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Situation Looking Dark for Knight As It Enters Lehman-Like Death Spiral

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Customers are bypassing the market-maker that must now raise an estimated $600 million in capital. Oh, and the company was downgraded.

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MINYANVILLE ORIGINAL Wow, that was fast. Knight Capital Group (KCG) looks like it is falling into a Lehman-like death spiral, due to lack of confidence. The market-maker, which would need to raise an estimated $600 million to cover its August 1 trading loss of $440 million, has been slapped with three downgrades in two days and has watched its major customers pull their businesses.

Egan-Jones cut Knight's credit rating to CCC Thursday after dropping it from B-plus to B earlier in the day, and also called the company's trading loss "debilitating." Egan-Jones estimated that Knight would need to raise $600 million to ameliorate the loss and stay afloat. Given the company's rapidly diminishing market capitalization, the most they could probably raise is $60 million - $80 million.

Meanwhile, TD Ameritrade (AMTD), Fidelity Investments, and numerous institutional investors bypassed Knight in routing orders to the market Thursday. TD Ameritrade said that it was testing systems and expected to continue to send orders through Knight in the future. TD Ameritrade averaged about 355,000 daily trades last quarter with 4.5% of those going through Knight.

Fidelity Investments also said it stopped routing orders through the market-maker. During the second quarter, Fidelity routed approximately 13% of its NYSE trades and 11% of its Nasdaq trades through Knight. Fidelity averages 400,000 daily commissionable trades per day.

Broker-dealer Street One Financial was reportedly approached by at least seven asset management firms to route trades. Street One executes trades for institutional investors.

Knight, with 14 years as a public company and 1,400 employees, appears to have been undone by a 40-minute algorithm run amok. Many in the market say that the company has little choice but to turn to bankruptcy reorganization.

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