Knight Capital in deep trouble

[The Outsider]

Not sure how many followed this news, but it has been huge in the financial circles over the past couple of days. Knight Capital is the largest market maker in business and alone accounted for around 15% of all trades on the NYSE. In a nutshell, they installed and released an upgraded version of their algorithmic trading software on Wednesday to get in sync with some changes which were going out in the NYSE. They did not wait to test out the upgraded product's compatibility with the upgraded NYSE in order to not miss out on profits - their competitors did not go for an immediate release. In 45 minutes of automated trading they lost $440 million and their stock price has plummeted 75% to rub salt on the wounds of those losses, bringing their market cap below their debt and are now seeking bail outs or buy outs from other firms. On the back of the NASDAQ fiasco on Facebook, it's another major setback for the way algorithmic trading is performed and leaves a lot of questions on the risk management strategies these firms are employing.

Knight Capital Group Inc. KCG -168.99% scrambled Thursday to shore itself up and reassure panicked customers after disclosing a stunning $440 million loss from a computer-trading glitch. Knight officials blamed software installed earlier this week for causing the brokerage firm to enter millions of faulty trades in less than an hour on Wednesday morning. The orders roiled trading in almost 150 stocks and left Knight holding losing positions in many shares at the end of Wednesday's trading session. As the company's stock slid 63% on Thursday, officials sought out a potential cash injection or buyer, according to people with knowledge of the talks. The firm is working with Sandler O'Neill + Partners LP to help advise on a potential sale. Among those in discussions with Knight is rival trading firm Virtu Financial LLC. J.P. Morgan Chase JPM -2.36% & Co. was approached to offer funding. Knight wouldn't comment on the status of the rescue talks. But market participants said the firm is running out of time. In the span of two days, the company's market value has plunged to $253.4 million from $1.01 billion, and its shares continued their nosedive in after-hours trading. "If they don't get an investor within the next 48 to 72 hours, I think Knight's going to have trouble surviving," said David Simon, chief executive of hedge fund Twin Capital Management LLC. Another sign of mounting pressure: Some major customers such as Vanguard Group Inc. and TD Ameritrade Holding Corp. AMTD -2.04% said they had stopped doing business with Knight. Regulators including the Financial Industry Regulatory Authority and the Securities and Exchange Commission said they are monitoring the situation and are in contact with Knight and other market players. The size and speed of the losses astounded investors and rivals and, skeptics said, served as another reminder of the perils of the superfast nature of stock-market trading. The hit to Knight rivals the current estimated industrywide losses caused by the technical troubles that disrupted Nasdaq OMX Group Inc.'s NDAQ -0.70% debut of Facebook Inc. FB -4.19% shares in May. For customers, the threat of a collapse of a brokerage has become an all-too-common event. While the circumstances of the situation at Knight are different and still in flux, MF Global Holdings Ltd. and Peregrine Financial Group Inc. left customers in the lurch after tumbling into bankruptcy. Just as jarring: Knight, a 17-year-old firm, is considered a pillar of the stock market, matching buyers and sellers for some $20 billion in trades a day on the New York Stock Exchange. Knight uses complex computer algorithms to trade swiftly in and out of stocks while retail brokerages rely on the company to execute billions of dollars of trades a year for small retail customers. The firm is also one of the biggest firms to handle trading in exchange-traded funds. While it has humans on hand to do some trading, much of its business is now computerized. The loss exceeded Knight's $365 million cash on hand at the end of the second quarter. Most of the trades were made Wednesday between 9:30 a.m. and 10:15 a.m. That would equate to about $10 million a minute. The computer program that caused the glitch was designed to integrate with a new system being installed Wednesday morning by the New York Stock Exchange, Knight Chief Executive Thomas Joyce said on Bloomberg television on Thursday. But an error in the Knight software caused a malfunction. By the time engineers could switch it off, millions of trades had gone through. Alarmed at the snafu and worried about further glitches, some customers said they moved their business elsewhere on Thursday. Knight also requested some customers stop sending it trades, according to brokers and traders. That is because Knight is required to set aside more capital against each trade, so the more business it does, the more capital it needs. And, after the loss, the firm was determined to keep its capital demands to a minimum. Among those dialing back trading were Citigroup Inc. C -2.25% and J.P. Morgan, whose stock-trading desks handle big transactions for institutional investors, according to people familiar with the matter. Knight executives at the company's Jersey City, N.J., headquarters spent Thursday on the phone seeking to assuage clients, while also trying to find sources of capital to keep the firm afloat. In a brief statement in the morning, Knight said it was seeking "strategic and financing alternatives." Mr. Joyce, who had knee surgery Tuesday, was in the office Wednesday and slept on the couch in his office Wednesday night, according to a person at the firm. About 15 other employees, including General Counsel Leonard Amoruso, also stayed all night at the office. On Thursday, food from McDonald's and pizzas from Domino's were brought in to feed employees. Finra, an independent regulatory authority for the securities industry, had examiners on site at the company's headquarters, a spokeswoman for the authority said. Finra is working with the firm and other regulators to review the impact of the technology snafu, she said. The firm is in compliance with its capital requirements, she said. Knight and Virtu, of New York, on Thursday held talks about a potential merger or cash infusion that could also involve private-equity firm Silver Lake Partners, already an investor in Virtu, the people said. The discussions were in early stages, and no deal is guaranteed, the people said. What's more, a deal could take time and require regulatory approval, and Knight could need financing more quickly than any agreement could be made. Like Knight, Virtu has relationships across Wall Street, handling trades as a market maker for hundreds of companies and funds. A tie-up would underscore Knight's desperation as its market capitalizationÍÖnder $300 million as of Thursday afternoonÍÇell below the amount of losses it said it would take from Wednesday's technology errors. Some analysts believe that Knight has a few days of breathing room to complete a deal or stabilize itself with a loan. Wednesday's glut of mistaken trades won't settle until Monday, meaning that Knight won't realize the estimated $440 million trading loss until then. Securities-industry law requires stock trades to settle up to three days after the date of the transaction. "They can survive a couple of days of harmed revenues," said Patrick O'Shaughnessy, analyst with Raymond James. "What they can't survive is capital calls or illiquidity."

http://professional.wsj.com/article/SB10000872396390443866404577564772083961412.html?mod=WSJ_hp_LEFTWhatsNewsCollection

[Nova]

It was a bug which went undetected causing a contagion effect. This Dark Knight will not rise from the ashes. :headshake:

[velu]

Costliest software upgrade and also it went live without proper testing . :D I guess the system didnt handle gap ups and gap downs properly .

[coffee_rules]

Software written by humans - can't be bug free.

[Precambrian]

Unbeleivable.. market making is one of the most time critical things and these guys didn't even bother to do a beta.. ****ing idiots deserve this.

[GautiMaan]

Hope my SQAT professor does not hear abt this:D

[Ram]

A friend of mine first mentioned to me about this over phone and I simply refused to believe him thinking that it was impossible for any company to make such a schoolboy error. Iknow definitely want to understand what went wrong for my own learning. I am right now working in a team that is is responsible for a portfolio management tool that is is used by some of the worlds most elite clients (we are talking 100s of billion of dollars). Obviously, our tool does require the same level of srisk management as a trading tool, but even otherwise we are absolutely paranoid about any change we make in the tool. Even a change as small as renaming a field name on a screen has to go through an elaborate impact analysis machine.