* Dormant software caused problem
* SEC asking if glitch should have been caught
By Jessica Toonkel and John McCrank
Aug 16 U.S. regulators are working to figure out
whether the trading snafu at Knight Capital Group that
resulted in a $440 million loss and nearly destroyed the firm
was exacerbated by a breakdown in risk management, according to
a source familiar with the situation.
A team of U.S. Securities and Exchange Commission's trading
and markets division staff and the Office of Compliance
Inspections and Examinations are focused on trying to uncover
what happened and whether the problem should have been caught,
said the source, who declined to be identified because the
individual is not allowed to talk to the press.
One of the questions being asked by the SEC is why there
appeared to be a breakdown in controls. There was no single
point person at Knight to deal with the problem when it
occurred, leading to further confusion and extending the time it
took to stop the flow, according to a second source.
A spokesman for the SEC declined to comment on the nature of
the investigation, instead referencing an August 3 SEC statement
on the matter that said there were rules in place that should
have prevented the problem.
Knight's trading glitch was the result of old software that
was somehow activated, unleashing a flood of errant trades into
the stock market on Aug. 1. The software problem at Knight
caused the firm to buy and sell about 150 different stocks over
30 to 45 minutes, amassing a $7 billion position it later had to
unload at a loss.
The amount of time it took the firm, along with NYSE
Euronext, which operates the New York Stock Exchange, to
halt the flow of errant trades has brought Knight's risk
management procedures into question.
NYSE could have halted Knight's entire order flow to the
exchange, but that would have affected many legitimate orders as
well, said the second source. In the end, it took steps by both
Knight and NYSE to stop the flow of bad trades.
Reuters previously reported that Knight's market-making
group was having difficulty isolating the problem in order to
halt the trading.
Knight Capital was the largest U.S. retail market maker in
2011. Market makers buy and sell shares on behalf of clients and
step in to provide liquidity using their own capital. The
trading program was the latest technology snafu to overwhelm a
market dominated by high-speed trading.
Knight's software was being updated in time for the August 1
launch of the NYSE's retail liquidity program, designed to
improve pricing for retail investors and also take market share
away from market makers.
Staff in the trading and markets division and the Office of
Compliance Inspections and Examinations worked through the
weekend following the August 1 incident to figure out what
caused the trading disruption at Knight, according to the first
Shares of Knight's stock have been hit hard since the event,
falling around 72 percent. The shares were down 3.4 percent at
$2.85 on Thursday.
Data from Thomson Reuters Autex shows that Knight has
regained most of the market-making share it lost in the wake of
the trading debacle.