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Knight Capital Implosion: The Latest Wall Street Alarm Bell That Everyone Will Ignore

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Wall Street's latest disaster is the trading firm Knight Capital (KCG), which somehow managed to lose hundreds of millions of dollars in a half hour last week from a "software glitch"--a capital loss that almost destroyed it.

Knight has now received an emergency investment of $400 million from a group of investors including TD Ameritrade, Blackstone Group and Chicago-based Getgo. These new investors will own 70 percent of Knight Capital.

This injection will allow the firm to keep operating, but between last week's losses and the additional dilution from today's investment, Knight shareholders have been pretty much wiped out. The deal will more than triple the number of shares outstanding, massively diluting current shareholders' stake in the firm.

The stock is down 70 percent in the last five days.

"Clearly, we're not happy with how it played out," said Knight Capital CEO Tom Joyce on CNBC Monday morning, adding the firm got the best deal is could considering the circumstances.

Knight Capital, which accounts for 10 percent of equity trading volume, is currently investigating the mishap. Joyce said he'd support further rules and regulation after fully understanding what went wrong last week Thursday.

The head of the New York Stock Exchange said as much last week. "It's important that we…and regulators are understanding, speed is not always better," said Niederauer. "Nobody rational would look at this [market] and say it isn't broken."

This disaster follows other technology-related screw-ups and controversies, including the NASDAQ seizure during the Facebook (FB) IPO, a massive problem with another electronic trading system, BATS, during its IPO, and the ongoing controversy about the impact and fairness of high-frequency trading, in which hedge funds and other institutions physically locate their computer system close to the stock exchanges to gain a millisecond edge over their competitors.

So, what does all this mean? Will Wall Street and regulators finally wake up to how much the world has changed in the past decade--and do something about it?

Unlikely, says Scott Patterson, a Wall Street Journal reporter and the author of DARK POOLS: High-Speed Traders, A.I. Bandits and the Threat to the Global Financial System.

The Knight Capital disaster, along with the many technical problems that have preceded it, should be taken as a sign of how much unseen technology risk has entered the financial system in recent years, Patterson says. Computer trading systems and exchanges have now gotten so complex that the the next Knight Capital may be a "Too Big To Fail" bank, which wakes up to find that a similar "glitch" has blown a multi-billion-dollar hole in its balance sheet. Unlike Knight Capital, that glitch will necessitate another taxpayer bailout and further undermine confidence in the global market system.

Regulators and Wall Street should be terrified by what happened to Knight, Patterson says. But, most likely, as with other warning signs, this latest technology problem will just lead to discussions that will then go nowhere.

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