Hush-Hush Investor Added to Knight Bailout Team

The bizarre implosion of Knight Capital (NYSE:KCG) is getting even more bizarre with the emergence of a previously undisclosed investor as part of the firm’s bailout group, the FOX Business Network has learned.

That investor, online brokerage Scottrade, was placed into the deal after Knight announced it had been rescued by a six-firm investor consortium that would sink around $400 million into the outfit to cover losses stemming from a flubbed trade, according to people with direct knowledge of the matter.

Old shareholders of Knight have seen the value of their holdings decline more than 70% since the firm announced that an errant trade blew a $440 million hole in its finances earlier in the month. Yet for the bailout group, the deal was easy money; each firm received securities convertible into Knight common stock at $1.50 a share. Shares of Knight closed at $2.82 on Tuesday.

Knight has yet to announce Scottrade’s inclusion. A person with direct knowledge of the deal said Scottrade is receiving a far smaller stake in the firm than the other investors -- around $10 million -- compared to anywhere between $30 million and $100 million for the other players.

Still, the last-minute inclusion of Scottrade into the deal will reduce each firm’s upside. The buyout group of Blackstone Group, Jefferies Inc., Getco LLC., Stifel Financial Corp., TD Ameritrade, and Stephens Inc., were convinced by Knight chief executive Tom Joyce to give up a slice of their shares to include Scottrade in the package the day the deal was announced on August 6, according to a person with direct knowledge of the matter.

A spokeswoman for Knight didn’t return calls for comment, nor did a spokesman for Scottrade.

The last-minute inclusion of Scottrade into the deal speaks to the clubby nature of the Wall Street trading community. Scottrade was a major customer of Knight, sending what’s known as “order flow” to Knight’s market making business which matches buyers and sellers of stock.

Including Scottrade in the deal is seen as payback to a firm that both gave business to Knight and continued to do so even after the botched trades put Knight’s existence into question. The terms of the bailout package offer what many believe is a no-lose proposition for any firm that is part of the group.

As for why the other players would give up a piece of deal, the same thing holds: all these firms do business with each other.

“Scottrade is a big customer of ours, so I had no problem doing it,” said a senior executive at one of the Knight bailout firms.

Still news that Scottrade got cut in at the last minute in what many are calling a sweetheart deal is controversial since so much shareholder wealth was destroyed by the bad trade and the dilution from the bailout.

“Let’s just say this looks really strange,” said one analyst who follows the company and asked not to be named.