Knight Capital reaches $12m SEC settlement over IT meltdown

Knight Capital reaches $12m SEC settlement over IT meltdown

Knight Capital has reached a $12 million settlement with US regulators over a technology meltdown which caused market chaos and drove the firm to the brink of bankruptcy.

On 1 August last year, a bungled software update affected Knight's algorithms and sent prices in more than 140 stocks haywire, costing the market maker $460 million. The firm was saved from bankruptcy by a group of investors and later merged with Getco.

A Securities and Exchange Commission investigation has found that the company failed to have adequate safeguards in place to limit risks, violating its market access rule.

The SEC highlights "two critical technology missteps" that contributed to the chaos. The first problem dated back to 2005, when a section of code in an automated equity router was moved.

Seven years later Knight deployed new code in the same router, sending it haywire. During the first 45 minutes after the opening bell on 1 August, the router sent more than four million orders into the market when attempting to fill just 212 customer orders.

Knight consequently traded more than 397 million shares, acquired several billion dollars in unwanted positions, and eventually suffered a loss of more than $460 million.

The second IT misstep saw Knight fail to pick up on a warning before the erroneous trades were made. Nearly 100 automated e-mails were sent out identifying the router error before markets opened on 1 August but were not acted on.

Daniel Hawke, chief, enforcement division's market abuse unit, SEC, says: "Brokers and dealers must look at each component in each of their systems and ask themselves what would happen if the component malfunctions and what safety nets are in place to limit the harm it could cause. Knight Capital's failure to ask these questions had catastrophic consequences."

In addition to the $12 million fine, Knight - without admitting or denying the findings - agreed to retain an independent consultant to conduct a comprehensive review of controls and procedures.

Comments: (1)

A Finextra member
A Finextra member 18 October, 2013, 11:31Be the first to give this comment the thumbs up 0 likes

According to this article, the root cause for that Knight Capital incident was failing business logic within a router. A router is a communications device, putting critical business logic there is a sign of a pretty strange IT architecture.

One can understand that the recently prevailing HFT frenzy with the perceived need for extreme speed and somewhat less focus on reliability could have led to such a strange design. But regulators are now starting to again put more focus on the reliability of exchange systems, as can be seen from a programmatic speech by Mary Jo White, head of the SEC. A short excerpt:

"I met with executives of the exchanges last month and challenged them to together develop and implement the necessary steps to improve the resilience of the technology surrounding critical market infrastructures. In short order, we expect to receive comprehensive action plans that address the standards necessary to establish highly resilient and robust systems for securities information processors. I have also asked the SEC staff to engage the exchanges, clearing agencies, and FINRA to conduct a “mapping” of other critical infrastructure systems and provide assessments of their robustness and resilience."

Source: http://www.sec.gov/News/Speech/Detail/Speech/1370539857459#.Uk6T5IZwp8F

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