What happened on Aug. 1, 2012
Regulators said Knight's automated equity order router turned faulty after the firm did not excise a piece of computer code and then deployed new code to the same router. That triggered a defective function that stopped the system from recognizing when certain orders had been filled.
Over roughly 45 minutes, the glitch blasted more than 4 million orders into the market even though it was trying to execute only 212 customer orders. In total, Knight traded over 397 million shares and wound up with "several billion dollars" of unwanted positions that it later liquidated, incurring $461 million in losses overall.
Prior to the failure, the company's internal alerts dispatched 97 automated emails addressing the routing problem to employees, but no steps were taken, according to the SEC.
Why the SEC said it broke the rules
According to the SEC, Knight breached the Market Access Rule, which obligates brokers to keep risk controls that prevent erroneous trades or orders that surpass preset credit or capital limits. The agency also said Knight inadequately assessed the effectiveness of its controls, thereby exposing both the firm and the market to risk.
Knight agreed to a $12 million penalty and is required to hire an independent consultant to carry out a comprehensive review of its controls and procedures aimed at ensuring the firm complies with the rule. The firm did not admit or deny the findings.
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Fallout and where Knight ended up
The trading shock forced the Jersey City, N.J.-based company to seek investors to keep operating. Chicago-based Getco Holding Co. later acquired Knight in a $1.4 billion transaction that closed in July.
"Given the rapid pace of trading in today's markets and the potential massive impact of control breakdowns, broker-dealers must be held to the high standards of compliance necessary for the safe and orderly operation of the markets," said Andrew Ceresney, co-director of the SEC's Division of Enforcement.
What this means for your portfolio
One software slip turned into hundreds of millions in losses, plus a regulatory settlement and a mandated controls review. The sequence is clear: Market Access Rule failures drew a $12 million penalty, the 2012 malfunction itself led to a $461 million loss and fresh capital needs, and the firm was later bought by Getco for $1.4 billion.
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