Tag Archives: Knight Capital

Is KCG Cracking Up? More Key Executives Quit ETF Trading Behemoth

As reported by various news outlets on Friday, KCG, the firm that was created last year via a “take-under” of former Knight Capital by HFT market-maker Getco Securities after Knight suffered a $460 million trading loss attributed to a technology snafu,  and whose business model somehow continues to pass the smell test by combining proprietary trading with “agency-only” execution of institutional orders that are directed to the firm courtesy of payment-for-order flow schemes, is suffering from more executive departures.

In a news release issued by the company, which was once considered to be a leading market-maker in ETFs, it was announced that Steven Bisgay, the firm’s CFO Richard Herr had left the firm. Two other senior executives have also apparently left during recent days, including Richard Herr, the firm’s head of corporate strategy and Andy Greenstein, the firm’s deputy general counsel. All three of these senior executives had come from Knight Capital when the 2 firms were combined in a $1.6 billion transaction.

According to one industry source, who is not authorized to speak on behalf of his firm stated, “The combination of the two cultures, one that is essentially an opportunistic trading shop and the other, which has been trying to justify its role as both a fiduciary broker and a prop trader is no doubt creating internal dysfunction.”

ETF $IPO-Knight Flames Irrational Exuberance With Irrational Pricing

indexuniverseBelow excerpt courtesy of Oct 24 IndexUniverse column re: The Renaissance IPO ETF, the newest entrance to the ETF market place, and tracks a market-cap-weighted index of recent US-listed IPOs. The fund acquires issues within 90 days or sooner after IPO and sells after 2 years.

“..The reason it (IPO) traded to a premium, most likely, is that the sole AP for the fund, Knight Capital [aka KCG] was caught off guard. The underlying stocks are plenty liquid, so there’s no reason to think Knight couldn’t make more shares, and obviously, with $31 million now in the fund, Knight indeed made more shares in a hurry. So the premium present in that first day’s trading was entirely irrational, and predictably collapsed.  To anyone who bought at that irrational price, all I can offer is my condolences. And perhaps a reminder that, in the end, fair value always wins. ..” Dave Nadig, IndexUniverse

Since the 2009 inception of the index IPO tracks—the Renaissance IPO Index—it’s returned an average annual return of 19.09 percent, just a touch over the Russell 3000’s return of 18.97 percent. Add in the effect of a 60 basis point management fee and it’s easy to be skeptical about whether the long-term returns will really play out for investors.

But that cautionary note seemed to be lost on the markets when IPO launched. In the first day of trading, IPO traded more than 800,000 shares. That’s a big day for a new niche ETF.

Unfortunately, the folks who were trading during that initial feeding frenzy caused an irrational “IPO pop” of their own.

For the entire article from IndexUniverse, please click here.


Knight Capital to Pay $12 Million Fine on Trading Violations

nytLogoOctober 16, 2013, 3:41 pm

On Wednesday, Knight Capital agreed to pay a $12 million fine to settle charges that it violated trading rules by failing to put adequate safeguards in place to prevent the barrage of erroneous stock orders.

Knight Capital, which was recently acquired by the high-frequency trading firm Getco for $1.4 billion, has neither admitted nor denied wrongdoing.

This is not Knight’s first run-in with regulators.  In 2002, Knight was fined $1.5million to settle charges of violations within the firm’s market-making and trading platform; violations that occurred between 1997-2001. In 2004, Knight reached a $79 million settlement of claims that it had overcharged customers ..”The Commission (SEC) issued an Order that found that Knight defrauded its institutional customers by extracting excessive profits out of its customers’ orders while failing to meet the firm’s duty to provide “best execution” to the institutions that placed those orders..”

Last year, Knight’s failure to manage its technology platform caused the firm to lose close to $500 million; Knight was since taken over by HF trading firm GETCO earlier this year.

Knight Capital and ETFs.. Setting the Stories Straight.

indexuniverseexcerpt from Olly Ludwig’s Nov 30 column

You might think that having Knight Capital in play could be a threat to ETF trading. Luckily it’s not.

Still, it struck me that thinking through the possibilities surrounding an acquisition of Knight by Getco or Virtu is a worthwhile exercise.

After all, Knight is the biggest ETF market maker out there, and if Knight’s transition to new ownership is fraught with unexpected twists and turns, does that mean that many exchange-traded funds, especially the smaller, less liquid ones Knight shepherds, won’t get the love they need to trade cleanly?

Specifically, I found myself wondering if ETF trading would be adversely affected if Reggie Browne and his team at Knight don’t land on their feet but rather somewhere else on the Street.

If you’re wondering who Reggie Browne is, you need to read Ari Weinberg’s story in Forbes about Browne. Calling Browne “The Godfather of ETFs” did elicit derisive guffaws in some pockets of the ETF industry, but the piece makes an important point: Knight and Browne are big fish in ETF trading.

