was taken over by JPMorgan Chase & Co. as it battled for survival in March 2008, said Aug. 7 on Bloomberg Television’s “Market Makers” program. “Where there is life, there is hope.”
Katie Spring, a Citadel spokeswoman, said the firm couldn’t comment on any discussions that might have taken place.
“Knight explored a wide range of alternatives,” Kara Fitzsimmons, a spokeswoman for the company, said in an e-mailed statement. “After a thorough review, Knight determined that the $400 million equity investment was the best and only alternative for the company and its shareholders.”
Joyce was under pressure to make a deal after his company, which executes about 10 percent of U.S. equity trades at its market-making unit, lost $440 million through programming errors on Aug. 1. While Knight received “dozens and dozens” of inquiries, the agreement with Jefferies, Getco LLC, TD Ameritrade Holding Inc., Blackstone Group LP, Stephens Inc. and Stifel Financial Corp. “was clearly the best,” Joyce said in a telephone interview Aug. 6.
Some Knight staff, concerned they would lose their jobs after a design flaw in software spewed out millions of mistaken equity orders, started speaking to Citadel and other potential employers almost immediately, people familiar with the matter said.
Citadel found Knight’s resistance to its offer hard to understand, according to two people with direct knowledge of the matter. On the other side, Joyce’s team faulted the suitor for a lack of specifics and was concerned Citadel was trying to pick up parts of the business inexpensively, said two people who asked not to be named.
The CEOs’ first contact came the morning of Aug. 3, two days after errant trades sent prices of 140 stocks into spasms and left Knight with depleted capital. Citadel’s Griffin telephoned Knight offering financing. Joyce called back an hour later and declined the offer, instead accepting funding from Jefferies into the weekend. Two days earlier, Jefferies CEO Richard Handler had e-mailed Knight from a vacation in France to see if he could help.
Griffin, whose Chicago-based hedge fund competes with Knight’s market-making and electronic-trading business, had a plan to bail out Knight for good, and wanted to bring it to Joyce personally.
The 43-year-old executive and a team of nine advisers flew in his private jet from Chicago. They arrived at Knight’s headquarters in Jersey City, New Jersey, at about 6 p.m. Friday, Aug. 3. The firm occupies six floors of a 25-story glass tower wedged between Newport Centre mall and the Newport PATH train station.
They had a 10-minute meeting with Joyce, and were shocked to hear he was going home. For his part, the Knight chairman had hobbled into work Wednesday on crutches, still recovering from knee surgery, hadn’t slept that night and only for three hours Thursday. Joyce told Citadel his people were exhausted and the sides met for about an hour.
After dispersing to Jersey City hotels, they returned at 8 a.m. Saturday, Aug. 4, meeting two hours later with the Knight finance team. The session ended at 11 a.m. when the Knight group left for another meeting. That was the last the Citadel officials would see of them.
Joyce and Griffin, who both majored in economics at Harvard in Cambridge, Massachusetts, didn’t know each other well and had never socialized. Griffin gained insights into Knight’s business when he hired Jamil Nazarali and Matt Cushman, managing directors at Knight’s electronic-trading group, for quantitative trading jobs last year.
As the depth of Knight’s troubles sunk in at the firm, Nazarali received numerous calls from old colleagues. Some executives at Knight were on guard for potential poaching from Citadel and others, contributing to the mistrust.
“Citadel doesn’t like it when it happens to them, but they don’t seem to have a problem going after other people’s employees,” Dan Teed, who helps oversee about $100 million as president of Wedgewood Investors Inc. in Erie, Pennsylvania, said in a telephone interview. “They’re direct competitors,” he said. “It’s not the main issue, but I guarantee that’s part of the situation.”
By not engaging with Griffin, Joyce may have sidestepped the fate of Mitchell Caplan, the CEO of E*Trade Financial Corp. who gave up his post after Citadel invested $2.55 billion in the New York-based brokerage in November 2007. The offer from Citadel was silent on Knight’s management team.
Knight executives dismissed the Citadel offer, having talked to 90 different suitors, some offering loans, including KKR & Co. and Fortress Investment Group LLC, according to a person with direct knowledge of the matter.
Knight has diversified its business by offering trading services to institutional investors and adding systems to trade currencies and fixed income. The company also expanded its market making to options and futures and has built up its European operations.
Citadel’s electronic-trading and market-making business is a unit of Citadel Securities, which says it executes about 10 percent of U.S. equity volume, according to its website, a similar amount to that handled by Knight.
“There would have been several redundancies had a deal with Citadel happened, and in the best of environments, which is a far cry from what we have today, significant job loss would have been likely,” said Mike Shea, a managing partner at Direct Access Partners who worked at Knight from 1995 to 2002. “Clearly, Knight decided this was an unacceptable alternative.”
Griffin and his team were still waiting in Knight’s offices Saturday afternoon when Griffin went out to find his counterpart. At 2:45 p.m., he told Joyce, “We’re not getting anywhere” and said he was going to leave, according to two people.
Griffin voiced concern that rival investors were in the building and his group was being denied access. He departed.
Citadel didn’t provide a specific term sheet or discuss details with Joyce before flying back to Chicago, according to the people.
Griffin was right about the opposing group. The Jefferies team was also reviewing the trading firm’s books. Separately, lawyers from Kirkland & Ellis LLP were preparing a bankruptcy filing, in the event a deal could not be reached.
After Citadel left, negotiations with the Jefferies team intensified because Joyce knew his options were narrowing. He slept four hours that night. On Sunday, Citadel came back at about 4 p.m. with an e-mail from Chicago offering a $500 million loan, said two people with knowledge of the matter. The loan would have given Citadel a minority stake in Knight and an interest in its HotSpot foreign-exchange unit, said the people.
By then, according to one of the people, Joyce was far along with the rival deal and went with the convertible stock offering being championed by Jefferies CEO Handler.
Knight’s new investors provided the $400 million cash needed to stay alive and received preferred shares that will represent 73 percent of the company once they are converted into common stock in about a week. Joyce said in a telephone interview with Bloomberg on Aug. 6 it was a permanent solution to the solvency crisis that began with the errant trades.
While owners of Knight stock saw the value of their stake diminish after a 61 percent plunge last week, the firms behind the infusion are sitting on potential gains. The shares represented by the convertible stock would be worth $843.7 million at yesterday’s closing price, data compiled by Bloomberg show.
“As much as I don’t like it, the shareholders took a beating, which is what we’re supposed to do,” Jay Kaplan, a fund manager at Royce & Associates LLC, which owned 11 percent of Knight’s stock and was its second-biggest holder as of June 30, said in a Bloomberg Television interview on Aug. 7. “Do we like what happened? No. Is it a reasonable outcome in light of what transpired? I suppose it is.”
On Monday afternoon, 20 minutes after trading had ended, Jefferies’ Handler sent a memo to the staff noting the role the company had played in saving Knight.
“A highly valued provider of stock market liquidity will be given the chance to thrive once again -- great news for the health of the global financial markets,” he wrote. “We are not doing G-d’s work, but collectively we are making a difference.”