How safe is computer trading after Knight Capital crash?

Aug 3, 2012

US broker in talks with private equity firms and big banks as it scrambles to save its life

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SERIOUS questions are being asked about super-high-tech computer trading as one of America’s biggest financial services companies, Knight Capital, was left "fighting for its life" after a software breakdown.

The software, newly installed this week, caused Knight’s computers to flood the New York Stock Exchange on Wednesday with erroneous orders. The glitch left Knight holding so many losing positions in various shares that it suffered a $440 million trading loss.

With customers including TD Ameritrade, the top US retail brokerage by trading volume, and such fund giants as Vanguard and Fidelity Investments unwilling to route their orders through Knight, shares in the New Jersey-based company plunged by 75 per cent, forcing it to seek new funding or file for bankruptcy protection.

According to the San Francisco Examiner, Knight has "opened its books" to several potential suitors, who include private equity firms and "at least one securities industry rival".

Knight is said to have taken on Goldman Sachs and Sandler O’Neill as advisers, though neither party has commented publicly so far.

The Wall Street Journal says Knight is in talks with trading firm Virtu Financial LLC. Across the financial media, there are claims that Knight has been asking both Bank of America and JPMorgan Chase & Co for financing.

The company is under pressure to strike a deal within days, or seek Chapter 11 bankrupty protection. "They have about 48 hours to shore up confidence," said James Koutoulas, head of an advocacy group for former customers of failed brokerages MF Global and Peregrine Financial, quoted in The Guardian.

Many observers are asking whether this event will mark a turning-point in high-tech trading practices.

"You can see how that one black swan event can literally take this company out," Tim Hartzell, chief investment officer at Houston-based Sequent Asset Management. "Maybe this is the new chapter for program trading and algorithm trading. We’ll have to go back and re-evaluate."

Larry Tabb, founder of Tabb Group, a financial consulting firm, told the Chicago Tribune: "You've got 13 exchanges, 50 dark pools, brokers that internalise client orders at their own desks and thousands of algorithms pumping orders in milliseconds. The structure just may be too complicated to work."

But as the Tribune reports, "Advocates of trading systems that can pump thousands of shares across Wall Street in milliseconds say the fault lies not in the systems but in the lack of controls at individual firms."

Knight blamed its technology breakdown on the new software, but "offered no explanation as to why traders didn't immediately intervene to arrest the obvious errors".

The US Securities and Exchange Commission said yesterday said it would consider whether new measures might be necessary to safeguard markets. "We are considering what, if any, additional steps may be necessary, beyond the post-Flash Crash measures that limited the impact of yesterday's trading," said NEC spokesman John Nester.

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