A group of investors rescued Knight Capital Group in a $400m deal that keeps the embattled leader in market-making for equities in business, but comes at a huge cost to investors.
Blackstone Group, rival market maker Getco and financial services companies TD Ameritrade Holding Corporation, Stifel Nicolas, Jefferies Group and Stephens purchased preferred shares for a 73% stake in the company.
The company broke the news just before the US markets opened today.
Knight shares fell by over 25% in early trade on Wall Street.
As what was the America'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 equity markets by stepping in to buy and sell stocks, using its own capital to ensure orderly, smooth activity.
Knight chief executive Tom Joyce, in an interview with CNBC television, said it was "absolutely" the best deal that could have been struck, and that there was no alternative to save the firm.
The rescuing companies will buy preferred stock convertible at $1.50 each with a 2% dividend to save Knight, which was brought to its knees last week by a software glitch that caused errant trading in dozens of stocks.
The preferred shares are convertible into about 267 million shares of common stock, Knight said in a US Securities and Exchange Commission filing. The company will also expand its seven-member board of directors with three new seats.
The New York Stock Exchange said it will temporarily transfer Knight's market-making responsibilities on over 500 stocks - and related Knight employees - to Chicago-based Getco, until the recapitalisation is complete.
The exchange said both companies co-operated with the transfer. Knight has about 1,400 employees, according to a company filing. After the announcement, Getco traders were seen working in Knight Capital's booth, with NYSE staff there overseeing them.
JP Morgan, in a client note after the initial reports on the rescue last night, said the deal presaged Knight's eventual breakup.
But even if Knight has been saved for now, the company could face litigation from shareholders who have seen the value of their holdings plummet. The potential liability could increase if it were found that Knight violated market rules.
The top US securities regulator said on Friday that government lawyers were trying to determine if Knight violated a new rule designed to protect the markets from rogue algorithmic computer trading programmes.
Knight's problems started early last 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% and leaving the company with the trading loss.
Knight's computers had been loaded with new software last Tuesday that was designed to accommodate a change on the NYSE, according to people familiar with the matter. When trading began, however, the computers poured a huge number of orders into the market. For about 10 minutes it was unclear where the orders were originating, according to people familiar with the matter.
After NYSE officials identified Knight as the source, it took another 10 minutes for the company to figure out the source.
The damage to Knight was swift. Whereas Knight once accounted for 20% of the market-making activity in shares of Apple, by Friday it was the market maker for just 2% of the share volume.
Knight's troubles highlight how vulnerable market makers are to the complex web of computers and software that constitute the modern marketplace. For investors already suspicious that the system might be fundamentally broken after the "Flash Crash" of 2010 and the botched Facebook initial public offering in May, the troubles at Knight have only added to concerns.
