3rd August 2012
Last night, Knight Capital Group Inc. appeared to be on the brink of crisis. Shares in the global financial services firm and the largest trader in U.S. equities, with a market share of 17.3% on the NYSE and 16.9% on NASDAQ, plummeted 63% on Thursday after the Jersey City, N.J.-based market-making firm said it has suffered a pretax loss of $440 million after it traded out of its entire erroneous trade position.
Market Watch says the erroneous trades took place on Wednesday morning after Knight's trading software was hit by a glitch and resulted in Knight sending numerous erroneous orders in NYSE-listed securities into the market. This software has been removed from the company's systems, Knight said.
"Although the company's capital base has been severely impacted, the company's broker/dealer subsidiaries are in full compliance with their net capital requirements," the company said in a statement on Thursday morning. "Knight will continue its trading and market making activities at the commencement of trading today. The company is actively pursuing its strategic and financing alternatives to strengthen its capital base."
So with Knight Capital's trading losses coming on the heels of other high-profile technological lapses that botched the initial public offerings of Facebook Inc. and Bats Global Markets Inc, one has to ask, what can be done to preserve the obvious advantages of technology (Financial markets have greatly improved over the past quarter-century as a result of increased computerization) and avoid such disasters?
Well, Floyd Norris of The New York Times writes, "Perhaps not very much. Regulators can put in rules, and programmers can put in programs, to avoid Wednesday's mistake. But in complex systems, there may be unforeseen results of any one fix, and the profits from being first to put in some new system may lead to the use of programs with undetected flaws."
"If the errors of today are too much to accept, we may have to give up some of the advantages of innovation. That could mean slower markets, with more chance for human intervention, or a move to raise trading costs enough to make some strategies that rely on fast and frequent trades simply too expensive to be worth the effort."
Meanwhile, the trading losses at Knight Capital Group Inc. has renewed pressure on Washington regulators to prove they are equipped to protect investors in markets that are increasingly computerized and fragmented.
"Things like this call the attention of regulators and people on the Hill to what really goes on in these markets — and they've been ignoring this stuff for years," said Bill Brown, a professor at Duke University School of Law and a former managing director at Morgan Stanley. "I hate to say this, but I am glad the chickens are coming home to roost now before they end up doing too much damage."
For their part, the US Securities and Exchange Commission (SEC), the federal agency responsible for enforcing federal securities laws and regulating the securities industry, says they are looking into the events surrounding Knight Capital Group's trading glitch.
"We continue to closely review the events surrounding yesterday's trading and discuss those events with other regulators as well as Knight Capital Group," Securities and Exchange Commission spokesman John Nester said.
"We also are considering what, if any, additional steps may be necessary, beyond the post-Flash Crash measures that limited the impact of yesterday's trading."
More on Mindful Money
To receive our free daily newsletter sign up here.