10-K 1 kcg2013123110-k.htm 10-K KCG 2013.12.31 10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________  
FORM 10-K
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
000-54991
Commission File Number 
KCG HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
38-3898306
(I.R.S. Employer Identification Number)
545 Washington Boulevard, Jersey City, NJ 07310
(Address of principal executive offices and zip code)
Registrant’s telephone number, including area code: (201) 222-9400
_______________________________________________ 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Class A Common Stock, $0.01 par value
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
_______________________________________________ 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ý    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  ý
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
Accelerated filer
 
¨
 
 
 
 
 
 
Non-accelerated filer
 
¨
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The aggregate market value of the Class A Common Stock held by nonaffiliates of the Registrant's predecessor, Knight Capital Group, Inc. ("Knight"), was approximately $800.6 million at June 30, 2013 based upon the closing price for shares of Knight's Class A Common Stock as reported by the New York Stock Exchange.
At February 27, 2014, the number of shares outstanding of the Registrant’s Class A Common Stock was 125,706,326 (including restricted stock units) and there were no shares outstanding of the Registrant’s Class B Common Stock or Preferred Stock.
_______________________________________________  
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement relating to the Company’s 2014 Annual Meeting of Stockholders to be filed hereafter (incorporated, in part, into Part III hereof).



EXPLANATORY NOTE
On July 1, 2013, Knight Capital Group, Inc. (“Knight”) merged with and into Knight Acquisition Corp., a wholly-owned subsidiary of KCG Holdings, Inc. (“KCG”), with Knight surviving the merger, GETCO Holding Company, LLC (“GETCO”) merged with and into GETCO Acquisition, LLC, a wholly-owned subsidiary of KCG, with GETCO surviving the merger and GA-GTCO, LLC, a unitholder of GETCO, merged with and into GA-GTCO Acquisition, LLC, a wholly-owned subsidiary of KCG, with GA-GTCO Acquisition, LLC surviving the merger (collectively, the “Mergers”), in each case, pursuant to the Amended and Restated Agreement and Plan of Merger, dated as of December 19, 2012 and amended and restated as of April 15, 2013 (the "Merger Agreement"). Following the Mergers, each of Knight and GETCO became wholly-owned subsidiaries of KCG.
All references herein to the "Company", "we", "our" or "KCG" relate solely to KCG and not Knight or GETCO. All references to GETCO relate solely to GETCO Holding Company, LLC and not KCG.
The Mergers were treated as a purchase of Knight by GETCO for accounting and financial reporting purposes. As a result, the financial results for the year ended December 31, 2013 comprise the results of GETCO only for the six months ended June 30, 2013 and the results of KCG (the combined Knight and GETCO) for the six months ended December 31, 2013. All periods prior to 2013 reflect solely the results and financial condition of GETCO.
All GETCO earnings per share and unit share outstanding amounts in this Annual Report on Form 10-K have been calculated as if the conversion of GETCO units to KCG Class A Common Stock took place on January 1, 2011, at the exchange ratio, as defined in the Merger Agreement.
For additional information relating to the Mergers and KCG see the Registration Statement on Form S-4 (Registration No. 333-186624) filed by KCG with respect to the Mergers, the Current Report on Form 8-K filed by KCG on July 1, 2013 with the U.S. Securities and Exchange Commission ("SEC") and the Current Report on Form 8-K filed by KCG on August 9, 2013, the Current Report on Form 8-K filed by KCG on November 12, 2013 related to the restatement of GETCO historical results and in other reports or documents KCG files with, or furnishes to, the SEC from time to time.


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KCG HOLDINGS, INC.
FORM 10-K ANNUAL REPORT
For the Year Ended December 31, 2013
TABLE OF CONTENTS
 
 
 
Page
 
 
 
PART I
 
 
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
 
 
 
Part II
 
 
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
Selected Financial Data
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosures
Item 9A.
Controls and Procedures
Item 9B.
Other Information
 
 
 
PART III
 
 
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accountant Fees and Services
 
 
 
PART IV
 
 
Item 15.
Exhibits and Financial Statement Schedules
Signatures
 
Certifications
 
 
Exhibit Index
 
 



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FORWARD LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-K, including without limitation, those under “Legal Proceedings” in Part I, Item 3, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 (“MD&A”), and “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A, the documents incorporated by reference herein and statements containing the words “believes,” “intends,” “expects,” “anticipates,” and words of similar meaning, may constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts and are based on current expectations, estimates and projections about KCG Holdings Inc.’s (the “Company” or “KCG”) industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company's control. Accordingly, readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict including, without limitation, risks associated with: (i) the strategic business combination (the "Mergers") of Knight Capital Group, Inc. (“Knight”) and GETCO Holding Company, LLC (“GETCO”) including, among other things, (a) difficulties and delays in integrating the Knight and GETCO businesses or fully realizing cost savings and other benefits, (b) the inability to sustain revenue and earnings growth, and (c) customer and client reactions to the Mergers; (ii) the August 1, 2012 technology issue that resulted in Knight’s broker dealer subsidiary sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market and the impact to Knight’s capital structure and business as well as actions taken in response thereto and consequences thereof; (iii) the costs and risks associated with the sale of Knight's institutional fixed income sales and trading business, the sale of KCG's reverse mortgage origination and securitization business and the departure of the managers of KCG's listed derivatives group; (iv) changes in market structure, legislative, regulatory or financial reporting rules; (v) past or future changes to KCG's organizational structure and management; (vi) KCG's ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by KCG's customers and potential customers; (vii) KCG's ability to keep up with technological changes; (viii) KCG's ability to effectively identify and manage market risk, operational and technology risk, legal risk, liquidity risk, reputational risk, counterparty and credit risk, international risk, regulatory risk, and compliance risk; (ix) the cost and other effects of material contingencies, including litigation contingencies, and any adverse judicial, administrative or arbitral rulings or proceedings; and (x) the effects of increased competition and KCG's ability to maintain and expand market share. The above list is not exhaustive. Because forward-looking statements involve risks and uncertainties, the actual results and performance of the Company may materially differ from the results expressed or implied by such statements. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Unless otherwise required by law, the Company also disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made herein. Readers should carefully review the risks and uncertainties disclosed in the Company’s reports with the U.S. Securities and Exchange Commission (“SEC”), including those detailed under “Certain Factors Affecting Results of Operations” in MD&A and in “Risk Factors” in Part I, Item 1A herein, and in other reports or documents the Company files with, or furnishes to, the SEC from time to time. This information should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto contained in this Form 10-K, and in other reports or documents the Company files with, or furnishes to, the SEC from time to time.


