[ by Howard Haykin ]

Thomas Joyce, Knight Capital Group Chief Executive, whose tenure was shaken by the firm’s $461 million trading loss in August, told directors he's had discussions about taking a job elsewhere - WSJournal reports.  And that company would be E*Trade Financial, which has had a series of CEOs over the past few years.  It's understood that Joyce's contract will expire at year-end.

In a statement e-mailed by the firm, Joyce is quoted as saying:  “I’m looking forward to continuing discussions with the board and working for Knight over the next few years.”  The Knight Board does not comment on these matters.

Joining E*Trade would unite Joyce with a company that tried and failed to acquire Knight as it veered toward bankruptcy in August -- Citadel LLC.  The Chicago-based hedge fund is E*Trade’s largest shareholder.

Knight Implodes Over a Computer Malfunction. Knight bombarded U.S. equity exchanges with erroneous orders on 8/1/12 after software that had been installed improperly malfunctioned, according to Joyce.  The trading caused volume to surge and prices to swing in dozens of securities. 

Thousands of erroneous purchase orders were executed that morning, leaving Knight with positions in securities that were valued at $7 billion or so.  The firm unwound these unwanted holdings - a major effort that resulted in some $461 million of losses.  Faced with a net capital squeeze and on the verge of bankruptcy, Knight was rescued by 6 Wall Street firms, including Jefferies Group and Blackstone Group.  The investing firms contributed $400 million, for which they received securities convertible into more than 70% of Knight’s equity.  Three new Knight directors were added to the board, representing the 6 firms.

It wasn't long before personnel changes were made at Knight.  Last month, Knight consolidated oversight of its finances and operations under a single executive and reassigned its technology chief.  Steven Bisgay, Knight’s CFO since August 2007, was named to the additional post of COO.  Steven Sadoff, the executive who had been in charge of operations and technology, moved to a role with Knight’s clearing, prime brokerage and futures businesses.

Interestingly, CEO Tom Joyce remained with the firm as CEO.  According to Knight's Form 10-K, filed with the SEC on 2/29/12, Joyce is the only key executive with an employment contract.  The following comment was included in that section:  “Our success will be dependent to a large degree on our ability to retain the services of our existing key executives and to attract and retain additional qualified personnel in the future.” “Competition for such personnel is intense.”

Knight Malfunction Coincides with Rollout of NYSE's Controversial 'Retail Liquidity Program'. August 1 was a significant date for another reason.  The NYSE and NYSE MKT launched their controversial "Retail Liquidity Program" that day.  The NYSE program was designed to loosen the stranglehold that market making firms like Knight had over retail investors. Under this program, trades from retail investors now shift to a special platform where trading houses compete to offer them the best price. 

Because the NYSE program offered the exchanges advantages over their rivals, the market making firms, it was likely that the NYSE and Amex would capture orders a large percentage of customers orders.

This outraged market making firms - especially Knight - that argued the NYSE program would unfairly take trading volume away from them - inasmuch as it provides an additional opportunity for price improvement to retail orders within an exchange environment, and enables greater transparency, liquidity and competition for individual investor orders.  Knight sought to stay nimble. Over the last several weeks, before the NYSE program was to launch, Knight tweaked its own computer coding to push itself onto the new platform.

Joyce apparently made the final, ultimate decision to upstage the NYSE and Amex roll out.  Based on accounts of Knight's trading debacle, we learn that Joyce insisted on rolling out Knight's new order system even though it had not been adequately tested.  From the moment the system was turned on, the system malfunctioned, spewing out erroneous orders that resembled a blizzard of buy orders.  

The Knight system was designed to position the firm competitively amid market changes that would take effect on Wednesday, according to people briefed on the matter.  Yet, unlike rivals that hesitated, Knight Capital's presence on Day 1 was solely based on a decision to upstage the NYSE and ensure that bragging rights and extra profits would remain with the market making firms.

While Knight's trading losses could be traced to computer malfunctions that spewed out erroneous orders, the losses were directly attributable to Tom Joyce's decision to boldly and brazenly upstage the Exchanges.  Had Joyce been of "sound body and mind" he never would have rushed to operate Knight's new order system on August 1 - it simply was not ready for prime time.  Again, the only reason Joyce acted as he did was that the NYSE and Amex rolled out their competitive Retail Liquidity Program that made the exchanges instant rivals of Knight for customer orders - though the Exchanges were armed with pricing advantages that the market makers did not.  

Hubris.  Man's Deadly Sin.

For further details, go to [Traders Magazine, 10/25/12].