UPDATE: TD Ameritrade, E*Trade, Vanguard Steer Clear of Knight Trading

--Several financial firms have stopped trading with Knight Capital or limited trading activity with the firm

--Knight shares plunged 63% Thursday

--"It's conservative clients staying away," says Aite Group co-founder

(Adds information on trading firms throughout.)

 
   By Liz Moyer and Brett Philbin 
 

TD Ameritrade Holding Corp. (AMTD), E*Trade Financial Corp. (ETFC) and Vanguard Group Inc. are among the financial institutions that have stopped trading with Knight Capital Group Inc. (KCG), while several banks limited their trades with the company, one day after a glitch cost it $440 million and raised fresh questions about the reliability of highly automated equity trading.

Knight Capital shares plunged 63% to $2.58 a share Thursday after the firm announced the cost of the glitch and admitted it was exploring ways to secure outside financing or potential deals. The stock continued falling after hours, sliding another 18% to $2.12.

The trading trouble was blamed on a software issue at Knight that caused wild price swings in dozens of stocks Wednesday. Knight is one of the biggest actors in the U.S. markets, particularly among the firms that handle orders from retail investors.

Knight is one of a half-dozen firms that dominate trading of retail orders, a business called wholesale market-making.

Its competitors in wholesaling include Citigroup Inc. (C), Citadel LLC, UBS AG (UBS, UBSN.VX) and E*Trade Financial. Goldman Sachs Group Inc. (GS), Cantor Fitzgerald & Co. and hedge fund Two Sigma also have been trying to break in.

Citadel experienced a big surge in its order volume on Wednesday after Knight asked trading firms to route their orders elsewhere, according to a person familiar with the situation. Citadel typically executes 20% of U.S. equity options volume and 10% of U.S. equity volume.

The decision by firms not to trade through Knight Thursday indicates a concern for the firm's stability, said Sang Lee, a co-founder of consulting firm Aite Group. Trades sent through Knight would settle in three days, potentially leaving them hanging over the weekend. "It's conservative clients staying away," Mr. Lee said.

Meanwhile, Citigroup and J.P. Morgan Chase & Co. (JPM) were among the banks that limited their trades with Knight Thursday, at the request of Knight, according to people familiar with the matter.

One market participant familiar with Knight's order flow at a U.S. exchange said volumes from Knight were only slightly below average, and it appeared to be Knight largely trading its own positions, rather than customer orders.

In a statement Thursday, Knight said its broker-dealer subsidiaries are in compliance with requirements to hold capital.

TD Ameritrade said Thursday it decided not to route customer orders through Knight Capital and was testing its systems after Wednesday's glitch, a company spokeswoman said. The Omaha, Neb., online brokerage will route orders to Knight in the future though, as long as the company remains "in good standing" with the equities exchanges, she said.

TD Ameritrade routed approximately 4% of its total customer orders to Knight Capital as of June 30, according to a regulatory filing.

E*Trade also wasn't routing customer orders through Knight and will be assessing the situation on a daily basis, according to a person familiar with the situation. A regulatory filing showed the firm sent 14% of its NYSE-listed trades through Knight.

A spokesman for Vanguard Group, the country's largest mutual-fund company, said the firm is rerouting trades through other vendors "given the issues" at Knight Capital.

In a June 30 regulatory filing, Vanguard disclosed it sent 26% of trades in NYSE Euronext-listed securities through Knight Capital Americas, and 24% of trades of Nasdaq-listed securities through Knight as of the end of the second quarter.

Privately held Scottrade Inc. said it also isn't "utilizing Knight for equity execution services," according to a spokeswoman.

Scottrade sent 30% of its trades in NYSE-listed securities and 37% of its trades in Nasdaq securities through Knight as of the end of June, according to a regulatory filing.

Sterne Agee & Leach Inc. also is routing its trades away from Knight, a spokeswoman confirmed Thursday.

The Birmingham, Ala., brokerage, with 140,000 customers in 50 states, said it used to route through Knight but was now routing elsewhere. Sterne routed 84% of trades of securities listed on NYSE through Knight Capital Americas as of the end of the second quarter, according to a filing. It routed another 7% through Knight Direct EMS, an electronic-trading system.

In trading securities listed on Nasdaq OMX, Sterne routed 77% through Knight Capital Americas as of the end of June, and 12% through Knight Direct EMS, according to the filing.

Sterne said it didn't have any exposure at Knight Wednesday.

It is relatively easy for firms to reprogram their computers to change the routing to other trading firms, Mr. Lee from Aite Group said.

Earlier Thursday, J.J. Kinahan, TD Ameritrade's chief derivatives strategist, said the company was "monitoring the situation," adding that this latest technology issue suggests "we [as an industry] couldn't have generated more bad public-relations events in the last six months had we set out to do so."

A series of tumultuous market events, including BATS Global Markets Inc.'s botched initial public offering, Facebook Inc.'s (FB) chaotic market debut and Knight's software problems have severely damaged a fragile retail investor psyche so far this year.

-Kirsten Grind and Alexandra Scaggs contributed to this article.

Write to Liz Moyer at [e-mail] and Brett Philbin at [e-mail]

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