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PART I
Item 1.
Business
Overview
KCG Holdings, Inc., a Delaware corporation (collectively with its subsidiaries, “KCG” or the “Company”), is a leading independent securities firm offering clients a range of services designed to address trading needs across asset classes, product types and time zones. The Company combines advanced technology with specialized client service across market making, agency execution and trading venues and also engages in principal trading via exchange-based electronic market making. KCG has multiple access points to trade global equities, options, fixed income, currencies and commodities via voice or automated execution.
On July 1, 2013, Knight Capital Group, Inc. (“Knight”) merged with and into Knight Acquisition Corp., a wholly-owned subsidiary of KCG, with Knight surviving the merger, GETCO Holding Company, LLC (“GETCO”) merged with and into GETCO Acquisition, LLC, a wholly-owned subsidiary of KCG, with GETCO surviving the merger and GA-GTCO, LLC, a unitholder of GETCO, merged with and into GA-GTCO Acquisition, LLC, a wholly-owned subsidiary of KCG, with GA-GTCO Acquisition, LLC surviving the merger (collectively, the “Mergers”), in each case, pursuant to the Amended and Restated Agreement and Plan of Merger, dated as of December 19, 2012 and amended and restated as of April 15, 2013 (the "Merger Agreement"). Following the Mergers, each of Knight and GETCO became wholly-owned subsidiaries of KCG.
Our corporate headquarters are located at 545 Washington Boulevard, Jersey City, New Jersey 07310. Our telephone number is (201) 222-9400.
Financial information concerning our business segments for each of 2013, 2012 and 2011 is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 (“MD&A”) and in the Consolidated Financial Statements and Notes thereto located in Part II, Item 8 entitled “Financial Statements and Supplementary Data.”
Available Information
Our Internet address is www.kcg.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Forms 3, 4 and 5 filed on behalf of directors and executive officers, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as well as our proxy statements, are made available free of charge on or through the “Investors” section of our corporate website under “SEC Filings”, as soon as reasonably practicable after such materials are electronically filed with or furnished to, the SEC. We also post on our corporate website our Code of Business Conduct and Ethics (the “Code”) governing our directors, officers and employees. Within the time period required by the SEC, we will post on our corporate website any amendments and waivers to the Code applicable to our executive officers and directors, as defined in the Code.
Our Board of Directors (the “Board”) has a standing Finance and Audit Committee, a Risk Committee, a Compensation Committee and a Nominating and Corporate Governance Committee. Each of these Board committees has a written charter approved by the Board. Our Board has also adopted a set of Corporate Governance Guidelines. Each committee charter, along with the Corporate Governance Guidelines, is posted on the Company’s website. None of the information on our corporate website is incorporated by reference into this report.
All of the above materials are also available in print, without charge, to any person who requests them by writing or telephoning:
KCG Holdings, Inc.
Investor Relations
545 Washington Boulevard, 3rd Floor
Jersey City, NJ 07310
(201) 222-9400
Unless otherwise indicated, references to the “Company,” “KCG,” “We,” “Us,” or “Our” shall mean KCG Holdings, Inc. and its subsidiaries.

5


Operating Segments
As of December 31, 2013, we had three operating segments: (i) Market Making, (ii) Global Execution Services, and (iii) Corporate and Other.
Market Making- The Market Making segment principally consists of market making in the cash, futures and options markets across global equities, options, fixed income, foreign currencies and commodities. As a market maker, KCG commits capital on a principal basis by offering to buy securities from, or sell securities to, broker dealers, institutions and banks. Principal trading in the Market Making segment primarily consists of direct-to-client and non-client exchange-based electronic market making, including trade executions conducted as an equities Designated Market Maker (“DMM”) on the New York Stock Exchange ("NYSE") and NYSE Amex Equities ("NYSE Amex"). The Company is an active participant on all major global equity and futures exchanges and also trades on substantially all domestic electronic options exchanges. As a complement to electronic market making, KCG’s cash trading business handles specialized orders and also transacts on the OTC Bulletin Board, marketplaces operated by the OTC Markets Group Inc. and the Alternative Investment Market (“AIM”) of the London Stock Exchange.
Global Execution Services- The Global Execution Services segment comprises agency execution services and trading venues, offering trading in global equities, options, foreign exchange, fixed income and futures to institutions, banks and broker dealers. KCG generally earns commissions as an agent between principals to transactions that are executed within this segment, however, the Company will commit capital on behalf of clients as needed. Agency-based, execution-only trading in the segment primarily consists of self-directed trading in global equities through a suite of algorithms or via our execution management system; institutional high touch sales traders executing program, block and riskless principal trades in global equities and exchange traded funds ("ETFs"); an institutional spot foreign exchange electronic communication network ("ECN"); a fixed income ECN that also offers trading applications; an alternative trading system ("ATS") for global equities; and futures execution and clearing through a futures commission merchant ("FCM").
Corporate and Other- The Corporate and Other segment invests principally in strategic financial services-oriented opportunities, allocates, deploys and monitors all capital, and maintains corporate overhead expenses and all other income and expenses that are not attributable to the other segments. The Corporate and Other segment also contains functions that support the Company’s other segments such as self-clearing services, including stock lending activities.

