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Knight avoids collapse with $400 million lifeline

Monday - 8/6/2012, 5:35pm  ET

AP Business Writer

NEW YORK (AP) - Knight Capital Group survived a near-death experience on Monday, lining up Wall Street firms to lend it badly needed cash after the brokerage lost $440 million last week when a malfunction in its trading system flooded the market with erroneous trades.

But the rescue, which came down to the wire, had a steep price: control of the firm. And it's still not certain that Knight will make it through the episode intact.

Knight's new investors will gain a 73 percent stake in the company and three board seats. The value of current shareholders' stake will also be heavily diluted. And Knight, which has removed the problem software and is still completing its own investigation of what went wrong, faces a difficult task of rebuilding trust with clients and persuading regulators that Wednesday's disaster was an anomaly. Its stock has plunged 70 percent since last Tuesday, before the glitch happened.

"This is an isolated situation," Knight's CEO Thomas Joyce said on CNBC Monday morning. "We screwed up. We paid the price."

All weekend, speculators wondered if Knight would be able to open for business Monday. The technical glitch briefly sent dozens of shares swinging wildly last week and left Knight responsible for many of the stocks that its computers accidentally ordered. The company had to drain its capital to cover the erroneous trades.

The trading disaster Knight caused has revived a thorny debate about how heavily stock trading has come to rely on massive computer systems. Stocks can now be traded in fractions of a second, often by automated programs.

Recent technical problems have eroded shareholders' confidence that they can trust the system _ a point punctuated again Monday, when a technical problem shut down markets in Madrid for five hours.

Early Monday morning, before the stock market opened at 9:30 a.m., it still wasn't clear whether Knight was OK.

Just after 7 a.m., Knight made a regulatory filing saying it had secured a $400 million lifeline but that the deal wasn't yet sealed.

An hour later, the New York Stock Exchange threw another twist into the story, announcing it had temporarily reassigned some of Knight's trading responsibilities to a rival firm.

At 9:22 a.m., Knight announced that the deal was completed, but didn't say who the investors were. At 9:24 a.m., it did.

Once trading opened, Knight's stock moved sharply lower in heavy trading. It ended the day down 98 cents, or 24 percent, at $3.07. That's far below its closing price of $10.33 on Tuesday, the day before the debacle occurred.

Knight Capital is a trading firm that takes orders from big brokers like TD Ameritrade and E-Trade. It then routes them to the exchanges where stocks are traded, like the New York Stock Exchange.

One of the roles Knight plays in the stock market is that of a "designated market maker." Those firms are responsible for keeping trading of the stocks they oversee orderly. They are viewed as particularly important during the open and close of trading, as well as during times when there is a lot of volatility in the market. Knight is responsible for the trading of 524 NYSE-listed stocks, a sizable chunk of the roughly 2,300 total corporate issuers.

Being on the defensive is a humbling position for Knight, which is considered a respected and top-tier trading firm. That, some observers say, makes its blunder all the more troubling: If it can happen at Knight, it can happen anywhere.

Manoj Narang, CEO of Tradeworx, a high-frequency trading firm, said the market would still function fine without Knight, if it has to.

"Markets are a battleground; it's survival of the fittest," Narang said. He compared the activities of Knight and other equity brokerages to driving a car: Sometimes there are accidents, but "that doesn't mean we should all stop using automobiles."

A decade ago, CEO Joyce was the architect of another rescue for Knight. That's when he was brought on to turn around a company mired in losses and sinking revenue. A Merrill Lynch veteran and an athlete during his days at Harvard, Joyce has been praised for being straightforward in his company's latest crisis.

The CEO, 57, had knee surgery last Tuesday and hobbled back to work the next day to the chaos emanating from the firm he leads. Knight, headquartered across the Hudson River from Wall Street in Jersey City, N.J., was founded in 1995 and has about 1,400 employees across the U.S. and internationally.

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