Knight Capital Americas

:
.1,*+7&$3,7$/$0(5,&$6//&
Professors Robert D. Austin and Darren Meister wrote this case solely to provide material for class discussion. The authors do
not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain
names and other identifying information to protect confidentiality.
This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without
the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction
rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business
School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com.
Copyright © 2015, Richard Ivey School of Business Foundation
Version: 2016-03-07
We’re pleased to report that total revenues rose 22.2 per cent and pre-tax earnings rose 24.8
per cent compared to 2010 . . . In 2011, we again led all securities firms in shares traded of
NYSE- and Nasdaq-listed stocks, ETFs [exchange traded funds], and OTC [over-the-counter]
Bulletin Board and OTC Market Securities. In recognition of our exceptional technology,
Knight was ranked 1st in the banking and financial services category of the InformationWeek
500, and 14th overall . . .
— Thomas M. Joyce, Knight’s chairman and chief executive officer (CEO) 2
On Wednesday, August 1, 2012, at 8:01 a.m., the computer systems of Knight Capital Americas LLC
(Knight) started to send emails to employees referencing “SMARS,” the company’s automated system
that sent equity orders to the market for execution. The would-be recipients were being notified about a
“Power Peg disabled error.” Over the next hour and a half, 97 emails were sent, but most went unread.
None prompted significant action. 3
A little before 9:30 a.m., Knight systems began processing 212 orders from broker-dealers who had
been pre-qualified to participate in a New York Stock Exchange (NYSE) program scheduled to start on
that day, the “Retail Liquidity Program” (RLP). Knight’s information technology (IT) staff had
deployed new software in the previous four days to prepare for the RLP launch. As stock markets
opened, the new software began to operate. 4
But there was something wrong. One of eight servers that ran SMARS software was somehow
different from the rest. This “rogue server” began sending trade orders to the market without keeping
track of whether previous orders had been filled. 5 In large volume and at a dizzying speed, buy and sell
orders streamed from Knight Capital into the markets.
These orders produced noticeable effects. The prices of 150 stocks of companies large and small began
to swing wildly, some rising, some falling, many by more than 10 per cent in mere minutes. 6 A trading
frenzy commenced as others joined in. Wells Fargo (WFC), for example, traded 22.6 million shares,
more than it had traded in the previous two days, in just a few minutes. 7
Knight continued this trading for 45 minutes. Realizing that something was wrong, the company then
notified clients “to route listed orders away” and shut down trading. The frenzy that Knight had started
continued, however, and at 11 a.m., the NYSE halted trading in six stocks, as so-called “circuit
breakers” triggered; later that afternoon, the NYSE would cancel trades in a handful of stocks that had
traded during the morning frenzy at 30 per cent or more higher or lower than their opening prices.
This document is authorized for use only by Daniela Seci in Strategic Information Systems Spring 18 taught by Rashmi Jain, Montclair State University from January 2018 to July 2018.
For the exclusive use of D. Seci, 2018.
3DJH
%(
Market observers concluded that Knight had likely been the cause of the market disruptions, and the
company’s stock began to trend downward. By the end of the day, Knight’s stock price would drop 33
per cent. 8
Less than an hour after the markets’ opening and struggling to understand what had happened,
managers at Knight were stunned to discover that the company had, in a mere 45 minutes, sent millions
of orders, resulting in four million trade executions in 154 stocks for more than 397 million shares.
Knight had assumed an approximately $3.5 billion net long position in 80 stocks and an approximately
$3.15 billion net short position in 74 stocks. 9
Later in the day, Knight announced that “a technology issue” had resulted in trading losses of
approximately $440 million, an amount comparable to its total market capitalization at market close on
Wednesday, that is, $681 million. 10 As one writer put it, the company had shown the world “how to
lose $172,222 per second for 45 minutes.” 11
CEO Joyce had been out of the office on Tuesday for knee surgery. On Wednesday morning, he
limped back into a company deep in crisis. The stock fell 63 per cent on Thursday, as the company
sought an investor or a buyer. Worth more than $1 billion at the beginning of the day on Tuesday,
Knight had shrunk to $250 million by Thursday night. Large customers, such as the Vanguard Group
and TD Ameritrade, announced that they had stopped doing business with Knight. Analysts suggested
that without rescue by an external party within two or three days, the company would not survive. 12
On Friday morning, Knight announced that it had secured a line of credit from a group of investors that
included TD Ameritrade and Blackstone in an arrangement that involved selling the new backers $400
million in convertible shares. The deal was painful for shareholders because it heavily diluted their
shares, but it was better than a Knight bankruptcy, the only apparent alternative. TD Ameritrade and
other firms promptly resumed business with Knight, and the stock began to recover. By the time
markets closed for the weekend, the stock was up 57 per cent from its low point.13 The company had
survived a near-death experience — but not without incurring serious damage to its reputation and
owners.
