No. of Recommendations: 38
By now, I assume everyone knows about Knight Capital’s (KC) slight software bug that caused them to lose $440 million in 45 minutes yesterday (8/1/12). What you might not be aware of is the role that KC has in the US markets. Knight is one of the largest “market makers” and “designated market makers” (DMM) in the US. They handle roughly 20% of all equity trades in the US.

As an individual investor, if you place a stock market order through Fidelity, Vanguard, TD Waterhouse etc. chances are good that it is “routed” through KC. Understand that the brokerages do NOT interface and/or trade directly with the exchanges like NYSE, ARCA, NASDAQ etc. All of the brokerages go through a middleman like Knight.

Let me skip ahead and say that the Knight obituary is pretty much complete. Odds are they will either go bankrupt or be bought out in a matter of days. When they go BK, the question is what chaos will ensue.

We have two broad case studies to consider.

1) All of the bank closings done by the FDIC which are incredibly smooth and transparent to the depositors. The FDIC does a great job IMO handling these.

2) Unfortunately, the other case study is MF Global which I have described as a black swan event. I did NOT think it was possible in 2011 US Markets for a firm to make off with $1.X billion client dollars. We will leave out the fact that no charges have been filed as of yet.

I absolutely, positively do NOT think that any client funds will be lost when KC goes bankrupt. I also do not worry that eventually all of the securities you bought or sold will be properly accounted for.

What concerns me is how orderly the BK will be. As we saw when MF Global went BK and the music stops, there are an incredible number of loose ends left dangling. Eventually the SEC and the SIPC and the exchanges and the brokerage firms will get it all straightened out IMO. God only knows how long it will take. In the best case, it is 100% transparent to all individual investors.

In the worst case, your account could show the wrong quantities, cost basis etc. Also since you never know who has what money when the music stops, some of the brokerage firms might shortchanged for a while. Fidelity, Vanguard, TD Waterhouse and others have already stopped using KC.

BOTTOM LINE 1 is that in the end, I am confident that all will be well with individual investor accounts. Unfortunately based on a sample size of one (MF Global), I am not as confident that the process will be transparent to the individual investors. I would NOT change brokerages due to this. The brokerages did nothing wrong IMO

BOTTOM LINE 2 is that the software trading bug that occurred does not surprise me at all. I have posted several times previously that I expected other “flash crash” type events to occur again. All of the software developers on the board can vouch that software bugs are a fact of life. There is ZERO reason to think this is that last one we will see. The only question is when the next one will occur and how bad it will be.

BOTTOM LINE 3 is that I expect the SEC to show the same strong leadership as they have in the past. Meaning they will put Larry, Curly and Moe on the case right away. The chances of them doing anything significant to prevent another occurrence are about the same odds as Yoda beating Michael Phelps in a swim race.


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No. of Recommendations: 4
What amazes me is that our designated officials allow a firm that is in business to make trades for its clients who are passing on orders gathered from *their* clients, all their orders headed for Wall Street to allow shares to change hands ... this same company that facilitates all this is performing HFT to compete against their clients and their clients' clients while simultaneously managing these orders from all these clients?! What kind of system is it that allows a firm like KC or TBTF banks to compete in this way in the first place? I mean what could possibly go wrong here? There's surely no reason for concern regarding conflict of interest or anything, right?

I only wish they would have sold their proprietary software to someone like Goldman Sachs. Of course if it were GS, JPM or some similar company that lost a billion dollars a minute they would have simply called Uncle Timmy and cried until the gubmint decided all the 'erroneous' trades needed to be unwound.

Maybe I'm amazed. Sadly, maybe not. :(

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No. of Recommendations: 3
My kin were around and invested in 1987 when the market crashed and they told me that the 'specialists' or market makers of the individual stocks had the two greatest profit years on record following that event. I'm probably not the only one here uncomfortable knowing that these profit motivated market makers are the valves the trades go through. It might be time to consider a not for profit organization performing this function. One of the first things that could be implemented is a unified, universal trading program that a specialized government body oversees and all market making houses must use. The program algorithms and code could be available for inspection and public scrutiny the same way linux code is so anyone witnessing or being a victim of its malfunction can report it. The only problem with this is that the earliest versions of the published code will probably be exploitable by a hacker since the talent pool coding outside the system is probably better than those putting these systems in place. This isn't a perfect solution either, frankly, the whole thing is depressing. I'm waiting to see what happens to Knight Capital.
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No. of Recommendations: 0
I'm waiting to see what happens to Knight Capital.

Up 57% AIT.

Aug. 3, 2012, 2:48 p.m. EDT
SEC's Schapiro:Knight Capital trade 'unacceptable'

By Ronald D. Orol
WASHINGTON (MarketWatch) - Securities and Exchange Commission Chairman Mary Schapiro on Friday said that while the erroneous trading at Knight Capital Group Inc. KCG +58.92% leading to a $440 million loss is "unacceptable," the agency has taken steps recently to limit its impact. "Recently-adopted circuit breakers halted trading on individual stocks that experienced significant price fluctuations, and clearly defined rules guided the exchanges in determining which trades could be broken giving the marketplace certainty," Schapiro said in a statement. The new circuit-breaker rules were adopted in response to the so-called "flash crash" that rattled markets on May 6, 2010. Schapiro added that the agency will consider whether Knight Capital checked its systems thoroughly before using them in the markets.
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No. of Recommendations: 0
HFT in Canuckia.

So far the new rules seem to be working.


Business Day : August 3, 2012 : Has IIROC rules made mini-flash crashes more likely? [08-03-12 2:40 PM]On April 1, IIROC's new market regulation fee model came into effect. But have the new rules inadvertently made mini-flash crashes like the one experienced this week more likely? BNN talks with Doug Clark, Managing Director, ITG Canada

IIROC - Investment Industry Regulatory Organization of Canada
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