August 3, 2012 / 7:33 PM / 7 years ago

Insurance may provide little relief for Knight Capital losses

* Trading company may not have been covered for bug

* Recovery will depend on who wrote the bad code

* Timing question weighs as well; settlement Monday

By Ben Berkowitz

NEW YORK, Aug 3 (Reuters) - As Knight Capital Group Inc struggles for survival after massive trading losses it said were caused by bad software, there seems to be little chance it can rely on insurance to save the day.

Knight lost as much as 80 percent of its market value on Wednesday and Thursday and said it would have to raise money after a glitch in software it installed on Tuesday triggered a cascade of mistaken trades that wiped out $440 million of its capital.

“ They are going to be looking anywhere and everywhere for coverage” provisions that might offset some of their losses, said Jonathan Ziss, a partner with the law firm Goldberg Segalla in Philadelphia.

While details of Knight’s coverage are unclear, its hopes for some sort of insurance recovery for its losses hinge in part on whether the buggy code was written by a Knight employee or came from a third-party vendor.

Representatives for Knight did not respond to messages for comment on what, if any, insurance coverage the firm has for the situation.

Insurance brokers say that if the code came from a third party, the vendor would likely have software errors and omissions insurance, designed to protect its customers from any fault in the vendor’s programming. There is no guarantee that the vendor had coverage, though, and the software company’s insurer would probably require it to eat a huge portion of the loss upfront.

If Knight developed the software itself, brokers say that could potentially be covered under the firm’s professional liability policy, though some insurance lawyers say that coverage is unlikely to cover such a huge loss.

Either way, the scale of the loss points to an ongoing problem for financial companies in a world of high-frequency trading, ever changing technology demands from customers and regulators, and the difficulty of insuring these companies.

“Sometimes you don’t have all the beta testing you’d like to have before you implement the software, and it’s becoming a more recurrent problem, not only with Wall Street firms but with other companies,” said Kevin Kalinich, global network and cyber risk practice leader for Aon Risk Solutions.

Even if Knight has coverage, the amount may be insufficient. Goldberg Segalla’s Ziss said the company’s professional liability policy may cover short-term legal and regulatory costs, but that it probably would not indemnify the firm for its own losses because of a software glitch.

“What they need is something to stem the cash bleed that’s going to occur and may already be occurring,” he said. “They may find themselves with at least the lubricant of early money to help with the legal spend.”

INSURER, HEAL THYSELF

People who work with insurers on their own technology say they are acutely aware of the damage possible from software bugs and the business interruptions they can cause, something that colors their view of customer risk as well.

“A number of large insurers have very strong policies on this because their reputation is at stake,” said Benjamin Moreland, a senior analyst at the information technology consultancy Celent.

Moreland said an insurer would demand its own computer programming providers be fully insured for any financial losses and lost business, but if the bad code were internal, it would more likely be a mad scramble to get all hands on deck and fix the problem internally, with no policy to offset the costs. The same is likely to apply to other financial firms.

Knight also faces a timing problem. Complex commercial claims can take months or years to process, and often end up in litigation. Knight’s big cash crunch is likely to come Monday, when the errant trades settle. Several private equity firms said Friday they would look at Knight and there was an unconfirmed report that Knight had secured a line of credit.

Knight’s shares were up 28 percent to $3.30 on Friday after losing 75 percent of their value over the past two days.

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