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The following table sets forth: (i) Revenues, (ii) Expenses and (iii) Pre-tax earnings (loss) from continuing operations of our segments on a consolidated basis (in thousands):
 
 
For the year ended December 31,
 
 
2013
 
2012
 
2011
Market Making
 
 
 
 
 
 
Revenues
 
$
688,197

 
$
495,427

 
$
862,759

Expenses
 
584,639

 
460,540

 
658,873

Pre-tax earnings
 
103,559

 
34,887

 
203,886

Global Execution Services
 
 
 
 
 
 
Revenues
 
197,766

 
36,211

 
27,599

Expenses
 
223,506

 
43,541

 
43,006

Pre-tax loss
 
(25,739
)
 
(7,330
)
 
(15,406
)
Corporate and Other
 
 
 
 
 
 
Revenues
 
134,208

 
19,596

 
25,089

Expenses
 
194,215

 
20,726

 
20,028

Pre-tax (loss) earnings
 
(60,007
)
 
(1,130
)
 
5,061

Consolidated
 
 
 
 
 
 
Revenues
 
1,020,171

 
551,234

 
915,448

Expenses
 
1,002,360

 
524,807

 
721,907

Pre-tax earnings
 
$
17,813

 
$
26,427

 
$
193,541

Totals may not add due to rounding.
See Footnote 24 "Business Segments" to the Company's Consolidated Financial Statements included in Part II, Item 8 "Financial Statements and Supplementary Data" herein for a summary of revenues by geographic region.
Market Making Segment
Business Segment Overview
KCG makes markets primarily in global equities, options, fixed income, foreign currencies and commodities. The Company is an active participant on all major global equity, futures and options exchanges. As a market maker, KCG commits capital on a principal basis by offering to buy securities from, or sell securities to, broker dealers, institutions and banks. Principal trading in the Market Making segment primarily consists of direct-to-client and non-client exchange-based electronic market making in equity securities quoted and traded on the NYSE, Nasdaq Stock Market, OTC market, NYSE Amex, NYSE Arca and several European exchanges. We are connected to a large number of external market centers including exchanges, ECNs, ATSs, dark liquidity pools, alternative display facilities (“ADF”), multilateral trading facilities (“MTF”) and other broker dealers.
The majority of revenues for this segment are derived from client electronic market making in U.S. equities. As a complement to electronic market making, our cash trading business handles specialized orders and also transacts on the OTC Bulletin Board, marketplaces operated by the OTC Markets Group Inc., and the AIM of the London Stock Exchange. We also provide trade executions as an equities DMM on the NYSE and NYSE Amex.
The majority of market making activity is conducted on a principal basis through the use of automated quantitative models. In direct-to-client market making, KCG derives revenues from the difference between the amount paid when securities are bought and the amount received when the securities are sold. In non-client, exchange-based market making, KCG generally derives revenues from pricing and arbitrage opportunities from financial instruments within the marketplace.
Clients and Products
KCG offers direct-to-client market making services across multiple asset classes primarily to sell-side clients including global, national, regional and electronic broker dealers as well as buy-side clients comprising, among others, mutual funds, pension plans, plan sponsors, hedge funds, trusts, endowments and traditional investment banks in North America, Europe and Asia. In 2013, KCG did not have any client that accounted for more than 10% of Market Making segment revenues.

