IT Risk as an Investment Consideration

Last week’s Knight Trading (KCG) disaster marked the first time that I can recall when a software glitch actually threatened the surivival of a public company. In recent years computer technology has played an increasing role in the functioning of the equity markets, and KCG’s mis-hap was preceded by the Facebook (FB) IPO mess and the Flash Crash in May 2010. And based on the terms of the $400MM in new capital KCG raised, such that the new investors will own 70% of the company at $1.50 a share, prior KCG investors are all but wiped out compared with the $12 price of recent weeks.

We’ve never considered investing in KCG, but investors might be forgiven for not having contemplated their exposure to bad implementation of a new trading system. KCG’s most recent 10-K is lighter than most in its list of Risk Factors, containing seven although they’re all important. Operational Risk is the relevant disclosure, “…from major systems failures.” which would seem to incorporate what happened. As well as raising further questions for regulators about how well they monitor the increasingly automated activities of the public markets, it also highlights the need for investors in such business to achieve greater comfort around “IT competence” when they invest in such companies.