Knight Capital gets $400 million rescue

Aug 06, 2012, 11:26 AM EDT
REUTERS/Brendan McDermid

* Investors get 70 percent-plus in company* Analyst says company likely to be broken up* CEO: Made best deal possible to save firm* Shares tumble about 24 percentBy Angela MoonNEW YORK, Aug 6 (Reuters) - A group of investors rescuedKnight Capital Group Inc in a $400 million deal thatkeeps the embattled leader in U.S. market-making for equities inbusiness, but comes at a huge cost to existing shareholders.Blackstone Group LP, rival market maker Getco andfinancial services companies TD Ameritrade Holding Corp, Stifel Nicolas, Jefferies Group Inc andStephens Inc purchased preferred shares for what works out to bea 73 percent stake in the company, Knight said in a statementjust before markets opened on Monday.As what was the largest U.S. provider of retailmarket-making in New York Stock Exchange and Nasdaq-listedstocks, Knight buys and sells shares for clients. It alsoprovides liquidity to equity markets by stepping in to buy andsell stocks, using its own capital to ensure orderly activity.Knight shares fell 25 percent to $3.04 in morning trade.Knight Chief Executive Tom Joyce, in an interview with CNBCtelevision, said it was "absolutely" the best deal that couldhave been struck, and that there was no better alternative amongthe roughly 90 approaches Knight received.The rescuing companies will buy preferred stock convertibleat $1.50 each with a 2 percent dividend to save Knight, whichwas brought to its knees last week by a software glitch thatcaused errant trading in dozens of stocks.The preferred shares are convertible into about 267 millionshares of common stock, Knight said in a U.S. Securities andExchange Commission filing. The company will also expand itsseven-member board of directors with three new seats.The New York Stock Exchange said it would temporarilytransfer Knight's market-making responsibilities on more than500 stocks -- and related Knight employees -- to Chicago-basedGetco, until the recapitalization is complete. The exchange saidboth companies cooperated with the transfer. Knight has about1,400 employees, according to a company filing.After the announcement, Getco traders were seen working inKnight Capital's booth, with NYSE staff there overseeing them.Vanguard Group, one of the customers that pulled orders fromKnight last week, said on Monday it was again routing there.JP Morgan analyst Kenneth Worthington, in a client noteafter the initial reports on the rescue on Sunday night, saidthe deal presaged Knight's eventual breakup."We don't expect investors to value Knight as an ongoingentity given its technology glitch generated a pretax loss equalto (about) 30 percent of shareholders equity and nearly wipedout the company in just 30-45 minutes of trading," he said.The atmosphere at Knight's Jersey City, New Jerseyheadquarters appeared relatively normal on Monday. Employeesdeclined to comment to the multitude of reporters outside.FUTURE STILL UNCERTAINBut even if Knight has been saved for now, the company couldface litigation from shareholders who have seen the value oftheir holdings plummet.The potential liability could increase if it were found thatKnight violated market rules. The top U.S. securities regulatorsaid on Friday that government lawyers were trying to determinewhether Knight violated a new rule designed to protect themarkets from rogue algorithmic computer trading programs.Joyce told CNBC he had spoken with U.S. Securities andExchange Commission Chairman Mary Schapiro last week, seekingrelief from the firm's predicament.Knight's problems started early on Wednesday, when asoftware glitch flooded the NYSE with unintended orders fordozens of stocks, boosting some shares by more than 100 percentand leaving the company with the trading loss.Knight's computers had been loaded with new software onTuesday that was designed to accommodate a change on the NYSE,according to people familiar with the matter. When tradingbegan, however, the computers poured a huge number of ordersinto the market.For about 10 minutes it was unclear where the orders wereoriginating, according to people familiar with the matter. AfterNYSE officials pinpointed Knight, it took another 10 minutes forthe company to figure out the source.DAMAGE SWIFTThe damage to Knight was swift. Whereas Knight onceaccounted for 20 percent of the market-making activity in sharesof Apple Inc, by midday on Friday it was the marketmaker for just 2 percent of the share volume, according to datafrom Thomson Reuters Autex.Knight's troubles highlight how vulnerable market makers areto the complex web of computers and software that constitutesthe modern marketplace.For investors already suspicious that the system might befundamentally broken after the "Flash Crash" of 2010 and thebotched Facebook initial public offering in May, the troubles atKnight have only added to concerns.Sandler O'Neill + Partners and Wachtell, Lipton, Rosen &Katz advised Knight Capital on the bailout. Barclays advised TD Ameritrade on its investment.