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In this segment, we generally compete based on our market coverage, execution quality, fulfillment rates and client service. In direct-to-client electronic market making in U.S. equities, execution quality is generally accepted as speed, spread and price improvement under SEC Rule 605. In other asset classes, standards for execution quality are client defined. In non-client exchange-based market making we seek to provide best prices for buy and sell orders on market centers throughout the day and compete with proprietary trading models used by our competitors based on, among other things, speed and quality of execution.
We continually work to provide clients with high quality, low-cost trade executions that enable them to satisfy their fiduciary obligation to seek the best execution on behalf of the end client as reasonably available in the marketplace. We continually refine automated quantitative models so that we remain competitive.
Global Execution Services Segment
Business Segment Overview
KCG provides agency execution services and trading venues for agency-based, execution-only trading in global equities, foreign exchange, fixed income, futures and options to institutions and broker dealers. The Company is an active participant on all major global equity, futures and options exchanges. KCG generally earns commissions and commission-equivalents as an agent between principals for transactions that are executed within the Global Execution Services segment, however, the Company will commit capital on behalf of clients as needed. The Global Execution Services segment is connected to a large number of external market centers similar to the Market Making segment.
The majority of revenues for this segment are derived from agency-based, execution-only trading encompassing self-directed trading in global equities through the Knight Direct and GETAlpha suite of algorithms or via the Knight Direct execution management system; institutional high touch sales traders executing program, block and riskless principal trades in global equities and ETFs; an institutional spot foreign exchange ECN (KCG Hotspot); a fixed income ECN that also offers trading applications (KCG BondPoint); an ATS for global equities (Knight Match); and futures execution and clearing through a FCM (KCG Futures).
Clients and Products
KCG offers agency execution services and trading venues across multiple asset classes to buy-side clients including mutual funds, pension plans, plan sponsors, hedge funds, trusts, endowments and sell-side clients including global, national, regional and electronic broker dealers. In 2013, our Global Execution Services segment did not have any client that accounted for more than 10% of our commissions earned.
In this segment, we generally compete on market coverage, liquidity, anonymity, trading costs and client service, including platform capabilities. KCG draws on in-house developed advanced trading technologies to meet client criteria for best execution and managing trading costs. As a result, the Company is able to attract a diverse array of clients in terms of strategy, size and style. KCG also provides algorithms and an execution management system that combine advanced technology, access to the Company’s differentiated liquidity and support from experienced professionals to help clients execute trades.
We offer clients a broad range of products and services and voice access to the global markets including sales and trading for equities, ETFs, options, futures and fixed income securities. We also provide soft dollar and commission recapture programs. Additionally, we provide buy-side clients with deep liquidity, actionable market insights, anonymity and trade executions with minimal market impact and offer comprehensive trade execution services covering the depth and breadth of the market. We handle large complex trades, accessing liquidity from our order flow, as well as other sources.
The Knight Direct platform provides direct market access to U.S. and international equities, options, futures, foreign exchange and commodities, whether self-directed, through the use of the Knight Direct and GETAlpha suites of algorithms or via internal crossing through our Knight Match ATS.
KCG Hotspot FX provides electronic foreign exchange trading solutions to buy-side firms through its foreign exchange ECN that provides clients with access to live, executable prices for 62 currency pairs as well as spot gold and silver streamed by market maker banks and other clients. KCG Hotspot FX offers clients several access options including direct high-speed connectivity and a traditional front-end application.
KCG BondPoint provides electronic fixed income trading solutions to sell-side firms. KCG BondPoint operates a fixed income ECN that serves as an electronic inter-dealer system and allows clients to access live and executable

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retail-sized offerings in corporate bonds, municipals, government agency, treasuries and certificates of deposits. KCG BondPoint also provides front-end applications for brokers and advisors as well as a trading application for traders.
KCG Futures is an FCM which provides clients in the U.S. and Europe with futures execution and clearing services to facilitate transactions among brokers, institutions and non-clearing FCMs on major U.S. and European futures and options exchanges.
Knight Match and GETMatched are ATSs providing clients with an anonymous source of non-displayed liquidity.
Corporate and Other Segment
Our Corporate and Other segment invests principally in strategic financial service-oriented opportunities; allocates, deploys and monitors all capital; and maintains corporate overhead expenses and all other income and expenses that are not attributable to our other segments. The Corporate and Other segment contains functions that support our other segments, such as self-clearing services, including stock lending activities. We self-clear substantially all of our domestic and international equity, ETF and equity option order flow.
The Corporate and Other segment’s revenues include returns from strategic investments, interest income from treasury investments and stock borrow activity, and other income. Operating expenses primarily consist of compensation for certain senior executives and other employees of the corporate holding company, stock loan interest related to the financing of our securities inventory, interest expense on our debt, legal and other professional expenses related to corporate matters, directors’ fees, investor and public relations expenses and directors’ and officers’ insurance.
Competition
Our client offerings as well as our non-client market making, including our trade execution services, compete primarily with similar products offered by domestic and international broker dealers, exchanges, ATSs, crossing networks, ECNs and dark liquidity pools. We also compete with various market participants who utilize highly automated, electronic trading models. Another source of competition is broker dealers who execute portions of their client flow through internal market-making desks rather than sending the client flow to third party execution destinations, such as KCG.
Our Market making segment competes primarily on the basis of our execution standards (including price, liquidity, speed and other client-defined measures), client relationships, client service, payments for order flow and technology. Over the past several years, regulatory changes, competition and the continued focus by regulators and investors on execution quality and overall transaction costs have resulted in a market environment characterized by narrowed spreads and reduced revenue capture. Consequently, maintaining profitability has become extremely difficult for many firms. In general, improvements in execution quality, such as faster execution speed and greater price improvement, have negatively impacted the ability to derive profitability from executing client order flow. For example, we have made, and continue to make, changes to our execution protocols and quantitative models, which have had, or could have, a significant impact on our profitability. To remain profitable, some competitors have limited or ceased activity in illiquid or marginally profitable securities or, conversely, have sought to execute a greater volume of trades at a lower cost by increasing the automation and efficiency of their operations.
Competition for order flow in the U.S. equity markets continues to be intense as reflected in publicly disclosed execution metrics, i.e., SEC Rules 605 and 606. These rules, applicable to broker dealers, add greater disclosure to execution quality and order-routing practices. Rule 605 requires market centers that trade national market system securities to make available to the public monthly electronic reports that include uniform statistical measures of execution quality on a security-by-security basis. Rule 606 requires broker dealers that route equity and option orders on behalf of their customers to make publicly available quarterly reports that describe their order routing practices and disclose the venues to which customer orders are routed for execution. These statistics on execution quality vary by order sender based on their mix of business. This rule also requires the disclosure of payment for order flow arrangements and internalization practices. The intent of this rule is to encourage routing of order flow to destinations based primarily on the demonstrable quality of executions at those destinations, supported by the order entry firms’ fiduciary obligations to seek to obtain best execution for their customers’ orders.
Our Global Execution Services venues compete with other electronic trading platforms for orders from institutional firms and, to a lesser extent, with sales and trading teams at larger firms. Competition for business with institutional clients is based on a variety of factors, including execution quality; research; soft dollar, commission sharing and recapture services; technology; market access (including direct market access and execution algorithms); client relationships; client service; cost; capital facilitation and reputation.