In September, Knight hired IBM to conduct a review of its internal systems development process. 14 In
October, the company announced its quarterly results — a net loss of $389.9 million on negative
revenues of $189.8 million — and disclosed that losses from the August 1 event had increased to $461
million. It also announced the creation of a board-level risk committee. 15
In December, Getco, a high speed trading firm that had been part of the investor group, agreed to
acquire Knight in a $1.4 billion deal. Upon completion of the deal in July 2013, Joyce announced his
resignation. 16

%$&.*5281′
Founded in 1995, Knight was “built on the idea that the self-directed retail investor would desire a
better, faster and more reliable way to access the market.” The company was a market maker, a brokerdealer that handled and submitted proposed trades on behalf of others (e.g., retail investors); it was the
largest in the United States in terms of volume on major stock markets (NYSE, NASDAQ). Knight
clients included more than 5,000 of the world’s largest institutions and financial services firms to
whom it provided ”superior trade executions in a cost effective way for a wide spectrum of clients in
multiple asset classes, including: equities (domestic and foreign securities), fixed income securities,
derivatives, and currencies.”
This document is authorized for use only by Daniela Seci in Strategic Information Systems Spring 18 taught by Rashmi Jain, Montclair State University from January 2018 to July 2018.
For the exclusive use of D. Seci, 2018.
3DJH
%(
By 2012, on active days Knight executed more than 10 million trades, with volume exceeding 20
billion shares. The company maintained offices in the United States, Europe and Asia and employed
more than 1,500 people. In 2011, Knight:
x
x
x
x
x
Made markets in or traded approximately 19,000 securities.
Executed trades of more than one trillion shares (approximately 4 billion per day) in U.S. equities.
Executed more than 900 million equity trades (approximately 4 million per day).
Traded more than $6.4 trillion in notional value (over $24 billion per day). ?
Accounted for approximately 10 per cent of all trades in listed U.S. equity securities.
The majority of trades executed by Knight originated with retail investors and came to Knight via retail
brokers. But institutional clients also provided orders to Knight on behalf of mutual funds and pension
plans. ?
Knight enjoyed particular renown for its use of technology. The company worked actively to promote
its reputation as a leader in the use of trading technology. In June 2012, five weeks before the problem
on August 1, Joyce gave testimony to the U.S. Congress, advising it on how to promote the efficiency
of stock markets. In the process, he advertised the unique merits of Knight’s IT capabilities:
Our data centers are some of the largest and most reliable in the industry. We spend tens of
millions of dollars every year making our technology platform better, faster and more reliable.
Today, we have the capacity to process 20 million trades per day. We have connectivity to
nearly every source of liquidity in the equities market, and our trade response times are
measured in milliseconds. Our years of research and development, technology platform
enhancements, and connectivity to liquidity wherever it resides is all brought to bear in our
endeavour to secure best execution on behalf of our customers . . . As a result, we believe that
Knight is uniquely qualified to comment on the market structure issues which are the focus of
this hearing.
In 2011, Knight’s revenues reached a record $1.36 billion, while earnings increased to $115.6 million.
At the end of 2011, Knight had $7.2 billion in assets, $4.4 billion of which primarily consisted of cash
or assets readily convertible to cash. During the time Joyce had been CEO, revenues had multiplied
nine times, and share price had climbed 85 per cent. 18
$ 9(5< %5,() +,6725
Purchase answer to see full
attachment