THOMAS JOYCE WILL NEVER FORGET HIS FIRST two days as CEO of Knight Trading Group. At 8:15 a.m. on Monday, June 3, 2002, the market maker’s stock hit the tape at just 14 cents a share in premarket trading, down from $6.35 at the previous close. Joyce, a 14-year veteran of brokerage Merrill Lynch & Co., who most recently had been global head of trading for Sanford C. Bernstein & Co., quickly figured out the problem: One of Knight’s own traders had placed an order to sell about 1 million shares of some penny stock, and a software glitch erroneously replaced it with Knight’s symbol.
“I had to get on the hoot-n-holler and introduce myself,” recalls Joyce, 57, referring to the squawk-box system that Knight and other firms use to communicate between offices. “‘I’m Tom Joyce,’ I told everyone, ‘and, yes, I know that our stock is trading at 14 cents.’ ”
The new CEO got Nasdaq Stock Market to break the trades. But the next morning the firm’s shares were under pressure once again. The Wall Street Journal had reported that the Securities and Exchange Commission was investigating allegations that Knight traders had been front-running client orders. By 8:30 a.m., Joyce was back on the hoot-n-holler, informing the firm’s traders that any improper sales practices would be stopped.
Knight’s board of directors had recruited Joyce to turn around the then-struggling market maker, which was losing money as a result of the drop in trading volumes after the dot-com bubble burst and the tightening of bid-offer spreads as stock quotes moved from fractions to decimals. The SEC investigation was a bonus.
Joyce, who has a BA in economics from Harvard University and was the oldest of five siblings growing up in a two-bedroom cape in Boston, set out to transform Knight’s business and culture. He has done both brilliantly. In 2002 the firm had $352.1 million in annual revenue and its trading was entirely manual. By last year its revenue had grown to $1.4 billion and 95 percent of its market-making activity was electronic. Market making represents about half of the revenue for Knight Capital Group, as the company is now known. Electronic execution services and institutional sales and trading make up the other half.
In 2004, Knight settled with the SEC for $79 million, neither admitting nor denying guilt. In fixing the firm’s culture, Joyce set out to replicate the principles he’d learned running various trading operations at Merrill Lynch: client focus, integrity, respect for the individual, responsible citizenship and teamwork.
“Tommy is the epitome of the Merrill-Knight culture,” says Daniel Tully, who created the principles as CEO and chairman of Merrill Lynch from 1993 through 1997. “I’m very proud of him — one, for remembering the principles and, two, for putting them into action.”
In April, Institutional Investor Editor Michael Peltz met with Joyce in his office overlooking Knight’s trading floor in Jersey City, New Jersey, to discuss how the firm’s business has changed during his decade as CEO — and what it takes to succeed on Wall Street today.
Institutional Investor: What did you know about Knight before arriving?
Joyce: There were always rumors in the market that somebody or another at Knight was doing something unseemly. Obviously, Knight got off to an incredibly fast start [in the mid-’90s], and I think some of the rumors might have been jealousy and some might have been reality. It turns out that there were some issues that we had to deal with once I showed up.
Did you know before you arrived that changes would need to be made?
My opinion from the outside looking in was, yes, they were not a very client-focused organization, but, of course, whenever there’s turmoil, there is often opportunity. And the turmoil here obviously ended up opening a door for somebody from the outside to come in, and fortunately that somebody was me.
As CEO, how do you implement change?
You need to use several tools at your disposal. One is the bully pulpit. You state flat out what the goals are — “We want to be a client-driven organization.” You also make whatever structural changes are necessary to enhance that. In our case we viewed that a lot of the employees had a flawed compensation plan, which was incenting people to act selfishly. So we changed the way people got paid in many cases. The third thing is, you try to walk the talk, to become an example of how you should behave.
How important is culture?
A great culture will get you through, if you will, extremes in the marketplace. So even though things are changing around you, you are still, and your organization is still, behaving in a very predictable, dependable fashion. What I wanted to migrate over to Knight [from Merrill Lynch] was that culture.
What was the reaction to the changes?
Well, we made some people unhappy, as you might imagine, because we had to change the business model as well as the cultural shift, so in some cases we encouraged people to leave because it was better for us if they left. In some cases people chose to leave because they decided they didn’t want to be part of the new world. Which is fine. I don’t think in general we lost a whole lot of people we wanted to keep.
At the same time, U.S. equity trading was undergoing enormous regulatory changes.
