A group of investors will rescue embattled market maker Knight Capital Group Inc in a $400 million deal that keeps the company in business, Knight said on Monday, but comes at a huge cost to investors.
The New York Stock Exchange said it will temporarily transfer Knight’s market-making responsibilities on more than 500 stocks and related Knight employees to Chicago-based Getco, until the recapitalisation is complete. The exchange said both companies cooperated with the transfer.
The rescuing companies will buy convertible preferred stock with a 2 per cent dividend to save Knight, which was brought to its knees last week by a software glitch that caused errant trading in dozens of stocks. The deal is expected to close later on Monday morning.
The preferred shares are convertible into about 267 million shares of common stock, Knight said in a US Securities and Exchange Commission filing, implying the investors would get a stake of a little more than 70 per cent in the company.
The filing did not name the investors. On on Sunday, sources familiar with the talks identified private equity firm Blackstone Group LP, Getco and financial services companies TD Ameritrade Holding Corp, Stifel Nicolas, Jefferies Group Inc and Stephens Inc as the prospective buyers.
J.P. Morgan analyst Kenneth Worthington, in a client note after the initial reports on the rescue on Sunday night, said the deal presaged Knight’s eventual breakup.
“We don’t expect investors to value Knight as an ongoing entity given its technology glitch generated a pre-tax loss equal to (about) 30 per cent of shareholders equity and nearly wiped out the company in just 30-45 minutes of trading,” he said.
Shares fell 30 per cent to $2.85 in heavy premarket trading after closing at $4.05 on Friday. Less than three weeks ago Knight traded for more than $12 a share.
But even if Knight has been saved for now, the company could face litigation from shareholders who have seen the value of their holdings plummet.
The potential liability could increase if it were found that Knight violated market rules. The top US securities regulator said on Friday that government lawyers were trying to determine if Knight violated a new rule designed to protect the markets from rogue algorithmic computer trading programs.
Knight’s problems started early on Wednesday, when a software glitch flooded the New York Stock Exchange with unintended orders for dozens of stocks, boosting some shares by more than 100 per cent and leaving the company with the trading loss.
As the nation’s largest provider of retail market-making in New York Stock Exchange and Nasdaq-listed stocks, Knight buys and sells shares for clients. It also provides liquidity to equity markets by stepping in to buy and sell stocks, using its own capital to ensure orderly, smooth activity.
Knight’s computers had been loaded with new software on Tuesday that was designed to accommodate a change on the NYSE, according to people familiar with the matter. When trading began, however, the computers poured a huge number of orders into the market.
For about 10 minutes it was unclear where the orders were originating, according to people familiar with the matter. After NYSE officials identified Knight as the source, it took another 10 minutes for the company to figure out the source.
The damage to Knight was swift. Whereas Knight once accounted for 20 per cent of the market-making activity in shares of Apple Inc, by midday on Friday it was the market maker for just 2 per cent of the share volume, according to data from Thomson Reuters Autex.
Knight’s troubles highlight how vulnerable market makers are to the complex web of computers and software that constitute the modern marketplace. For investors already suspicious that the system might be fundamentally broken after the “Flash Crash” of 2010 and the botched Facebook initial public offering in May, the troubles at Knight have only added to concerns.