Knight Capital Group Inc. (KCG)’s weekend rescue put an end to solvency concerns at the firm, according to Chairman and Chief Executive Officer Thomas Joyce. It also sent the stock more than 70 percent below its level a week ago.
The Jersey City, New Jersey-based company, one of the country’s biggest market makers, faced too many risks to make its equity price a top priority in the bailout, Joyce said in a telephone interview yesterday. Knight fell 24 percent to $3.07 in New York as investors prepared for hundreds of millions of shares to enter the market via convertible securities.
“It is a permanent solution,” said Joyce, whose ownership stake has declined by $8.9 million in the last week based on data in a Jan. 31 filing. “We understand the dilution is a large amount, but for the future of Knight Capital Group, as tough as it was to see happen, it was the right thing to do.”
Knight, driven to the brink of bankruptcy by trading losses Aug. 1, received $400 million through the sale of convertible stock. Jefferies Group Inc. conceived and structured the investment and bought shares along with Getco LLC and Blackstone Group LP, brokerages Stifel Nicolaus & Co. and TD Ameritrade Holding Corp., (AMTD) as well as the investment bank Stephens Inc.
The investors agreed to buy preferred stock that will be convertible into about 267 million common shares at $1.50, the company said yesterday. The new investment in Knight will represent 73 percent of the company once the 2 percent preferred shares are converted in about a week.
Jefferies’s investment was the biggest at $125 million, according to a government filing by Knight. Getco and Blackstone bought $87.5 million each; TD Ameritrade received $40 million and Stephens and Stifel got $30 million each, it showed. Three directors will be named, one each by Blackstone and Getco backer General Atlantic LLC, and one subject to approval by Jefferies.
While owners of Knight stock saw the value of their stake diminish after a 61 percent plunge last week, the firms behind the infusion are sitting on potential gains. The shares represented by the convertible stock would be worth $820 million at yesterday’s closing price, data compiled by Bloomberg show.
“The investment terms were onerous, to be sure,” wrote Patrick O’Shaughnessy, a Chicago-based analyst at Raymond James & Associates Inc., in a note to clients yesterday. “But beggars can’t be choosers and we suspect it was either accept these terms of face bankruptcy for Knight.”
The company’s $375 million of 3.5 percent convertible bonds due in March 2015 jumped 9.1 cents to 88.1 cents on the dollar as of 3:52 p.m. in New York yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt, which traded as low as 40 cents on the dollar on Aug. 2, is yielding 8.7 percent, down from 20.5 percent last week.
Daniel Coleman, Getco’s chief executive officer, said in a telephone interview yesterday that he decided to participate in the deal while on vacation after discussing the importance of Knight with members of his company’s board over the weekend. Getco is a competitor of Knight’s in market making.
“A world without Knight is not necessarily a better world for Getco, it’s probably a worse one,” he said. “Knight’s a big liquidity provider, they do a good job helping people transfer risk in different things. There would be more friction if they’re gone.”
The software malfunction was the latest black eye for the computer infrastructure of an equity market still haunted by the May 2010 market crash, Facebook Inc. (FB)’s botched share offering, and the failed IPO of Bats Global Markets Inc.
Schapiro asked SEC staff to speed up efforts to propose a rule requiring exchanges and other market centers to have programs in place to ensure the integrity of their systems and trading capacity, she said in a statement on Aug. 3.
Last year, she said the SEC should mandate compliance with the agency’s automation review policies, instituted after the 1987 crash to ensure exchanges have appropriate technology and testing mechanisms. That would also encourage exchanges to disclose material problems to the public.
Representative Maxine Waters of California, a senior Democrat on the House Financial Services Committee, said the panel should hold hearings to get to the bottom of the turmoil.
“With a drumbeat of financial market snafus continuing, it’s clear that the industry, with guidance from regulators, needs to strengthen their internal controls,” Waters said.
Joyce, who intends to remain CEO, said retail brokers were “coming back from many, many corners” after they routed business away during and after the malfunctions. Knight sent mistaken orders into the market just after the start of trading on Aug. 1 because of a design flaw in software to connect with a New York Stock Exchange program for individual investors.
Obtaining capital to fund businesses such as market making was viewed as necessary to keep Knight afloat. Analysts at CLSA Credit Agricole Securities wrote last week that bankruptcy was a possibility if the firm failed to get financing.
“It was obviously a greatly flawed application,” Joyce said. “It is perplexing. We have launched an investigation. We intend to come up with new and better ways to enhance the infrastructure.”
The deal announced yesterday came after “dozens and dozens” of inquiries were made over the weekend, Joyce said. “We had several alternatives and this was clearly the best one for our stakeholders.”
Knight’s market-making unit executes about 10 percent of U.S. shares. Its mishap caused shares to move as much as 151 percent.
“I’d like to think there is no long-term damage to the company because reputations are built on a series of actions and behaviors over time and our clients understand where we’re coming from,” Joyce said. “Our clients know that everybody makes mistakes, even rather large ones on occasion.”
To contact the editor responsible for this story: Lynn Thomasson at email@example.com