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KCG Pays $13M To End Investors' Suit Over $460M 'Glitch'

 A New Jersey federal judge on Monday preliminarily approved a $13 million settlement to end investors' claims that high-frequency trading house Knight Capital Group Inc. knew its internal controls were deficient that led to its $460 million one-day trading loss in 2012.

U.S. District Judge Madeline Cox Arleo signed off on the deal and set a final hearing for July 1. The case stems from Knight’s disastrous sequences of trades on Aug. 1, 2012, which it blamed on technical glitches that caused it to buy $7 billion of unwanted positions in about 45 minutes.

The investors claimed the software malfunction caused Knight’s stock to tumble 75 percent and left it near bankruptcy. They said Knight failed to adopt industry-standard risk management practices, citing the U.S. Securities and Exchange Commission’s October 2013 report that found Knight didn’t have the mechanisms in place to prevent the technical problems. The SEC fined a Knight affiliate $12 million.

“The scope of the company’s catastrophe is so breathtaking, and the catalysts for Knight’s implosion are so rudimentary, that even to this day commentators of the spectacle are dumbfounded as to the magnitude of Knight’s risk management and control deficiencies,” the plaintiffs said in their most recent complaint in December 2013.

The plaintiffs argued Knight lost $750 million in market capitalization from the errant trading and that executives failed to disclose that it lacked the required financial controls meant to protect high-frequency broker-dealers.

But Knight countered that it never knowingly misled investors and always cautioned about the risk inherent in its trading software. The SEC had found that no individual Knight employees, including former CEO Thomas Joyce, should be held responsible for the firm's mistakes.

The SEC said that Knight failed to fix a coding mistake in a router for its high-speed trading computers, ultimately causing hundreds of millions of unwanted trades to get processed in the first hour of trading. The software placed repeated orders for six small companies on the New York Stock Exchange: Wizzard Software Corp., China Cord Blood Corp., Reaves Utility Income Fund, E-House China Holdings Ltd., American Reprographics Co. and Quicksilver Resources Inc.

Before a merger with Getco LLC, Knight was one of the largest high-frequency trading houses in the world. The brokerage used superfast computers to process trades in milliseconds as a way to maximize volume and profit from minuscule price changes.

The unwanted trades at Knight were much more than a technical glitch, the SEC said. Rather, they stemmed from a failure on the firm's part to have the proper systems in place to prevent a trading mistake and then fix the mistake when it happened. Regulators said Knight employees were forced to address problems while the trading system was still live.

The case against Knight was the first enforcement action over violations of the 2010 market access rule. That rule, mandated by the Dodd-Frank Act, requires broker-dealers to put in place controls and procedures to limit the risks that can arise when they offer market access to clients.

Attorneys for the parties did not immediately respond Monday to requests for comment.

The plaintiffs are represented by James E. Cecchi of Carella Byrne Cecchi Olstein Brody & Agnello PC and Maya Saxena, Joseph E. White III, Lester R. Hooker and Brandon T. Grzandziel of Saxena White PA.

Knight is represented by Brian J. McMahon, Joshua R. Elias and Michael C. Landis of Gibbons PC and Jay P. Lefkowitz, Matthew Solum and Ross L. Weiner of Kirkland & Ellis LLP.

The case is Juan Fernandez et al. v. Knight Capital Group Inc. et al., case number 2:12-cv-06760, in the U.S. District Court for the District of New Jersey.