Understanding the two behemoths at the center of the financial press these past few weeks, and the events that have led up to the present scenario.
In 1999, Stephen Schuler and Dan Tierney launched the Global Electronic Trading Company (Getco), based in Chicago, IL. Schuler had been a floor trader at the Chicago Mercantile Exchange (CME) for most of his career at this point, and Tierney a trader on the floor at the Chicago Board Options Exchange (CBOE). Both were convinced that electronic trading was the future of the markets, at a time when voice and open outcry, particularly in the Windy City, still dominated the day-to-day trading industry.
However, their idea wasn't entirely radical and out of the ordinary. Hull Trading had been growing in size for years at that point, Josh Levine had been quietly giving Datek a leg up by canoodling the Nasdaq Small Order Entry System (SOES) with automation for some time, and Dave Cummings was about to begin his habitual search for a broker willing to cut him a deal on a system he'd invented for electronic trading, cutely named Tradebot.
Cut through the next few years, the fragmentation of markets due to regulation, and the explosive emergence of high-turnover, high-speed trading models, and high-frequency trading (HFT) was firmly established. Even more so, the integration of alternative trading systems such as Island and Archipelago into exchange infrastructure had cemented its Anointed Son status among the financial community, a bit of a far cry from when NYSE brokers would walk into Datek's offices on Broad Street, incensed at the SOES Bandits, and try to punch out the managers.
The resulting entity, if approved, could become a buy and sell-side juggernaut. For Getco, it will open it up to previously unheard of levels of scrutiny, while Knight may well become absorbed into what will clearly be the paternal entity.
Getco, now run by Daniel Coleman, remains one of the highest-profile yet most-obscure market-makers in the industry, accounting for a large amount of equities trades at blistering rates of turnover, matched or approached by only a few other HFT shops. Employing over 400 people, it is the second-largest designated market-maker (DMM) on the New York Stock Exchange, and operates in over 50 markets.
Wind back to 1995, now, with the formation of the Knight-Trimark Group by Kenneth Pasternak and Walter Raquet. Originally a trade execution provider, it listed on the Nasdaq in 1998, changing its name to Knight Trading Group in 2000.
During Pasternak's tenure as CEO from 1995-2002, the company became one of the leading market-makers in US wholesale securities markets. With his departure, Thomas M Joyce, formerly of Sanford C Bernstein, Merrill Lynch and the Nasdaq board of directors, took over at the top of the group, which changed its name in 2005 to the Knight Capital Group.
In May 2012, the company's Electronic Trading Group (ETG) posted an average daily trading volume of more than $21 billion, making it one of the pre-eminent market-making entities in US equities. With a reputation for stability and growth, the company was well-regarded in Wall Street and beyond until a near-fatal technology glitch earlier this summer pre-empted the current merger bid from Getco.
The incident, which occurred on August 1 2012, was primarily due to installed software that went rogue and began entering millions of trades when the markets opened. Within an hour, entered positions were at a state where the company would face losses of around $440 million to unwind. The US Securities and Exchange Commission (SEC), in line with previous statements about reversing trades following the 2010 Flash Crash and other events, denied permission for Knight to roll them back.
The company faced collapse. The cost of the trades threatened the capital base of the firm, and government bail-out was out of the question. Instead, it turned to the industry. A consortium of rival firms, led by Getco, agreed to provide a desperately need cash infusion in exchange for large percentages of the company. Knight recovered, and with TD Ameritrade announcing that it would resume the routing of orders to the broker, confidence began to recover as well.
Continuing concerns around Knight, however, not helped by the company's poor results (primarily, it must be said, due to losses incurred by the technology issue mentioned above) led many to postulate it would soon face takeover bids. Virtu and Getco emerged as the front runners in the financial press, and Getco confirmed its interest through a merger bid formally submitted to the Knight board recently.
The resulting entity, if approved, could become a buy and sell-side juggernaut. For Getco, it will open it up to previously unheard of levels of scrutiny, while Knight may well become absorbed into what will clearly be the paternal entity, with Dan Coleman in position at the new CEO and Knight's Joyce as the non-executive director of the board.
If Knight's board accepts the proposal, which seems relatively likely at this point, the shareholders and regulators may weigh in with their opinions soon, as well. It's worth watching.
As always, if you have an opinion on the Knight/Getco situation, please do weigh in by giving me a call on +44207 316 9811 (London) or by sending an e-mail to [email protected].
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