9


We believe the trend toward increased competition and the growth of alternative trading venues will continue. We may experience competitive pressures in these and other areas in the future as some of our competitors seek to obtain greater market share by reducing prices.
Discontinued Operations
Management of the Company from time to time conducts a strategic review of its businesses and evaluates their potential value in the marketplace relative to their current and expected returns. To the extent management and the Company's Board of Directors determine a business may return a higher value to stockholders through a divestiture, or is no longer core to the Company's strategy, management may pursue a sale process.
In July 2013, KCG entered into an agreement to sell to an investor group Urban Financial of America, LLC, formerly known as Urban Financial Group, Inc. (“Urban”), the reverse mortgage origination and securitization business that was previously owned by Knight. The transaction closed on November 30, 2013 and the results of Urban's operations have been reported in Income from discontinued operations, net of tax on the Consolidated Statements of Operations for the year ended December 31, 2013.
August 1, 2012 Technology Issue
On August 1, 2012, Knight experienced a technology issue at the opening of trading at the NYSE. This issue was related to the installation of trading software and resulted in Knight's broker dealer subsidiary, Knight Capital Americas LLC (“KCA”) (now known as KCG Americas LLC), sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market. Although this software was subsequently removed from Knight's systems, it resulted in trading losses to Knight and subsequent related legal and professional costs of $468.1 million (the “August 1, 2012 Loss”). As this loss was incurred prior to the consummation of the Mergers, it is not included in KCG's Consolidated Statement of Operations but various legal and other professional fees incurred after the Mergers are included.
Infrastructure
We continue to invest significant resources to expand our execution capacity, upgrade our trading systems and infrastructure, enhance and strengthen our controls and we plan to make additional investments in technology and infrastructure in the future. We’ve been reinforcing and bolstering our operational model to manage the complexities of the combined firm. Our ability to identify and deploy emerging technologies that facilitate the execution of trades, including developing and enhancing our quantitative client market making models and proprietary trading models, is key to the successful execution of our business model. Technology has enhanced our capacity and ability to handle order flow faster and also has been an important component of our strategy to comply with government and industry regulations, achieve competitive execution standards, increase trading automation and provide superior client service. We continually enhance our use of technology and quantitative models to further refine our execution services, develop and enhance our non-client principal trading models and reduce trading costs. Following the events of August 1, 2012, Knight took several remedial measures designed to strengthen and enhance its controls, and KCG has continued with these endeavors following the Mergers.
We use our proprietary technology and technology licensed from third parties to execute trades, manage risk, monitor the performance of our traders, assess our inventory positions and provide ongoing information to our clients. We are electronically linked to institutions and broker dealers to provide immediate access to our trading operations and facilitate the handling of client orders. Our business-to-business portal and Knight Link®, Knight Match, KCG BondPoint, KCG Hotspot FX and Knight Direct platforms and the Knight Direct and GETAlpha suites of algorithms, provide our clients with an array of tools to interact with our trading systems, multiple marketplaces throughout the globe and most U.S. equity, ETF, options, fixed income and futures market centers.
We have developed a proprietary clearing platform in connection with our self-clearing activities and have deployed a dedicated team of technology, operations, finance, legal and compliance professionals to support these efforts. We self-clear substantially all of our domestic and international equity, ETF and equity option order flow.
Alternative trading and data center facilities are in place for our primary domestic operations. These facilities have been designed to allow us to continue a substantial portion of our operations if we are prevented from accessing or utilizing our primary office locations for an extended period of time. While we take significant steps to develop, implement and maintain reasonable business continuity plans, we cannot guarantee that our alternative systems and facilities will provide full continuity of operations should a significant business disruption occur.

