Via LA Times :

The high-speed trading arms race being waged on Wall Street has finally claimed its first major casualty.

Knight Capital Group, a brokerage that handles nearly 11% of all stock trading in U.S. companies, is in danger of collapsing after a software glitch triggered millions of unintended orders. The New Jersey firm lost $440 million in less than an hour — nearly four times the company’s profit last year.

The blunder, which Knight’s chief executive said on television was “a bug, a large bug” in its computer systems, caused Wall Street to shudder. Major clients including Vanguard Group, E-Trade and TD Ameritrade, which rely on Knight to fill orders for retail investors, pulled their business on fears that the damage isn’t over. Leaders of the embattled brokerage scrambled Thursday to find rescue funding or even a buyer.

But, more broadly, the debacle highlights concerns on Wall Street and in Washington about structural flaws in the U.S. financial system. Observers are worried that the reliance on computer-driven trading, where stocks are bought and sold in the blink of an eye, could lead to a major equities meltdown.

“The ghosts in the machine have gotten out of control,” said Larry Tabb, chief executive of Tabb Group, a financial research and advisory firm. “There are increasingly more problems and we haven’t been able to get this right.”

Knight’s software executed in a matter of minutes a series of trades that were designed to be done over a period of days. This glitch is just one of a series that have plagued Wall Street in recent years.

In May, the Nasdaq Stock Market botchedFacebook Inc.’s initial public offering. The latest glitch is also an echo of the 2010 “flash crash” that terrified investors after high-speed trading went haywire and $1 trillion vanished from the stock market.

In Washington, Knight’s trading disaster has rekindled worries that new regulations haven’t been effective in protecting investors.

Regulators and key lawmakers were looking into the situation Thursday, underscoring broad concerns about the stability of equity markets. The Securities and Exchange Commission briefed Democratic and Republican staff members of House and Senate committees that oversee the financial industry.

“While the committee is alert to extraordinary or abnormal market events, it is important for us to gather all the facts before determining a course of action,” House Financial Services Committee Chairman Spencer Bachus (R-Ala.) said.

Rep. Maxine Waters (D-Los Angeles), the top Democrat on the panel’s subcommittee that oversees capital markets, said she was very concerned about the volatility triggered by Knight. She supports hearings on the broader effects of the incident and other recent trading troubles.

“Like the problems with the Facebook initial public offering, events like this only further serve to undermine investor confidence in the markets,” Waters said. “Though we don’t yet know exactly what caused the problem with Knight Capital, with a drumbeat of financial market snafus continuing, it’s clear that the industry, with guidance from regulators, needs to strengthen their internal controls.”

Indeed, investors have stuck mostly to the sidelines after suffering crippling stock losses during the financial crisis. Many people have steered clear of sinking money into stocks, worried that big institutional investors and their high-speed tools can manipulate the market.

Knight’s losses reaffirmed Los Angeles retiree Robert Altman’s decision to pull nearly all of his investments out of stocks. Altman said his distaste for the market’s wild swings and technical glitches may confirm industry fears that recent Wall Street technical mishaps could scare off retail investors.

“I’m out of it,” said Altman, 73, who has plowed his savings into municipal bonds. “The little guy has no business in the market anymore.”

Former Sen. Ted Kaufman, a vocal critic of high-frequency trading and how Wall Street has evolved, criticized Congress for denying the SEC adequate funding to do its job. He said post-“flash crash” regulations — even those that have yet to take effect — fail to address the larger structural problems on Wall Street.

What was once a duopoly of two major exchanges, the New York Stock Exchange and the Nasdaq, has evolved into more than a dozen separate trading platforms. There are also numerous “dark pools” where hedge funds and other large investors trade out of public view — what Kaufman likened to the Wild West.

“This is like a volcano that keeps sending out signals,” said Kaufman, a Democrat from Delaware who is now teaching at Duke University’s law school. Wall Street keeps sending out warnings like Knight’s loss, he said, “and we’re not doing anything about it.”

Although the trading did not cause widespread turmoil in the financial system, it has threatened Knight Capital’s very existence. Its stock has plummeted. On Thursday, Knight shares fell $4.36, or 63%, to $2.58. They dropped 13% more in after-hours trading.

Knight Capital is a key behind-the-scenes company that played an enormous role in the stock market’s boom and bust in the dot-com era.

Known at the time as Knight/Trimark, the company rose to prominence in the late 1990s by handling the trades of individual investors who flooded into the market in that period. Though less visible than online brokers such as E-Trade and Ameritrade, Knight executed the swarms of orders that the brokerages funneled to it.

The brokerage operates a cavernous trading floor from its headquarters in gritty Jersey City, N.J., across the Hudson River from Wall Street, that has been a favorite of Hollywood movie makers. Its trading floor served as the backdrop for Oliver Stone’s “Money Never Sleeps,” the sequel to “Wall Street.”

Kenneth Pasternak, who co-founded and once ran Knight, did not think the firm’s loss would be fatal (he suggested Knight’s post-tax loss could be closer to $250 million), nor did he think its losses exposed a major structural problem in U.S. financial markets.

Regulators and the industry may need to require better oversight of technological risks, much like auditing and management protections put in place to guard against frauds and trading losses caused by humans, Pasternak said.

What happened at Knight could easily be prevented in the future, he said. “It’s part of the maturation process,” as automation on Wall Street evolves, Pasternak said. “It’s an immaturity that can easily be cured.”

Regulators said they are closely examining Knight’s trading loss.

The SEC said it is considering what additional safeguards the market might need to prevent similar losses in the future. Meanwhile, the Financial Industry Regulatory Authority, Wall Street’s self-regulatory body, said it had examiners at Knight Capital and the firm was “in compliance with net capital requirements.”

Knight, for its part, said it removed the problematic software from its systems Thursday. A spokeswoman did not respond to a request for comment.

One of Wall Street’s biggest critics when it comes to high-speed trading, Joe Saluz zi, said it was only a matter of time before another glitch throws the market into turmoil.

“Everyone is at risk,” said Saluzzi, a partner in the brokerage firm Themis Trading. “There’s no doubt it will happen again. It’s just a matter of how severe it will be next time."