News

The Dark Knight Falls

Knight Capital (NYSE:KCG) looking for investors, Citadel, KKR bow out GS Knight Capital Group Inc. is fighting for its survival after a $440-M last week loss driven by a software failure is working to find an investor after 2 potential suitors said they were no longer interested. Citadel LLC and KKR & Co. are no longer exploring an investment. Knight, responsible for about 10% of American equity volume, turned to Goldman Sachs Group Inc. (NYSE:GS) on 1 August to buy the firm out of trading positions acquired by mistake when a computer program malfunctioned, a person with knowledge of the matter said. It has until the close of business on 6 August to complete the transaction. The Street now has a lot of questions about Knight's liquidity; do they have the money to get through the trade settlement on Monday, they have to find somebody to either invest capital into the company or somebody who's just going to buy the company outright IMO. Citadel, a hedge fund that has a market-making and electronic-trading business, walked away from talks Saturday with no comments, the same is thought for KKR. Knight may raise $400-M through the sale of convertible bonds to investors including Getco LLC and TD Ameritrade Holdings Corp., according to a TV report. Knight made it to the weekend after receiving short-term financing for market making. TD Ameritrade and Scottrade Inc., which sent trades elsewhere for execution after Knight's software failure, said on 3 August they were routing orders back. Knight's stock rose 57% to 4.05 in New York after falling 75% in the prior 2 sessions. Thomas Joyce, Knight's CEO was in meetings at the company's headquarters in Jersey City, New Jersey, according to his secretary on 4 August, he did not return a call seeking comment. As the company opened its books to potential saviors, KKR, TPG Capital and Silver Lake were among buyout firms that had an initial interest although one said chances of a private-equity deal are small. Citadel had expressed interest, as has Two Sigma Securities LLC, a New York-based market maker, people with direct knowledge of the matter said. A spokeswoman for Chicago-based R.J. O'Brien & Associates declined to comment on an 3 August, after a newspaper report that the company was among a group of potential buyers in talks about Knight's futures brokerage. Kara Fitzsimmons, a Knight spokeswoman, declined to comment Sunday. David Wells, a spokesman for New York-based Goldman Sachs, said he could not comment. "I seriously doubt they will go out of business," Kenneth Pasternak, who co-founded Knight in Y 1995, said in an interview on 3 August. Mr. Pasternak bought shares in Knight during its 2-day plunge. "I just hope they can maintain. My fear is they will be bought by some big bank and become consumed." Knight is working with Sandler O'Neill & Partners LP as its advisers in the rescue talks. The trading fault, which caused stocks to move as much as 151%, left the firm with a "large error position," Knight's CEO, Thomas Joyce said on 2 August. Knight may or may not have the ability to withstand this on a balance sheet basis, but their biggest risk is if people decide not to do business with them, as confidence with a counterparty like a Knight is only as strong as their skills as well as their balance sheet. Fitch Ratings said in a statement that it does not expect any major counterparties of Knight to suffer large losses even in a bankruptcy scenario since many have already switched to other market makers. The issue still may lead to a structural change in the business, the ratings firm said. The events precipitated by Knight's malfunction "pose risks for equity trading volume as many investors become more concerned about seemingly unforeseeable risks related to trading technology problems and the broader market impact of high- frequency trading systems that periodically break down," Fitch said in the statement. Knight's $440-B loss compares with net income of $115.2-M in Y 2011 and is more than the company's market value as of 3 August. The company was worth as much as $4.8-B in Y 2000 and valued at more than $1-B before the trading mistakes, according to data. The loss represents about 40% of Knight's book value and would "exhaust" the firm's cash. Knight had $365-M of cash as of the end of June, with about $70-M in its revolving credit line. Knight's market-making unit executed a daily average of $19.5-B worth of equities in June, according to its website. The unit traded 711-M exchange-listed shares a day in June. The NYSE reviewed trading in 140 stocks from Molycorp Inc. to AT&T Inc. as the market's 1 August open was disrupted. Trades that occurred during the height of the volatility were canceled in 6 securities, where prices swung at least 30% in the 1st 45 mins. Trades in all of the other stocks were allowed to stand. George Smaragdis, spokesman for the Financial Industry Regulatory Authority, said on 3 August that FINRA has examiners at Knight and is working with the firm and other regulators to review the impact of the incident. Securities and Exchange Commission Chairman Mary Schapiro, whose agency is the main market overseer in Washington, described the Knight event as "unacceptable," and promised to issue regulations to help prevent similar mishaps.