Knowing that makes the acquisition of Knight by Getco or perhaps Virtu entirely understandable. What upstart trading firm wouldn’t want that feather in its cap? It would be a strong signal that whoever ends up buying Knight has grown up and moved out of the sandbox and into the shark tank.

Incidentally, our thinking here at IndexUniverse on this potential acquisition of Knight is that this is pretty much a corporate story, that Browne and his team are likely to make a smooth transition to wherever they end up, and the world of ETF trading really won’t be affected whatsoever (MarketsMuse editor note: MAYBE)

Still, as I said, I thought it might be worthwhile to look at the story behind the story.

And the crux of that story is that the ETF trading operation—that is, Reggie and his team—is a huge piece of the motivation to do this deal.

MarketsMuse Editor Note–the full IndexUniverse article can be viewed here—but before clicking away..read  a superb comment on that article–and its worth re-broadcasting:

One critical observation that has NOT been made re: role of ‘Godfather Knight’ (or any proprietary trading firm) within the ETF landscape: Knight is a Market-Making firm–NOT a broker. Brokers work as fiduciary agents For customers, market makers (aka MMs) trade Against customers’ best interests. This is NOT a slanted bash on MMs. Having been one for many years (as well as having been a major exchange specialist—a now antiquated role that mandated putting customer interests ahead of all else), MMs Absolutely Do Perform an Integral Role within the ecosystem….. But, MMs (Knight and all others) trade at risk when it suits THEIR profit purpose, not because of an altruistic desire to simply facilitate a customer’s investment/trading strategy.

Given the massive institutional use of ETFs, PMs and RIAs, as well as their custodians should [hopefully] hold themselves to a particularly high fiduciary obligation to secure the best available price in the marketplace when buying/selling. If only evidenced by the ongoing attention on Knight, it would seem that many investors (or maybe its just the media) have yet to focus on the notion of aggregated prices and better brokers who systematically canvass all ‘liquidity centers” to capture the best aggregated price based on all of the players interests. It really is that simple, but few people want to deliver this message for various political reasons.

In the ETF world, MMs “accommodate” a customer order ONLY if/when (i) they have first determined that they can capture a risk-free ‘spread’ that exists either at a ‘dark pool’ accessible by the market-maker but not the customer, or (ii) when there is a risk free spread between the cash ETF and the underlying components thanks to the fragmentation of screen-based markets. More simply—if the MM is selling the cash ETF to a customer, the MM will concurrently be buying each of the underlying components –effectively ‘creating’ the ETF-but  only when the aggregate price of the underlying components is less than the price of the cash ETF. Could the customer do the same arbitraging? That depends. But they can certainly use a broker that canvasses the market properly.  

Any market that relies on, or has come to depend exclusively on one primary player is not a marketplace. More importantly- when one player is perceived as the dominant in the space, any snafu will wreak havoc on the market itself and the credibility of the product. In Knight’s case we can look to 2 recent events that created temporary havoc—which is presumably why this firm is about to come under new ownership (again).  

Light On Knight: Editorial Opinion

Editorial Opinion

In an era in which “CYA” is perhaps the most-used acronym by institutional fund managers focused on fiduciary responsibilities, its almost surprising to notice the many anecdotal remarks that point to a single-point-of reliance on Knight Capital’s role within the ETF marketplace.  Some would think it “shocking” that so many institutions were caught without having a chair when Knight stopped the music and instructed their customers to trade elsewhere.

Yes, based on volume/market share, Knight had become the single-largest “market-maker” for ETFs, as well as a broad universe of exchange-listed equities. Arguably, their pole position is courtesy of pay-to-play pacts with large equity stake holders and ‘strategic partners’ who control significant retail and institutional order flow; including household names such as TD Ameritrade, E-Trade and Blackrock.

This is not to suggest that Knight Capital has not earned its designation for being a formidable market-maker within the securities industry. Their most senior executives are deservedly well-regarded by peers, competitors and clients alike, and their trading capabilities are revered by many.

And yes, Knight’s most recent travails are, to a great extent the result of a  “bizarre software glitch” that corrupted the integrity of their order execution platform. There’s a reason why software is called soft-ware.

That said, this latest Wall Street fiasco–which resulted in a temporary disruption of NYSE trading and the permanent re-structuring of one of the biggest players on Wall Street who was rescued from the brink of total failure– is less about that firm being “too big to fail”,  or the many spirited debates regarding “algorithms that have run amok”, or even the loudly-voiced and often under-informed shouts coming from politicians in Washington regarding the ‘pock-marked’ regulatory framework by which US securities markets operate.

This story is about something much more basic: dependence by seemingly savvy fiduciaries  on a single, market-making firm that figuratively and literally trade against customers in order to administer the daily execution of literally hundreds of millions of dollars worth of retail and institutional customer orders. This happens, all despite the same fiduciaries  commonly inserting the phrase “best execution” within their very own mandates, internal policy documents and regulatory filings.

