It hasn’t been a great week for the US securities trading industry to say the least – Nasdaq OMX Group Inc (parent company of the exchange) confirming in a regulatory filing that it now expects to incur costs well in excess of the $62m already set aside to fight off lawsuits from firms hit by the glitch-ridden Facebook IPO back in May. This came after UBS claimed it had lost more than $350m alone in botched order executions and would be seeking financial redress accordingly.
The company also announced it’s co-operating with an SEC-led investigation into the problems at the exchange during the $16bn IPO when market makers reportedly lost more than $500m after the exchange’s trading software failed, leaving pre-market orders unconfirmed for several hours (rather than the usual milliseconds) and many traders in the dark as to how much stock they actually owned.
Yet if that wasn’t bad enough the curse of the propeller heads has also managed to strike at Knight Capital Group – the largest retail market maker of US stocks reporting losses of $440m, due to a trading foul-up caused by its own software.
Given market makers are crucial to the smooth and orderly running of the market by matching orders from buyers and sellers and, when required, providing liquidity by stepping into the market itself, the irony won’t have been lost on investors.
Knight could hardly claim it didn’t see the problem coming either, having noted in its 2011 annual report that capacity constraints, systems failures and delays could ultimately result in transactions failing to be be processed ‘as quickly as our clients desire’ and lead to ‘decreased levels of client service and client satisfaction’, ‘harm to our reputation’, increased operating expenses and litigation. Which is a polite way of saying they weren’t entirely sure whether they were up to the task in the first place.
What has been especially disturbing regarding the Knight case – aside from fighting for its very corporate existence – is the speed with which the company has unravelled since its trading software first sent bogus, rapid-fire trades into the market for 45 minutes last Wednesday and left the firm nursing major losses on stocks it bought at inflated prices.
As recently as June, Knight’s CEO, Thomas Joyce, told Congress that the firm deployed some of the world’s most sophisticated trading technology to execute client orders and that trade execution ‘was better than ever’.
Self evidently it wasn’t.
SEC officials have supposedly already visited the company’s offices in New Jersey to determine precisely what went wrong and examine ways of improving existing financial risk management controls so that in future, orders that are either erroneous or exceed pre-set capital or credit thresholds, won’t be executed.
As a result of the Nasdaq and Knight Capital debacles the SEC will now consider whether new measures might be necessary to safeguard markets on top of those implemented after the so-called May 6 2010 Flash Crash, when stock prices nosedived in the space of a few minutes. While various theories have been put forward to explain the price slide the fact that it occurred at all demonstrated the market’s vulnerability.
This will be of little comfort to Knight however as it looks to rebuild its finances and its reputation.