Yes. The first thing was when markets went to decimals, which happened right about ’01. And then the SEC instituted Regulation NMS. It has a whole bunch of rules and regulations, but if you pick one theme, it was encouraging competition through the use of technology to deliver better executions to investors. And it worked, in our opinion. We had to gin up our game. A lot of other people had to change their approach. The execution quality that the retail investor enjoyed went up dramatically thanks to competition. So by introducing and encouraging the use of technology in the trading process, you ended up with a better stock market. Regulation NMS made the U.S. equity markets more competitive and arguably the best in the world.
Is there one part of the business whose growth has surprised you the most during your decade as CEO?
I think the business that surprised me is, frankly, our core business — the market-making business — because it’s gone through the most change. It’s gone from manual to automated. It’s seen competitors come at it, but it continues to deliver the goods for the clients. We continue to extract a nice return from the business for shareholders. So even though it’s a very dynamic and competitive situation, it continues to find ways to grow, and I think that’s a testament to the innovative spirit that’s here.
How critical is technology to your success?
Wildly so. Technology is the backbone of everything we do, whether it’s software development, infrastructure or the exchangelike capabilities that we have to handle millions of trades every day. About a third of our staff is technology-oriented. Clearly, everybody looks at the market-making business and thinks technology, but the impact of technology on the other businesses is extremely important as well.
Even institutional sales and trading?
Yes, because just communicating with our clients is becoming more automated, whether it’s simple things like instant messaging or straight-through processing when trades get done to make sure you handle the back-office components of a trade. All that stuff has to be dependable, reliable, and technology allows us to deliver. So even the kind of traditional voice businesses, where there’s a lot of dialogue between clients and us, there’s kind of a technology wrapper around the whole thing.
How important are exchange-traded funds to Knight?
Exchange-traded funds have been a big part of both the market-making business and the institutional equity business in that retail is trading ETFs more and more, obviously. And a lot of the institutional clients are using ETFs in ways to get exposure to the market. So there’s definitely been some migration from single-stock trading to using ETFs, and as that business has grown, we clearly wanted to be there in the midst of that growth.
Is the recent drop in U.S. equity-trading volumes cyclical or representative of a more structural change?
I don’t see any reason why it would be structural. Structural to me implies something is broken. I don’t think that anything is broken. I think we’re in a cycle. It happens to be a down cycle, but it’s still a cycle that will, as it has in the past, turn. I don’t know what the catalyst will be. It’s hard to know what a catalyst is until after the fact when you look back on it. But this is now the third year in a row of declining volumes. If there’s one thing I believe in, maybe in life but certainly in financial services, it’s that there is this element of regression to the mean. At some point, the trends will turn around. In the past it has typically turned around after the third down year.
Are there forces in place to boost that turnaround?
I think as people gain more confidence in the economy, as they see employment trends improve, as confidence starts to be regained and as people realize if they’re going to save for the future they need better than a 2 percent return, people will start to migrate back into the equity markets. I think that’s likely to happen within the next year.
Has high frequency trading had an impact on equity market volume and volatility?
High frequency traders are generally proprietary traders and tend to migrate toward asset classes where they can get a return. If volumes are high — if the traditional, long-term investors are more active — then high frequency traders also become more active, and vice versa. I think volatility is driven by macro events more than by the minutiae of how one trades. I tend to believe that periods of high volatility can be traced back to a macro event, whether it’s implosions in Europe or the U.S.’s struggles to get its debt ceiling stuff figured out.
Do high frequency traders deserve the criticism they’ve received?
I don’t think it’s deserved. I don’t want to be the defender of high frequency traders, but when you look at all the data, high frequency trading has narrowed spreads and made trading more efficient. So I believe that high frequency traders have been, by and large, good for the markets. They can be looked at as intermediaries, and there have always been intermediaries in the stock market. It can’t be a shock to us in 2012 that computers are behind a lot of the way people interact with the securities markets now.
Many financial firms seem to have forgotten how to put clients’ interests first. Will that have to change for Wall Street to repair its image?
I think Wall Street has to have an intense focus on delivering results for clients. You can define clients in any way, whether they’re institutional clients or individual clients. But I think Wall Street has to get back to what made it an important part of the U.S.’s economic landscape, and that is focusing on delivering products to clients to help them achieve their investment goals and their economic goals. And if Wall Street stays focused on the client, then I think the outcome will be one that we can all be proud of. • •
