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'Flash crash' rules made Knight keep bad trades

WASHINGTON (MarketWatch) -- Knight Capital Group Inc. was forced to keep more than 100 bad trades that sent the market-maker near the edge of bankruptcy because of Securities and Exchange Commission rules adopted after the 2010 'flash crash.'

Last Wednesday, a glitch in Knight Capital Group. (KCG) trading software led to erroneous trades at 140 stocks trading on the New York Stock Exchange and NYSE MKT, a trading venue for small company stocks formerly known as NYSE Amex LLC.

Desperate to keep the company afloat, Knight Capital CEO Thomas Joyce spoke with SEC Chairman Mary Schapiro Wednesday about having its erroneous trades cancelled. Citing SEC rules, Schapiro effectively turned him down, according to a person familiar with the agency.

Joyce's effort came a day before the company said it would book a $440 million loss from the software snafu, necessitating a $400 million capital injection that came Monday from a group of investors including Jefferies Group Inc. (JEF) , all of which was critical for the firm to avoid extinction. Knight Capital's stock is down roughly 70% for the month to $3.12 a share, down from its Tuesday close of $10.33.

Wednesday's trading glitch triggered erroneous trade rules adopted by the SEC in September 2010 after the so-called "flash crash" that rattled markets on May 6, 2010. During the flash crash, nearly $1 trillion in market value evaporated in minutes and the Dow Jones Industrial Average (DJIA) dropped nearly 1,000 points before recovering some ground to a 348-point loss.

Exasperating retail investors, stock exchanges collectively agreed to cancel trades at prices at hundreds of corporations that were 60% above or below their price at 2:40 p.m. May 6, before the massive market disruption.

The situation led to the SEC's new rules, which aimed to provided clarity about when trades are cancelled. Based on these rules, exchanges and the Financial Industry Regulatory Authority will break trades that are at least 30% away from the "reference price," typically the last sale price before pricing was disrupted, in cases where more than 20 stocks are involved.

With the Knight Capital disruption, more than 20 stocks were involved. The NYSE and NYSE MKT said it cancelled trades in six stocks because they were 30% or more away from reference price.

These were trades in Wizzard Software Corp.(WZE) , China Cord Blood Corp.(CO) , E-House (China) Holding Ltd.(EJ) , American Reprographics Co. (ARC) , Quicksilver Resources Inc. (KWK) and Reaves Utility Income Fund (UTG)

The other affected stocks were not cancelled because they did not trade more than 30% away from their reference price, according to a NYSE spokesman.

Many online brokerage firms route trading orders from their retail customers to Knight Capital. After the Knight disruption, some of these brokerage firms reportedly suspended and later resumed sending a portion of their customer orders to the embattled Jersey City, N.J.-based firm. Read David Weidner's column about how electronic trading failed the marketplace

A Knight Capital spokesman did not return calls.