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Intellectual Property and Other Proprietary Rights
Our success and ability to compete are dependent to a significant degree on our intellectual property, which includes our execution technology, quantitative client market making and non-client principal trading models and information regarding our client base. A large portion of our technology was developed internally, and we rely primarily on trade secret, trademark, copyright, domain name, patent, commercial and contract law to protect our intellectual property. It is our policy to enter into confidentiality, intellectual property invention assignment and/or non-competition and non-solicitation agreements or restrictions with our employees, independent contractors and business partners and to control access to and distribution of our intellectual property.
Government Regulation and Market Structure
Most aspects of KCG’s business are subject to extensive regulation under federal, state and international laws, rules and regulations. Regulators in the U.S. and international jurisdictions continue to promulgate numerous rules and regulations that may impact KCG’s business. In the U.S., these regulatory bodies include the SEC, the Commodity Futures Trading Commission ("CFTC"), FINRA, National Futures Association ("NFA"), NYSE, NASDAQ, other self-regulatory organizations ("SROs"), and other regulatory bodies, such as state securities commissions. In Europe and Asia, these regulatory bodies include the UK Financial Conduct Authority ("FCA"), the Singapore Exchange, the Securities and Exchange Board of India ("SEBI"), and the Australian Securities and Investment Commission ("ASIC"). In addition, KCG is subject to various laws and rules in the countries in which it does business.
As a matter of public policy, regulatory bodies are charged with safeguarding the integrity of the financial markets and protecting the interests of investors by ensuring that trading on their markets is reliable, transparent, competitive, fair and orderly. Regulated entities, such as KCG, are subject to rules concerning all aspects of their business, including trade practices, best execution for customers, anti-money laundering, capital adequacy, record retention, technology implementation, risk management, supervision, and officer, supervisor and employee conduct. Failure to comply with any of these laws, rules or regulations could result in administrative or court proceedings, censures, fines, the issuance of cease-and-desist orders, injunctions or the suspension or disqualification of the entity and/or its officers, supervisors or employees.
Legislation and regulatory requirements and market structure changes have had an impact on KCG’s regulated subsidiaries by directly affecting their method of operation and, at times, their profitability by imposing significant obligations and restraints on KCG and its affiliates. These increased obligations and restraints require the implementation and maintenance of internal practices, procedures and controls, which have increased KCG’s costs and may subject KCG to regulatory inquiries, claims or penalties.
The regulatory environment in which KCG operates is subject to constant change. KCG’s business, financial condition and operating results may be adversely affected as a result of new or revised legislation or regulations imposed in the U.S. and abroad by regulatory authorities, applicable state agencies and administrative departments and other regulatory bodies. Additional regulations or changes in interpretations or enforcement of existing laws and rules often directly affect the method of operation and profitability of KCG. KCG cannot predict what effect, if any, such changes might have on its subsidiaries. However, there have been, and could be, significant technological, operational and compliance costs associated with the obligations that derive from compliance with such laws, rules and regulations.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was enacted in the U.S. Implementation of the Dodd-Frank Act continues to be accomplished through extensive rulemaking by the CFTC, SEC and other governmental agencies. The Dodd-Frank Act and the current rulemaking to implement this law are not currently expected to have a material impact on KCG’s business. It is possible, however, that future rulemaking or changes to the market structure and practices in response to the Dodd-Frank Act may impact KCG’s businesses.
The SEC and other regulatory bodies have recently enacted and are actively considering rules that may affect the operation and profitability of KCG. In particular, on August 1, 2012, SEC Rule 613 was published in the Federal Register. This rule requires the securities exchanges and FINRA to act jointly in developing a national market system plan to develop, implement, and maintain a consolidated audit trail ("CAT"), with respect to the trading of listed equity securities and listed options. Once implemented, maintaining a CAT will impose substantial new reporting requirements on broker dealers, such as KCG. In addition, the SEC proposed Regulation SCI in March 2013. If adopted, Regulation SCI will require members of exchanges and broker dealer operators of alternative trading systems with significant volume to meet new requirements regarding testing and systems integrity.

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The SEC may also consider proposing other market structure changes. In January 2010, the SEC published a Concept Release that asked for comment on issues such as high frequency trading, co-location, internalization, and markets that do not publicly display price quotations, including dark liquidity pools. These topics and others, such as the use of rebates by exchanges, could be included in any comprehensive review of US equity market structure by the SEC, for which there is recent and growing support.
The financial services industry in many countries is heavily regulated, much like in the U.S. The compliance requirements of these different regulatory jurisdictions and other factors may limit KCG’s ability to conduct business or expand internationally. For example, the review of Markets in Financial Instruments Directive ("MiFID"), which was implemented in November 2007, is nearing completion. Proposed changes to MiFID, which consist of a directive called MiFID 2 and regulations called MiFIR, are expected to be finalized in April 2014. The adoption of MiFID 2/MiFIR will include many changes likely to affect KCG’s business. For example, the changes will require firms like KCG and other market participants to conduct all trading on European markets through authorized investment firms. MiFID 2/MiFIR will also require market makers, including KCG, to post firm quotes at competitive prices and will supplement current requirements with regard to investment firms’ risk controls related to the safe operation of electronic systems. MiFID 2/MiFIR may also impose additional requirements on trading platforms on which KCG trades, such as circuit breakers, synchronization of business clocks and flagging of algorithms. The implementation of these new requirements is tentatively planned for the second half of 2016 and may impose technological and compliance costs on KCG as a participant in those trading platforms.
In addition, France and Italy have adopted financial transaction taxes ("FTTs"). These taxes have not had a material impact on KCG’s profitability, however, changes to or expansion of these FTTs could impact KCG’s business. In addition, eleven European Union ("EU") Member States are working to agree on FTTs under the EU’s enhanced cooperation procedure, which would apply the FTTs only in those Member States that volunteered to participate in the FTTs. The scope of instruments and transactions that may be covered by these FTTs is still under discussion and it is, therefore, premature to determine the impact of such FTTs on KCG’s business. However, any FTTs may have a material effect on KCG's business, financial condition and operating results.
For risks related to government regulation and market structure, see "Risk Factors - Regulatory and legal uncertainties could harm KCG's business" included in Part I, Item 1A herein.
Net Capital Requirements
Certain of our subsidiaries are subject to the SEC’s Uniform Net Capital Rule or capital adequacy requirements by foreign regulators. These rules, which specify minimum net capital requirements for registered broker dealers, are designed to measure the general financial integrity and liquidity of a broker dealer and require that at least a minimum part of their assets be kept in relatively liquid form. In general, net capital is defined as net worth (assets minus liabilities), plus qualifying subordinated borrowings and certain discretionary liabilities, less certain mandatory deductions that result from excluding assets that are not readily convertible into cash and from valuing conservatively certain other assets. Among these are deductions of non-allowable assets and adjustments, commonly called haircuts, which reflect the possibility of a decline in the fair value of an asset before disposition.
Failure to maintain the required net capital may subject a firm to suspension or revocation of registration by the SEC or FCA and suspension or expulsion by FINRA and other regulatory bodies, and ultimately could require the relevant entity’s liquidation. The Uniform Net Capital Rule prohibits payments of dividends, redemption of stock, the prepayment of subordinated indebtedness and the making of any unsecured advance or loan to a stockholder, employee or affiliate, if such payment would reduce the firm’s net capital below required levels.
A change in the Uniform Net Capital Rule or other similar rules effected by foreign regulatory authorities, the imposition of new rules or any unusually large charges against net capital could limit those operations that require the intensive use of capital and also could restrict our ability to withdraw capital from our broker dealer subsidiaries. A significant operating loss or any unusually large charge against net capital could adversely affect our ability to expand or even maintain our present levels of business.
For additional discussion related to net capital, see Footnote 22 “Net Capital Requirements” included in Part II, Item 8 “Financial Statements and Supplementary Data” of this document.
Employees
At December 31, 2013, our headcount was 1,229 full-time employees, compared to 1,397 full-time employees (excluding employees of Urban) at July 1, 2013, the Merger date, and 409 full-time employees at GETCO at December

