## Facts

- Knight Capital Americas LLC was a registered broker-dealer and market maker that used an automated equity order-routing system, SMARS, to convert parent orders into exchange-routed child orders.
- Before August 1, 2012, Knight modified SMARS code, but a technician failed to copy the new code to one of SMARS’s servers, and no verification process detected the incomplete deployment.
- The unupdated server continued running old, dormant code containing a “cumulative quantity” feature that malfunctioned and repeatedly generated child orders without properly stopping when parent orders were filled.
- On August 1, 2012, while processing 212 retail orders, the malfunctioning server routed millions of orders into the market over about 45 minutes.
- Knight obtained over 4 million executions in 154 stocks for more than 397 million shares, creating unintended positions of approximately $3.5 billion net long and $3.15 billion net short.
- Knight incurred losses exceeding $460 million and the erroneous activity disrupted trading in numerous securities.
- Knight lacked controls reasonably designed to prevent or promptly detect the malfunction, including: deficient code-deployment procedures, inadequate testing and change management, failure to treat pre-market warnings as actionable alerts, and risk tools not linked to automated order blocking when capital thresholds were exceeded.

## Issues

1. Whether Knight failed to comply with Exchange Act Rule 15c3-5 by not maintaining reasonably designed, automated risk management controls and supervisory procedures for market access.
2. Whether Knight’s deficient controls and supervisory procedures resulted in erroneous orders and market disruption constituting violations and/or causing violations of federal securities law requirements tied to market access.

## Decision

- The SEC instituted a public administrative cease-and-desist proceeding and accepted Knight’s Offer of Settlement without admissions or denials (other than jurisdiction).
- The SEC found Knight violated Rule 15c3-5 by failing to implement and maintain risk management controls and supervisory procedures reasonably designed to manage the risks of its market access.
- The SEC ordered Knight to cease and desist from committing or causing violations and future violations of Rule 15c3-5 and related provisions.
- The SEC censured Knight.
- The SEC imposed a $12 million civil monetary penalty.
- The SEC required undertakings to strengthen controls, including enhancements to code deployment, pre-trade controls, real-time monitoring, and incident response.

## Legal Principles

- A broker-dealer with market access must maintain risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory, and other risks of market access.  
- Rule 15c3-5 requires automated controls applied on an order-by-order basis to prevent erroneous orders and enforce pre-set credit or capital thresholds.
- Deficient software development, change management, and code-deployment governance may constitute failures of required market-access supervisory procedures when they permit large-scale erroneous trading.
- Risk controls that are not integrated with order entry, and therefore cannot automatically block order flow when thresholds or abnormal activity occur, are inconsistent with the Market Access Rule’s automation and effectiveness requirements.
- Supervisory systems for automated trading must be designed to detect and respond quickly to malfunctions, including meaningful pre-market alert review and effective shutdown capability.

## Conclusion

The SEC concluded that Knight’s August 1, 2012 trading disruption resulted from failures in automated pre-trade risk controls and technology governance required by Rule 15c3-5, and it imposed a cease-and-desist order, censure, a $12 million penalty, and remedial undertakings to strengthen market-access controls and supervision.


In re Knight Capital Americas LLC, Admin. Proc. File No. 3-15570 (SEC Oct. 16, 2013)