Knight Capital Group Inc. was fighting for its survival on Thursday after a trading glitch that roiled markets wiped out $440-million (U.S.) of the firm's capital, forcing it to seek new funding as its shares plunged 70 per cent in two days.
Some of the company's biggest customers, including TD Ameritrade Holding Corp., the No. 1 U.S. retail brokerage by trading volume, and Fidelity Investments are not routing orders through Knight. Smaller customers also were taking business elsewhere.
The company, one of the largest U.S. market makers, said it is "actively pursuing its strategic and financing alternatives," raising the possibility Knight could be sold or even face bankruptcy.
The troubles at Knight have driven uncertainty among investors worried that a potential failure of the firm could cause problems for the many brokers who execute trades through Knight.
"They have about 48 hours to shore up confidence," said James Koutoulas, chief executive officer of Typhon Capital Management, a Knight customer whose firm lost money in the collapses of brokerages MF Global and PFGBest.
The incident is the latest in a series of market snafus that are driving up volatility and undermining public confidence. They include the troubled Facebook initial public offering in May, the failed IPO of exchange venue BATS Global Markets in March, and the Flash Crash in May, 2010.
"Will they be able to get out of this death spiral considering where the stock is and the amount of capital they have to raise?" asked James Dailey, portfolio manger at TEAM Asset Strategy Fund in Harrisburg, Pa.
Knight has approached JPMorgan Chase & Co. for financing, according to a report on Fox Business Network. A spokesman for JPMorgan declined to comment. Efforts to reach Knight Capital for a comment were unsuccessful.
"What is more important is the question of market structure," Mr. Dailey said. "There could be an issue with the amount of the order flows that get redirected to other places, and the potential of that stressing other systems."
TD Ameritrade, which averaged just over 355,000 trades a day last quarter, is currently not sending orders through Knight as it tests its systems to make sure everything runs smoothly, said Joe Kinahan, chief derivatives strategist at TD Ameritrade.
The company routes about 4.5 per cent of its orders through Knight.
"We are monitoring the situation," Mr. Kinahan said, adding that as long as Knight remains in good standing with the exchanges, TD Ameritrade will resume sending orders through it.
He said that every client trade that TD Ameritrade sent out on Wednesday was filled, because Knight was quick to tell the brokerages to reroute their orders.
Knight's shares were down 54 per cent at $3.09 in midday trading after hitting a 13-year-low of $2.97 a share.
A SYSTEMIC RISK FOR MARKETS?
Although Knight opened for trading on Thursday, there were questions about how the firm's possible failure might affect the vast network of brokers that rely on it to process orders and whether a failure could cause serious market stress.
"Knight is the one franchise that has built a network of well over 800 broker-dealers throughout the country," said Chris Nagy, a market structure consultant.
"Many of those 800 broker-dealers, although they have very small amounts of order flow, in aggregate, represent a significant amount of volume. That's the concern, because quite frankly, those firms have no other options."
Knight's daily market-making volume was $19.5-billion in June.
Street One Financial, a Huntington Valley, Pa.-based firm that executes trades for institutional investors, on Thursday got calls from seven new asset management firms wanting to place trades because they did not want to trade with Knight owing to concerns over the firm's viability.
"They have heard the reports that Knight is asking JPMorgan for an emergency loan and they don't want to risk it," said Scott Freeze, chief executive officer of Street One Financial.
Wednesday's technology breakdown roiled the prices of about 140 stocks listed on the New York Stock Exchange, undermining fragile investor confidence in the stability of U.S. stock markets.
The U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority are looking into Knight's trading error, according to William Brodsky, CEO of top U.S. options market CBOE Holdings Inc.
"It's obvious that it appears that there was a technology glitch in the trading algorithm," Mr. Brodsky told analysts on Thursday. "All markets have rules to address these types of situations."
Speaking on Bloomberg Television, Knight Capital CEO Tom Joyce said the firm had "excess capital right now." On Tuesday night, it had put in new software that had a bug, he said.
The firm said it was in compliance with capital requirements and that it had traded out of the entire position. The Financial Industry Regulatory Authority, which oversees broker-dealers, confirmed Knight was in compliance.
"This issue was related to Knight's installation of trading software and resulted in Knight sending numerous erroneous orders in NYSE-listed securities into the market," Knight said. "This software has been removed from the company's systems."
Specialists in securities industry operations issues said the wave of recent problems pointed to an unsettling reliance on automated trading facilities that is robbing investors of confidence in the markets.
"We're losing the human control in our business," said Joe Anastasio, a founding partner of financial services consulting firm Capco who specializes in stock trading issues. "We've been so focused on automated throughput of orders and high-volume execution with no human intervention that we have lost the human logic factor when things go wrong."
One of the problems, he said, is that millions of orders stack up overnight for automatic execution at the opening of trading, with a single error potentially creating a deluge of bad trades.
On July 18, Knight reported second-quarter profit of $3.3-million, down 81 per cent from a year earlier after recording a $35.4-million pretax trading loss from the Facebook initial public offering. The company has not yet filed its second-quarter report with regulators.
Knight's average daily U.S. equities market-making volume has fallen from a year ago as trading volumes have declined across the stock market. Daily market-making volume was $19.5-billion in June, a 12-per-cent decline from a year earlier.