Traders Call for Stronger SEC Monitoring after Knight Capital Losses

The trading losses at the electronic market maker Knight Capital Group Inc (KCG) caused by a software problem have prompted traders to renew their calls for stricter rules for the complex computer systems which underpin trading, the Financial Times reported on 5 August 2012. While the US Securities and Exchange Commission (SEC) has already implemented some measures to prevent a repeat of the infamous 2010 “flash crash”, market participants as well as lawmakers do not see the rules as sufficient, given the recently observed series of technological lapses.

On August 1, a Knight Capital-operated electronic system malfunctioned and caused prices of numerous stocks to fluctuate widely during the first 45 minutes of trading. The glitch in the company’s software caused large numbers of unwanted and duplicate trades to be ordered on the company’s behalf over a short period causing prices for the most effected shares to fluctuate wildly. As a result, the NYSE cancelled trades in six stocks, reviving memories of the 2010 “flash crash”. The incident is the latest in a series of technology issues, which caused problems with the initial public offerings of Facebook Inc (FB) on Nasdaq and BATS Global Markets Inc on its own exchange, as reported by the FT.

!m[](/uploads/story/230/thumbs/Pic1_inline.png)Although the SEC, the leading US market regulator, has already implemented measures such as circuit breakers to address rapid market swings, traders and investors are concerned that the existing rules do not correspond to the growing complexity of share trading. The FT quotes NYSE’s chief executive Duncan Niederauer, who said that the Knight Capital incident was a “call to action” and that there was “a crisis of confidence” among the public. Bloomberg on the other hand presented the opinion of Bill Brown, a professor at Duke University School of Law and a former managing director at Morgan Stanley (MS), who noted that such issues called the attention of regulators who have been ignoring the problem for years.

On August 3, the SEC released a statement made by its chairman Mary Schapiro, who said that Knight Capital’s “apparent trading error” was “unacceptable” and announced that the SEC was planning industry roundtables to discuss further measures. Bloomberg reports that representative Maxine Waters of California, a senior Democrat on the House Financial Services Committee, said that the panel should also hold hearing so as to determine what caused the problem.

Meanwhile, Knight Capital has been fighting for survival, with $440 million wiped off its capital as a result of the unintended bids which the software error eventuated in, with Bloomberg reporting that on August 2, the company’s market value plunged to $253 million, compared with a peak of $4.8 billion in 2000. Yet, the company’s shares rebounded 57 percent to close at $4.05 on Friday, on news that Goldman Sachs (GS) had stepped in to buy Knight Capital out of trading positions acquired when the computer programme malfunctioned.

Now, as it seems, Knight Capital might have found a buyer, with the FT reporting on August 6 that a consortium of four companies was preparing to inject $400 million into the market maker by means of a convertible share placement. The agreement in question involves Blackstone Private Equity (BX), Getco, rival market maker backed by General Atlantic, Ameritrade (AMTD) and Stifel Nicolas (SF). Upon conversion into shares, the companies will own approximately 70 percent of Knight Capital. According to the FT, Knight Capital, as well as Blackstone, Getco and Ameritrade have declined to comment on the matter.
Bloomberg quotes David Whitcomb, founder of Automated Trading Desk, a Knight Capital competitor owned by Citigroup Inc, who noted that it was not overly surprising that among the sources of financing for Knight were some of their customers. “Their customers want to keep a diverse set of market makers going so as to maintain a high level of competition,” he pointed out.
Yet, as noted in the FT article, while Knight Capital may be able to survive with the return of such capital flow, in the coming days, attention will focus as to whether clients that have already shifted to other companies will return.