Knight nears $400 million capital injection: sources

NEW YORK (Reuters) - Knight Capital Group Inc looked set on Sunday to receive a $400 million capital injection from a group of investors, as it sought a rescue deal to avoid bankruptcy after a crippling $440 million loss, two sources familiar with the situation said.

The investors include private equity firms Blackstone Group and General Atlantic, which owns a stake in Chicago market-maker Getco, as well as brokerages TD Ameritrade and Stifel Nicolas, according to the sources.

The investment is expected to be made through convertible preferred stock, which will have a conversion price of $1.50 per share and carry a coupon of 2 percent, one source said.

CNBC reported that the four buyers would own about 70 percent of Knight following the conversion, which the broadcaster said was expected to take place after 10 business days.

Knight, Blackstone, TD Ameritrade and GA declined to comment. Stifel was not immediately available.

An announcement on a deal is expected on Sunday or early Monday as Knight needs to assure its customers about the viability of the company before markets open, one source said earlier.

Knight has also been in talks with restructuring lawyers as it seeks to keep its options open, the source said.

A financing deal, if finalized, would help Knight continue to operate and avoid any further disruption and uncertainty for its brokerage clients, which include firms such as TD Ameritrade, Vanguard and Fidelity Investments.

But at terms for the convertible preferred stock, it would also lead to major dilution for Knight.

Knight's shares closed up 57 percent at $4.05 on Friday, well below their $10.33 closing price on Tuesday, the day before the trading debacle.

Knight's problems started early on Wednesday when a software glitch flooded the New York Stock Exchange with unintended orders for dozens of stocks, boosting some shares by more than 100 percent and leaving the company with a $440 million trading loss that now imperils its business.

As the nation's largest provider of retail market-making in New York Stock Exchange and Nasdaq-listed stocks, Knight buys and sells shares for clients. It also provides liquidity to the equity market by stepping in to buy and sell using its own capital to ensure orderly, smooth activity.

For example, through Tuesday, Knight had accounted for 20 percent of the market-making activity in shares of Apple, one of the most actively traded stocks on a daily basis. By midday on Friday, Knight was the market maker for just 2 percent of the share volume, according to data from Thomson Reuters Autex, though market makers may not be reporting all trade data.

While Knight's closure would not disrupt trading, since big clients have routed orders to other firms, its demise could have further shaken investor confidence.

Knight's troubles also highlight how vulnerable market makers are to the complex web of computers and software that constitute the modern marketplace. For a market already suspicious that the system might be fundamentally broken after 2010's "Flash Crash" and the botched Facebook IPO in May, the troubles at Knight have only added to concerns.

'HANDCUFFED TO KNIGHT'

TD Ameritrade, the No. 1 U.S. brokerage by trading volume, has exclusive clearing deals with Knight and it would be in its best interests to keep the embattled equities trader afloat.

Two months ago, Knight bought Penson's futures business for $5 million. TD Ameritrade exclusively clears its clients' futures and forex trades through that platform. The Omaha, Nebraska-based brokerage's entire bond platform is also with Knight.

"They really are handcuffed to Knight," a source with knowledge of TD Ameritrade's arrangements with Knight said.

Getco was founded in 1999 by two Chicago traders, and is also an electronic trading firm that matches buyers and sellers in fractions of a second.

CEO Daniel Coleman is a proponent of high-speed trading technology, touting the belief that it allows investors access to liquid markets at a lower cost. In June, Coleman told a Congressional panel that market makers like Getco "reduce market volatility by buying when others want to sell and selling when others want to buy."

There was little activity on Sunday outside Knight's headquarters in Jersey City, across the Hudson River from New York City's financial district. A security guard told Reuters that a large delivery of lunch had arrived at the office building earlier in the day.

Two men exiting the premises on Sunday afternoon, who declined to comment when asked whether they worked for Knight Capital, had TD Ameritrade security passes hanging from their pockets.

REGULATORS, INVESTORS SHOW CONCERN

Even if Knight receives the capital injection, it will have to persuade clients to resume trading with it and identify the reasons behind the software glitch.

Customers including TD Ameritrade and Scottrade said on Friday they would return business to Knight, the nation's largest retail market maker of U.S. stocks. Others, including Vanguard, said they were not trading with the company yet.

Knight also could face litigation from shareholders who have seen the value of their holdings plummet over the last few days.

The potential liability could increase if it were found that Knight violated any rules. The top U.S. securities regulator said on Friday that government lawyers were trying to determine whether Knight violated a new rule designed to protect the markets from rogue algorithmic computer trading programs.

The Securities and Exchange Commission's market access rule, which took effect last year, requires brokers to put in place risk control systems to prevent the execution of erroneous trades or orders that exceed preset credit or capital thresholds.

Such concerns kept some potential investors on the sidelines this weekend. Several private equity firms that are usually active in the sector decided against entering the fray, as they feared they lacked enough time to do due diligence around those issues, according to sources close to some of these firms.

Bank of America Corp was among the banks that looked at Knight but is not a likely candidate for a deal, a source familiar with matter said. Bank of America declined to comment.

Some online foreign-exchange trading firms also looked into the possibility of buying Knight's Hotspot FX unit but it was unclear whether Knight explored that avenue, one source familiar with those discussions said.

(Additional reporting by Edward Krudy, Jessica Toonkel, Nick Brown, Angela Moon; Writing by Katya Wachtel; Editing by Paritosh Bansal, Dale Hudson, Diane Craft)

Source: http://news.yahoo.com/knight-nears-400-million-capital-injection-sources-004052510--sector.html

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