(Reuters) - Knight Capital Group Inc KCG.N regained some of the market share it lost after a huge trading shortfall last week nearly forced it out of business, and the New York Stock Exchange said on Tuesday it would reinstate Knight's full market-making duties as of next week.
Knight, which secured a $400 million bailout from a group of independent investors in exchange for a 73 percent stake, may have turned down a more lucrative rescue bid that might have had less of an effect on shareholders from hedge fund Citadel LLC, sources familiar with negotiations said on Tuesday.
Knight and its bankers talked to around 90 potential suitors in the five days between the trading error and completion of the deal on Monday.
The deal Knight signed was the only one that could have been completed and announced before the markets opened on Monday, according to two sources.
"We would have been out of business, we would have had no clients come back to us, we would have been done," said a person at Knight who asked not be named due to the sensitivity of the issue, regarding the firm's need to get a deal done before markets reopened after the weekend.
A person familiar with Citadel's position countered that Citadel has a history of getting deals done quickly.
However, Knight had to convince the U.S. Securities and Exchange Commission, as well as the New York Stock Exchange on Sunday night it could meet its capital requirements, a separate source said.
The bailout succeeded in restoring some confidence in the firm days after a software glitch caused a trading loss of $440 million - most of Knight's capital - and caused customers to flee. Trading volumes are now steadily recovering.
Knight is the largest U.S. provider of retail market-making when combining New York Stock Exchange- and Nasdaq-listed stocks and over-the-counter securities, buying and selling shares for clients.
NYSE Euronext in a statement on Tuesday said that Knight would resume as of August 13 all of the responsibilities that have been temporarily transferred to Getco, another market-making firm and a participant in Knight's bailout.
Knight's share of volume in the Nasdaq 100 tracking ETF (QQQ.O) was 20 percent at noon Tuesday, according to Thomson Reuters AutEx data, above its usual average of 13.3 percent.
In other heavily traded stocks, Knight was handling more volume than in the last few days, but volumes had not reached the levels from before the snafu, according to those figures.
As a market maker, it provides liquidity to equity markets by stepping in to buy and sell stocks, using its own capital to ensure orderly activity.
Knight shares opened trading more than 6 percent higher but gave up all the gains during the course of the day. The stock closed down 1 cent at $3.06, giving Knight market capitalization of $301.5 million, slightly below the bailout amount under the deal with a consortium led by Jefferies Group Inc JEF.N. Under the deal, the consortium will have three seats on an expanded board.
Knight had an offer from Citadel for a $500 million loan, in addition to a position of 10 percent to 20 percent of the company, as well as a majority stake in Knight's Hotspot FX foreign currency platform, two of the sources said.
Citadel, known widely as a hedge fund, is also the largest market-maker in listed securities. The firm had no comment.
"Knight explored a wide range of alternatives. After a thorough review, Knight determined that the $400 million equity investment was the best and only alternative for the company and its shareholders," Knight said in a statement.
While the Citadel offer would have caused far less shareholder dilution, the transfer of Hotspot FX, which research firm Sandler O'Neill valued at an estimated $155 million, would have reduced Knight's overall value, one of the sources said.
The source added that because the deal was debt and not equity, it also would not solve the capital deficiency that was created by Knight's $440 million loss.
Blackstone Group LP (BX.N), the private equity firm that was part of the six-member consortium that bailed out Knight, was also in talks with the trading firm about an investment or a management buyout for months before the trading snafu, according to another person familiar with that matter.
Blackstone declined to comment.
Under the $400 million capital infusion for Knight, Jefferies got the biggest piece of the pie, with shares that will represent a 22.8 percent stake in Knight. Blackstone and Getco will each hold a 16 percent stake. The other consortium members are financial services companies TD Ameritrade Holding Corp AMTD.N, Stifel Nicolaus (SF.N) and Stephens.
TD Ameritrade will hold 7.3 percent, and Stifel and Stephens each get 5.5 percent.
For other investors, the question is how much Knight is actually worth, given its current circumstances. KBW analyst Niamh Alexander assigned a new price target that is 75 percent of tangible book value, citing two months of trading losses, risk of lawsuits, and dilution. Before the loss, Knight traded at 90 percent of book.
Barclays Capital analyst Roger Freeman, in a note on Monday, also suggested that a valuation around 75 percent of tangible book value was reasonable in light of Knight's situation.
An industry recruiter who has reached out to 30 Knight employees, ranging from managing directors down the chain, said Tuesday that some people were saying they were going to stick it out, while half gave him their resumes.
Knight CEO Thomas Joyce said on Monday that the firm would look at its business units over the next few months and decide whether all of the parts should remain in place.
JPMorgan analysts have suggested that investors will look at Knight only as the sum of its parts, in expectation of an eventual breakup. Among the most attractive assets are Hotspot FX and Urban Financial, the second-largest reverse mortgage lender in the United States.
Reporting by Ben Berkowitz in Boston and John McCrank in New York, additional reporting by Rodrigo Campos, Matt Goldstein, Jed Horowitz, Jessica Toonkel and Greg Roumeliotis in New York; Editing by Lisa Von Ahn and Leslie Adler