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Knightmare on Wall Street (book)

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Knightmare on Wall Street, The Rise and Fall of Knight Capital and the Biggest Risk for Financial Markets (ISBN 978-0-9896577-0-9), published on August 1, 2013, chronicles the rise and fall of Knight Capital. Knightmare on Wall Street is written by Edgar Perez, author of the previously released The Speed Traders, published in English (2011), Chinese (2012) and Bahasa Indonesia (2012).The book focuses on Knight Capital’s 17 years of existence as an independent company, from its founding by trading pioneers Walter Raquet and Kenneth Pasternak through the August 1, 2012 trading disruption to its acquisition by GETCO, transaction closed on July 1, 2013.

Plot Summary

[1] The book begins by reconstructing the events of the morning of August 1, 2012, during which the firm issued a number of erroneous orders into the market causing a major disruption in the prices of 148 companies listed at the New York Stock Exchange. Throughout the morning, Knight Capital accumulated a $7 billion position it had to quickly unload not to break its capital limits. It was later discovered the disruption was due to an error in installing new software to participate in the Retail Liquidity Program sponsored by the New York Stock Exchange.

Founded by Ken Pasternak and Walter Raquet in 1995, Knight Capital was one of the companies that grew fast by riding the retail investing revolution during the Internet boom years and leveraging a series of changes in the structure of financial markets by the Securities and Exchange Commission.

The book recreates the sequence of events after the trading incident and the reactions of top managers such as CEO Thomas M. Joyce, Steven Sadoff, and Michael Tobin, as well as regulators such as Mary Schapiro, former Chairman of the Securities and Exchange Commission and Duncan Niederauer, Chief Executive Officer of the New York Stock Exchange. The author analyses the major characters’ personalities in detail as, he claims, their decisions and indecisions played a major role in the error that ultimately cost Knight $461 million.

Knight was rescued with a $400 million investment by a consortium of clients and investment firms secured on August 6, 2012. A few months later, a bidding war between GETCO (one of the original investors) and Virtu Financial ensued to gain control of the company, of which are presented in the last chapters of the book.

Important Personalities

Kenneth Pasternak, founder of Knight Capital Group

Walter Raquet, Chief Operating Officer of Knight Capital Group

Thomas M. Joyce, Chairman and Chief Executive Officer of Knight Capital Group

Richard Handler, Chief Executive Officer, Jefferies

Joe Moglia, Chairman, and Fred Tomczyk, Chief Executive Officer, TD Ameritrade

Daniel Coleman, Chief Executive Officer, GETCO

Bill Ford, Chief Executive Officer, General Atlantic

Vincent Viola, Founder and Chief Executive Officer, Virtu Financial

Dick Grasso, former Chairman, New York Stock Exchange

Kenneth Griffin, Founder and Chief Executive Officer, Citadel

Mary Schapiro, former Chairman, Securities and Exchange Commission

Duncan Niederauer, Chief Executive Officer, New York Stock Exchange

Robert Greifeld, Chief Executive Officer, NASDAQ

Jimmy Dunne, Head of the Executive Committee, Sandler O'Neill

Detailed Chapters

Chapter One: The Lazy Morning that Wasn't

This chapter narrates what happened with Knight Capital in the morning of August 1, 2012. Perez says this incident shouldn’t have happened to a firm that boasted of being an important source of liquidity in the fragmented U.S. equity market. The firm that applied the most sophisticated trading technologies to the trade execution process wasn’t able to avoid sending millions of mistaken orders to the New York Stock Exchange, which ultimately led to a $460 million loss.

Chapter Two: The Biggest Risk for Financial Markets

This chapter present the author’s points of view regarding recent regulatory changes and technology evolution which have transformed the investing landscape. The author claims that the speed of change has created winners and losers; among the winners were those who recognized that this was no fad and embraced accordingly and the losers are no longer with us, he says. Regulators around the world are now trying to respond to the evolution of technology in financial markets and grapple with increasing pressure to manage it.

Chapter Three: Flash Crash, Pipeline, BATS and…

This chapter details a number of incidents in the financial markets that have received media attention in the last years. Instead of blaming electronic trading for these incidents, the author calls for regulators to step up their game and guarantee fair and orderly markets. From the Flash Crash through the Pipeline Trading fiasco to the failed BATS Global Markets IPO, this chapter brings an introduction to the top-of-mind concerns investors around the globe exhibit today.

Chapter Four: The Men Behind Knight

This chapter starts with a conversation in November 1993 between Larry Waterhouse, President of Waterhouse Securities, the 5th largest discount firm in the U.S. by then, and Walter Raquet. Waterhouse’s order flow couldn’t sustain a competitive market maker; so Raquet suggests getting 5 firms together. The day after, Raquet had a $5million commitment and the partnership of Ken Pasternak, his Troster Singer colleague.

Chapter Five: The Ascendance of Knight

This chapter presents the story of Knight Capital from its founding to its ascendance to the pantheon of financial firms. By the end of 1999, the author says, Knight executed some 40% of all online trades and controlled almost one-fifth of the trading in Nasdaq/OTC stocks. That was more than Merrill Lynch, Morgan Stanley Dean Witter, Goldman Sachs, and Salomon Smith Barney combined.