Many of these fiduciaries may not truly appreciate where Knight resides in the trading market ecosystem, the actual meaning of  “best execution”, or how they can achieve true best execution without being reliant on a single firm whose first priority is not to the client, but to themselves and their shareholders, who depend on the firm’s  ability to extract trading profits when ‘facilitating’ customer orders as being the ultimate metric for the value of their employee bonus and/or their ownership of shares in that enterprise.

CNBC, Barrons, and IndexUniverse (among others) have been following this story closely, and we point to excerpts from a reader comment posted in response to IU’s Aug 6 column  “4 ETF Lessons From Knight”  by Dave Nadig: Continue reading

Knight Seeks Lifeline After $440 Mil Loss : What’s Next?

Courtesy of Olly Ludwig/IndexUniverse

Knight Capital (NYSE: KCG), the biggest ETF market maker in the U.S., is seeking financing after saying that a trading glitch involving its systems on Wednesday that affected 148 stocks will result in a $440 million pre-tax loss. The company’s stock was down 45 percent in early morning trade.

“The company is actively pursuing its strategic and financing alternatives to strengthen its capital base,” Knight said on Thursday in a press release, stressing that it will be business as usual for the company in the wake of the wayward trading episode.

The swiftly moving story is one of the more astonishing developments in the world of electronic securities trading, where Knight plays a dominant role. Industry sources say that whatever reputational challenges Knight faces at this very moment pale in comparison to the attractiveness of its business, or at least particular pieces of it.

The Jersey City, N.J.-based firm, the biggest ETF U.S. market maker, said in the press release that while the whole episode “severely impacted” its capital base, its broker-dealer units remain in compliance with net capital requirements.

*Editor insert: MarketsMuse spoke with one industry expert, who requests no mention of his name, but framed the Knight story as follows: “This is exactly the type of episode that should cause institutional fund managers to re-think how/where their orders are executed. Relying on a single market-making firm–which by definition, is counter-intuitive to the notion of best execution–is a recipe for disaster. The right approach is to use a qualified, agency-only liquidity aggregators– firms that focus on capturing best prices by canvassing a broad list of market-makers. The latter approach addresses the PM’s fiduciary obligation, and significantly mitigates dependence on one market-maker, particularly one that may have been perceived for being “too big to fail.”

The Accident That Happened

On Wednesday, Knight saw its stock drop by a third due to the wayward program trading involving its system. The episode was reportedly triggered by a human error that caused hundreds of trades to be executed in minutes instead of over a longer period.

“An initial review by Knight indicates that a technology issue occurred in the company’s market-making unit related to the routing of shares of approximately 150 stocks to the NYSE,” the company said in a prepared statement on Wednesday.

For the full IndexUniverse coverage, click here

Exchanges Duel With Newcomers Over Trading Transparency; Payment for Order Flow Debate


June 26, By Nathaniel Popper

MarketsMuse Editor Note: In what might prove to be the catalyst for even greater scrutiny of securities industry practices re market transparency, below extracts of article from front page of NY Times June 26 Business Section i.e. profile “lit” v. “dark” liquidity centers–and the nuances by which investor order flow is administered, and the impact on market integrity makes for a good read.

While most people trading stocks at home imagine their orders zipping from their brokers onto one of the nation’s stock exchanges, almost none of the trades go anywhere near those public markets.

In reality, most trades placed through online brokers like TD Ameritrade and Scottrade are sold to Wall Street firms, which accumulate and trade against tens of millions of these shares a day, rather than send them to a regulated exchange like Nasdaq or the New York Stock Exchange. The Wall Street firms then quickly flip them and turn an easy profit because they have more resources and market knowledge than mom-and-pop investors.

The trading, which takes place away from the gaze of regulators and the public in what are known as the dark markets, has taken off in recent years and steadily eaten into the portion of all stock trading that takes place on the public exchanges. Now, though, the exchanges are fighting back by looking to create dark markets of their own.

NYSE Euronext, the company that owns the exchange, is asking regulators to approve a new platform that would attract orders from ordinary investors and then divert them away from the normal exchange with the aim of getting the investor a better price. Nasdaq and the exchange company Direct Edge said they have similar plans in the works.

The proposal looks like a technical tweak to help ordinary investors. But it has become the front line in a battle over what the nation’s stock markets should look like after nearly a decade of fragmentation has resulted in over a third of all stock trades occurring in the dark, up from 15 percent in 2008, according to Rosenblatt Securities, a brokerage firm.

In the past, the exchanges have pushed regulators to force the dark markets to become better lit, but James Allen, the head of capital markets policy for the CFA Institute, said that with the new proposals the exchanges are acknowledging “that if you can’t beat them, join them.”

The practice [payment for order flow] took off after a series of regulatory changes over the last decade made it easier to trade off exchanges and more expensive to trade on exchanges. Today, four firms — Knight Capital Group, UBS, Citigroup and Citadel — have made a business out of paying for retail trades and trading against them. These firms generally pay retail brokers 15 cents for every 100 shares they are sent to trade against, industry experts say.

“…The retail brokers contend that the internalizers allow them to get the quickest and best execution for their customers…” Continue reading