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31, 2012. The decrease in headcount from July 1 is primarily due to reductions in workforce completed following the Mergers. Of our 1,229 full-time employees at December 31, 2013, 1,042 were employed in the U.S. and 187 outside the U.S., primarily in London. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are good.
Item 1A.
Risk Factors
A number of industry-related and other risks may adversely affect the business, financial condition and operating results of KCG. Additional risks and uncertainties not currently known to KCG also may adversely affect its business, financial condition and/or operating results in a material manner. In addition, KCG may also be affected by general risks not directly related to its business, including, but not limited to, acts of war, terrorism and natural disasters. KCG cannot assure that the risks described below or elsewhere in this or other of its reports filed or furnished with the SEC are a complete set of all potential risks KCG may face.
Conditions in the financial services industry and the securities markets may adversely affect KCG’s trading volumes and market liquidity
KCG’s revenues are primarily transaction-based, and declines in global trading volumes, volatility levels, securities prices, commission rates or market liquidity could adversely affect the business and its profitability. There may be periods when market conditions may have an adverse impact on KCG’s business and profitability. The level of activity in the markets in which KCG conducts business is directly affected by numerous national and international factors that are beyond KCG’s control, including economic, political and market conditions, the availability of short-term and long-term funding and capital, the level and volatility of interest rates, legislative and regulatory changes and currency values and inflation. Declines in the volume of equities, fixed income and other financial instruments will generally result in lower revenues from market making and transaction execution activities. Lower levels of volatility, which tends to correlate with trading volumes, will have the same directional impact. Lower price levels of securities and other instruments, as well as tighter spreads, can result in reduced revenue capture, and thereby reduced profitability from trade executions. Increased competition can pressure commission rates, spreads and related fee schedules. Declines in market values of securities or other financial instruments can result in illiquid markets, which can increase the potential for losses on securities or other instruments held in inventory, the failure of buyers and sellers to fulfill their obligations and settle their trades, and increases in claims and litigation. Accordingly, reductions in trading volumes, volatility levels, securities prices, commission rates or market liquidity could materially affect KCG’s business and profitability.
KCG’s future operating results may fluctuate significantly as a result of numerous factors
KCG may experience significant variation in its future results of operations. Fluctuations in its future performance may result from numerous factors, including, among other things, global financial market conditions and the resulting competitive, credit and counterparty risks; cyclicality, seasonality and other economic conditions; the value of KCG's securities positions and other financial instruments and KCG's ability to manage the risks attendant thereto; the volume, notional dollar value traded and volatility levels within the core markets where KCG's market making and trade execution businesses operate; the composition, profile and scope of our relationships with institutional, broker dealer and bank clients; the performance, size and volatility of KCG's client market making portfolios; the performance, size and volatility of KCG's non-client exchange-based trading activities; the overall size of KCG's balance sheet and capital usage; impairment of goodwill and/or intangible assets; the performance of KCG's global operations, trading technology and technology infrastructure; the effectiveness of KCG's self-clearing and futures platforms and KCG's ability to manage risks related thereto; the availability of credit and liquidity in the marketplace; KCG's ability to prevent erroneous trade orders from being submitted due to technology or other issues (such as the events that affected Knight on August 1, 2012) and avoiding the consequences thereof; the performance and operation of, and connectivity to, various market centers; KCG's ability to manage personnel, compensation, overhead and other expenses, including KCG's occupancy expenses under KCG's office leases and expenses and charges relating to legal and regulatory proceedings; the strength of KCG's client relationships; changes in payments for order flow; changes to execution quality and changes in clearing, execution and regulatory transaction costs; interest rate movements; the addition or loss of executive management, sales, trading and technology professionals; geopolitical, legislative, legal, regulatory and financial reporting changes specific to financial services and global trading; legal or regulatory matters and proceedings; the Mergers and the costs and integration associated therewith; the amount, timing and cost of business divestitures/acquisitions or capital expenditures; the integration, performance and operation of acquired businesses; the incurrence of costs associated with acquisitions and dispositions; investor sentiment; and technological changes and events.

