In addition to finding the violation, the order describes aspects of the CFTC’s new business conduct rules applicable to swap dealers. JPMorgan registered with the Commission as a swap dealer as of December 31, 2012, and at that time became subject to the Commission’s new swap dealer regime, including rules that impose supervision and control obligations. Although these rules did not apply to the Bank at the time of the events in question, the order explains how some of these new rules would have covered the matters set forth in the order, and concludes that had the regulations been in place, much of the offending conduct at issue (and the significant losses it caused) may well have been detected and remedied internally much more quickly, thereby potentially reducing losses.
Knight Capital to pay $12 million for market disruption
The Securities and Exchange Commission (SEC) announced that Knight Capital Americas LLC has agreed to pay $12 million to settle charges that it violated the agency’s market access rule in connection with the firm’s Aug. 1, 2012 trading incident that disrupted the markets.
An SEC investigation found that Knight Capital did not have adequate safeguards in place to limit the risks posed by its access to the markets, and failed as a result to prevent the entry of millions of erroneous orders. Knight Capital also failed to conduct adequate reviews of the effectiveness of its controls.
“The market access rule is essential for protecting the markets, and Knight Capital’s violations put both the firm and the markets at risk,” said Andrew Ceresney, co-director of the SEC’s Division of Enforcement. “Given the rapid pace of trading in today’s markets and the potential massive impact of control breakdowns, broker-dealers must be held to the high standards of compliance necessary for the safe and orderly operation of the markets.”
Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit, added, “Brokers and dealers must look at each component in each of their systems and ask themselves what would happen if the component malfunctions and what safety nets are in place to limit the harm it could cause. Knight Capital’s failure to ask these questions had catastrophic consequences.”
According to the SEC, Knight Capital made two critical technology missteps that led to the trading incident on Aug. 1, 2012. Knight Capital moved a section of computer code in 2005 to an earlier point in the code sequence in an automated equity router, rendering a function of the router defective. Although this function was not meant to be used, Knight left it in the router. In late July 2012 when preparing for participation in the NYSE’s new Retail Liquidity Program, Knight Capital incorrectly deployed new code in the same router. As a result, certain orders eligible for the NYSE’s program triggered the defective function in Knight Capital’s router, which was then unable to recognize when orders had been filled. During the first 45 minutes after the market opened on Aug.1, Knight Capital’s router rapidly sent more than 4 million orders into the market when attempting to fill just 212 customer orders. Knight Capital traded more than 397 million shares, acquired several billion dollars in unwanted positions, and eventually suffered a loss of more than $460 million.