UK: Rogue Trader: The Knight Capital IT Crash

Last Updated: 24 September 2012
Article by Ivor Drake

When things go wrong in automated high frequency trading, they can go disastrously wrong. This is perhaps unsurprising when you consider that about 165,000 separate trades can be completed by a high frequency trading platform, which buys and sells large volumes of stock in short periods of time, in the time it takes for Usain Bolt to react to a starting pistol1.

One such example was the so called "flash crash" on 6th May 2010, where the Dow Jones Industrial Average plummeted 600 points in 5 minutes losing 7% of its value. Approximately $1 trillion in market value disappeared temporarily, only to recover those losses in the following 20 minutes, which serves to highlight the magnitude of market failures exacerbated by high frequency traders and trading algorithms.

The recent IT failure at Knight Capital reminds us that automated high frequency trading can cause significant market risk and no one knows who will be next to suffer such a catastrophic event.

What went wrong at Knight Capital?

The headlines were that there was a defect in a high-frequency trading algorithm that lasted for 45 minutes which generated thousands of mistaken orders for approximately 150 stocks (buying stocks at a high price and selling stock at a low price). When Knight Capital sold out of their positions they were left with a $440 million loss. The net effect resulted in Knight Capital's share price to plummet 75% of its value in two days and pushed Knight Capital into seeking emergency funding by a group of independent investors in exchange for a 73% stake in the company.

It is thought that the trading program error was linked to the launch of the New York Stock Exchange's "Retail Liquidity Program" (RLP) on 1st August 2012. The RLP was designed to offer individual investors the best possible bid-offer spread. This meant market participants had a relatively short period of time (under two months) to write computer code to make use of RLP. The trading program error at Knight Capital happened in the first 45 minutes of trading on 1st August 2012. Although Knight Capital has not been forthcoming with detailed explanations as to what precisely went wrong, the prevailing view of independent commentators is that the computer code that went into the live environment to introduce the RLP was:

  • actually a test program designed to simulate trade requests and evaluate if they went through properly2; or
  • not exhaustively tested and failed to pick up the interaction with a high-frequency trading algorithm3.

What are the effects?

First and foremost there are effects on the company affected by the trading glitch on their reputation in the market place and often their financial viability which causes clients to drain away. It has been a very embarrassing episode in Knight Capital's history as it had previously been a well-respected market maker until the incident. In the immediate aftermath Vanguard Group and Fidelity Investments did not route trades to Knight Capital due to a lack of confidence in Knight Capital's systems.

There is also a wider macro effect as a result of lower confidence in the strength of the market infrastructure to deal with such disruptions which lead to large losses. A recent study showed that only 2% of 260 respondents rated their confidence in the US equity market structure as "very high" compared with 12% after the "flash crash" in 20104. The likelihood is that pending improved regulation in the area of automated high frequency trading in the UK and US is likely to bolster the low confidence in the market.

It is understood that the Financial Services Authority (FSA) in the UK is considering introducing stricter rules in relation to high frequency trading following a review of such practices earlier this year5. So it is highly likely that further regulation in this area will also be introduced in the UK as well as the US following the Knight Capital crash.

Prevention is far better than cure 

As lawyers in the financial services field we scratch our heads and wonder what part we can play in protecting our client or our company from such a risk. There will certainly be a role in interpreting the forthcoming regulations regarding high frequency trading to be introduced by the FSA. In addition, to the extent that there are any IT suppliers or external consultants involved in providing program code for trading purposes lawyers acting for the recipient will need to ensure that as much risk as is reasonably possible is placed on the IT supplier to deliver suitable and tested software code and implement such code in a way that minimises the risk of a trading collapse.

It is customary in important services agreements to have a disaster recovery plan if, for example, unusual incidents beyond the reasonable control of the supplier (e.g. fire or flood) occur without warning. The impact on the provision of the services is reduced by the implementation of a well thought out plan as to how to deal with such circumstances to ensure the continuation of services. If trading companies have not done so already they should consider having a financial disaster recovery plan, such that certain steps are identified in advance which would be taken in the event of a catastrophic financial incident (such as a defect in a high frequency trading platform) occurring.

There are also practical and operational issues which the legal team can raise in an effort to de-risk the business of a trading company, such as:

  • Testing code. Clearly had the defective software code been tested prior to introduction onto Knight Capital's live IT environment then it is likely the disastrous ramifications would have been picked up nullifying the problem. In addition, any such implementation of new software code could be subject to a soft launch in the live environment prior to market opening (e.g. at a weekend or overnight) and monitored so that any unusual activity can be identified at the earliest opportunity. 
  • Human oversight. A criticism of Knight Capital is that it took so long for them to notice the problem when other market participants were aware of a potential issue minutes after the market opened6. Stating the obvious, trading companies should ensure that there is a human being which is responsible for monitoring all trading systems of a company at times when the markets are active to identify irregular trading emanating from its automated trading systems. Although such algorithms have their own in built safety systems human oversight can double-check when those are not performing or there are unexpected situations. Clearly the nominated person should have written operating parameters for each high-frequency trading system and where a system performs outside such parameters have the authority and instant ability to flip the "off" switch to give the company time to react and rectify the issue. 
  • Circuit breakers. Following the "flash crash" the Securities and Exchange Commission (SEC) introduced circuit breakers based on the increase or decrease in the price of individual stocks. Perhaps there also needs to be a wide spread introduction of circuit breakers in relation to large trading volumes on particular stocks as the price based circuit breakers didn't avert the large scale losses of Knight Capital. The SEC is looking at this issue and will "accelerate ongoing efforts to propose a rule to require exchanges and other market centers to have specific programs in place to ensure the capacity and integrity of their systems"7.

What can be done if the worst happens?

It is clear that regulators (particularly in the US) will be reluctant to help. The SEC refused to have the majority of the $7 billion worth of trades made by Knight Capital cancelled as those trades didn't increase the share price of the majority of the purchased stocks by more than 30%, the cancellation threshold, which followed the rules established after the flash crash in May 2010. This reiterated that regulators are not there to keep financial institutions afloat but rather guard against systemic risk in financial markets.

Even though legal terms may state that a trading company is not responsible for trading losses of its clients, it is unlikely that a company would choose to place the losses on their clients as it would destroy its client base and it would be unlikely to receive any support in the market to recapitalise itself.

Without a shadow of a doubt, prevention is better than cure.

Closing thoughts

Knight Capital had become an important broker in US stock and accounted for approximately 10% of daily US trading volume, which resulted in it receiving 90 or so offers to recapitalise following the IT failure8. However, other less prominent market participants are not so likely to be as lucky and should consider both ways to prevent such issues arising in the first place and a financial disaster recovery plan if they do.

In the same way companies spend vast amounts of money for ever greater transaction speed and lower latency, perhaps they should also spend just as much money (if not more if they are interested in preserving their business for shareholders) on reliable order stopping/capping software to prevent a repeat of the Knight Capital crash. Coupled with taking the prudent measures set out in this article in advance of an incident, this will ensure that trading companies are doing their utmost to de-risk their business.









Thomas Joyce CEO of Knight Capital on the IT glitch:

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.