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September 30, 2002

Knight on the Comeback Trail Will New Leadership Make a Difference?

By Gregory Bresiger

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  • Knight on the Comeback Trail Will New Leadership Make a Difference?
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Many mighty market makers have fallen in the last two years and are now trying to find their way back.

The biggest of these formerly great market makers is Knight Trading Group, once led by two men, Kenneth Pasternak, Walter Raquet and the Knights of the Round Table, which exploded on the scene about six years ago.

"Market making these days is a perfect example of how the SEC cut a business down to size. They set out to cut down spreads and they succeeded. Today this is not a good business," said Matthew Park, an analyst with Thomas Weisel Partners. Park's firm gives Knight a neutral rating. The bulk of a dozen analysts following the firm, who are listed at Knight's Web site, either give it a neutral or negative rating.

"The story of Knight is the story of what is going right and what is going wrong in this business," said one trader who does business with the giant firm and didn't want to be quoted by name.

The Knight story was one of a sudden but remarkable success, which was propelled by the online trading boom. That boom, which came to a screeching halt in the past 18 months, assured Knight of a continuous flow of volume from consortium members of the so-called Roundtable, firms such as Ameritrade, BHF Securities, E*Trade Securities and Waterhouse Securities.

In the last year or so, Knight has changed leadership, settled controversial lawsuits, has seen its once fat earnings disappear and laid off hundreds of professionals. Pasternak, the trading brains, left the firm and is said to be mulling a political career. Raquet, the marketing brains, remains with Knight.

Where does Knight go now?

"I'm waiting to see their business plan," said Ken Worthington, an analyst with CIBC World Markets. Right now he rates Knight as an underperformer. That's because Knight, he says, has gone through some rough years.

Back in 2000, Knight Trading Group, a market maker frequently rumored to be courted by many looking for a quick way into the business, recorded fat margins. By the end of 2000 earnings were a remarkable $2.04 a share. At the start of the fat cycle, market making was the most successful part of the company which includes a listed trading unit. Today, listed trading is more significant.

"Knight was really benefiting from its success on the retail side and from its success with online traders. That's where a lot of their order flow came from. And let's face it," said Weisel's Park, "this kind of business isn't coming back anytime soon."

Enormous Volume

Still, Knight's current volume - in August about 3.3 billion Nasdaq shares, another 2.2 billion listed shares - is enormous. Back in the early dog days of summer 1996, Knight was handling about 3.5 percent of Nasdaq volume; today that total has jumped to some nine percent, according to AutEx/BlockDATA.