Chapter Six: Knight in Free Fall

This chapter describes how Knight Capital saw its market capitalization fall from a peak of $8 billion, due to the move by the Nasdaq to begin using a decimal pricing system, the emergence of ECNs, the Internet boost and ensuing dramatic decline in volumes. Among this turmoil, the independent directors asked Pasternak to step down.

Chapter Seven: New CEO on Board

This chapter presents a brief biography of Thomas Joyce, chronicling his rise in the Global Institutional Equity business during his 15 years at Merrill Lynch, where his last position was Head of Global Equity eCommerce from 1999 through 2001. The golf-fanatic father of three probably never expected to live the most stressing five days of his life in August 2012.

Chapter Eight: Stabilizing the Ship

This chapter begins with the appointment of Joyce as Chief Executive Office and President, after a very disappointing performance for the company in the prior year. The author claims. The focus he brought to the company resulted in undeniable recovery and his appointment as chairman in 2004.

Chapter Nine: Unfriending Facebook

This chapter describes NASDAQ’s failure to deliver a smooth opening for all involved in the Facebook IPO, despite a reputation of home to the most successful tech IPOs. This chapter describes what really happened on May 18, 2012, why Knight’s Joyce was as incensed with NASDAQ and how alternatives were offered for participants to recover their losses.

Chapter Ten: What Made Knight Tick and Profit

This chapter describes why the New York Stock Exchange decided to implement its Retail Liquidity Program (RLP), what is behind the implementation at trading firms of new products for retail or institutional clients, and the sequence of events that led to the trading malfunction on August 1.

Chapter Eleven: The Fight for the Firm’s Survival

This chapter describes the series of trading errors that led Knight to face a loss of more than $440 million. According to the author, Joyce had never been afraid of publicly condemning exchanges in the past, or breaking with the party line in the world of high-frequency trading; this time, his firm was in the hot seat.

Chapter Twelve: Surviving One More Day

This chapter describes what happened after Knight Capital unloaded its unwanted positions before dawn on August 2, 2012. This chapter chronicles the challenge for Joyce and his team on the day after the trading glitch to explain to the trading community that this was an isolated incident, to provide confidence that the issue had been solved, despite not being able to explain what really happened, and to convince clients that the company was going to survive.

Chapter Thirteen: 90 Interested Parties

This chapter reviews the work Joyce and his advisors did to go through 90 potential alternatives, debt, equity or a combination, clients, counterparties and competitors presented to them and how they ultimately stayed with three options, including bankrupting the company. In the end, Joyce went for a consortium of firms led by Jefferies, the bank that was with him from the moment the disruption happened.

Chapter Fourteen: Enjoying the Light of a New Day

This chapter starts with a relieved Joyce going on a conference call on August 6, 2012, to announce investors that Knight Capital had been able to secure an investment from a group of six firms that included one of their competitors, GETCO. For the author, destiny was aligning the stars for these two firms, Knight Capital and GETCO, to cross paths again in the next months.

Chapter Fifteen: Rebuilding the Business

This chapter looks at the firm’s efforts to reclaim the leading positions in electronic trading it had enjoyed for the last years and how it struggled to recover in the months after the trading malfunction.

Chapter Sixteen: Barbarians at the Gate?

This chapter describes GETCO’s courtship of Knight Capital, which started when they inspected Knight’s books early August. The other bidder was Virtu Financial. Ultimately, the board decided to accept GETCO’s proposal, in an acquisition that marked the end of Knight as an independent company.

Chapter Seventeen: The End of the Independent Knight

This chapter describes GETCO’s plans to expand its market making operations and achieve the scale that would’ve been hard to build organically. For Knight, it was the end of Raquet and Pasternak’s dream to build the number one firm in the securities busineses.

Reception

Reception to the book was mostly positive. For UltraHighFrequencyTrading.com, the author succeeded in highlighting operational risks that hide behind seemingly sophisticated IT departments and shrinking budgets to surface when you least expect it. The book presents a fair critique of the personalities involved in the trading incident. The author is critical of the board and management insofar as not to look closely at a risk factor that proved almost fatal to the firm.[2]

The book goes into great detail when it analyses the backstories of the main characters involved in the company and helps to understand the true reasons why top executives don't take decisive action when their CEOs are not present, said Modern Finance Report. “Excellent book, but readers have to invest some time slogging through the first 25% of the book to get back to the action. As soon as Joyce comes back to the office after surgery and realizes the extent of the challenges ahead, all hell breaks loose and things start to get very exciting again.” [3]

References

  1. Knightmare on Wall Street Summary, "knightmareonwallstreet.com"
  2. Knightmare on Wall Street Review, "ultrahighfrecuencytrading.com", "July 31, 2013"
  3. Trading firms would do well to heed lessons in testing and crisis management, "Modern Finance Report", "August 5, 2013"

External links

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