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Such factors may also have an impact on KCG's ability to achieve its strategic objectives, including, without limitation, increases in market share, growth and profitability in the businesses in which KCG operates. If demand for KCG's services declines or our performance deteriorates significantly due to any of the above factors, and KCG is unable to adjust its cost structure on a timely basis, KCG's operating results could be materially and adversely affected. As a result of the foregoing factors, period-to-period comparisons of KCG's revenues and operating results are not necessarily meaningful, and such comparisons cannot be relied upon as indicators of future performance. There also can be no assurance that KCG will be able to continue to achieve the level of revenues that KCG has experienced in the past or that KCG will be able to improve its operating results.
KCG trading activities expose it to the risk of significant losses
KCG conducts the majority of its trading activities as principal, which subjects its capital to significant risks. These activities involve the purchase, sale or short sale of securities and other financial instruments for KCG’s own account and, accordingly, involve risks of price fluctuations and illiquidity, or rapid changes in the liquidity of markets that may limit or restrict KCG’s ability to either resell securities or other financial instruments KCG purchases or to repurchase securities or other financial instruments KCG sells in such transactions. From time to time, KCG may have large position concentrations in securities or other financial instruments of a single issuer or issuers engaged in a specific industry, which could result in higher trading losses than would occur if KCG’s positions and activities were less concentrated. KCG’s broker dealer subsidiaries have not historically maintained such large position concentrations in the ordinary course of their businesses, but have nonetheless occasionally acquired or held such positions as a result of various market conditions or other unusual facts or circumstances. The performance of KCG’s trading activities primarily depends on its ability to attract order flow, the composition and profile of its order flow, the dollar value of securities and other financial instruments traded, the performance, size and volatility of KCG’s market making portfolios, the performance, size and volatility of KCG’s client and non-client principal trading activities (including high frequency trading), market interaction, the skill of KCG’s trading personnel, the ability of KCG to design, build and effectively deploy the necessary technologies and operations to support all of its trading activities and enable KCG to remain competitive, general market conditions, effective hedging strategies and risk management processes, the price volatility of specific securities or other financial instruments, and the availability and allocation of capital. To attract order flow, KCG must be competitive on price, size of securities positions and other financial instruments traded, liquidity offerings, order execution speed, technology, reputation, payment for order flow and client relationships and service. In KCG’s role as a market maker, it attempts to derive a profit from the difference between the prices at which it buys and sells securities. However, competitive forces and regulatory requirements often require KCG to match, or improve upon, the quotes other market makers display and to hold varying amounts of securities in inventory. By having to maintain inventory positions, KCG is subject to a high degree of risk. There can be no assurance that KCG will be able to manage such risk successfully or that KCG will not experience significant losses from such activities, such as the losses related to the events that occurred at Knight on August 1, 2012. KCG trades with others who have different information than it does, and as a result, KCG may accumulate unfavorable positions preceding large price movements in companies. Should the frequency or magnitude of these events increase, KCG’s losses will likely increase correspondingly. All of the above factors could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG’s market making activities have been and may be affected by changes in the levels of market volatility
Certain of KCG’s market making activities depend on market volatility to provide trading and arbitrage opportunities to KCG’s clients, and decreases in volatility may reduce these opportunities and adversely affect the results of these activities. On the other hand, increased volatility, while it can increase trading volumes and spreads, also increases risk as measured by Value-at-Risk, which we refer to as VaR, and may expose us to increased risks in connection with market making activities or cause KCG to reduce its market making positions in order to avoid increasing VaR. Limiting the size of KCG’s market making positions can adversely affect profitability. In periods when volatility is increasing, but asset values are declining significantly, it may not be possible to sell assets at all or it may only be possible to do so at steep discounts. In such circumstances we may be forced to either take on additional risk or to incur losses in order to decrease our VaR.

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The valuation of the financial instruments KCG holds may result in large and occasionally anomalous swings in the value of its positions and in its earnings in any period
The market prices of KCG’s long and short positions are reflected on its books at closing prices which are typically the last trade price before the official close of the primary exchange on which each such security trades. Given that KCG manages a globally integrated portfolio, it may have large and substantially offsetting positions in securities that trade on different exchanges that close at different times of the trading day. As a result, there may be large and occasionally anomalous swings in the value of KCG’s positions daily and, accordingly, in its earnings in any period. This is especially true on the last business day of each calendar quarter.
KCG may fail to realize the anticipated benefits of the combination of GETCO and Knight
The success of KCG will depend on, among other things, KCG’s continued ability to combine the businesses of GETCO and Knight in a manner that permits growth opportunities and does not materially disrupt the existing customer relationships of KCG nor result in materially decreased revenues due to loss of customers. If KCG is not able to successfully achieve these objectives, the anticipated benefits of the Mergers may not be realized fully or may take longer to realize than expected.
Business combinations involve numerous risks, including difficulties in the assimilation of the operation, systems, controls and technologies of the companies and the diversion of management’s attention from other business concerns. This is the case particularly in the fiscal quarters immediately following the completion of a business combination because the operations of the businesses are integrated during this period. Achievement of the benefits expected from the Mergers have required, and in the future may require, KCG to incur significant cost in connection with, among other things, implementing financial and operating systems, and integrating technology platforms. KCG may not accurately anticipate all of the changing demands that the Mergers may impose on management, its operational and financial systems and its technology infrastructure.
Further it is possible that the continued integration process could result in the disruption of KCG’s ongoing businesses and relationships or cause issues with standards, controls, procedures and policies that adversely affect the ability of KCG to maintain relationships with customers and employees or to achieve the anticipated benefits of the Mergers.
The market price of KCG Class A Common Stock may decline if, among other factors, the integration of the Knight and GETCO businesses is unsuccessful, the operational cost savings estimates are not realized or key employees leave KCG. The market price of KCG Class A Common Stock also may decline if KCG does not achieve the perceived benefits of the Mergers as rapidly as, or to the extent, anticipated by financial or industry analysts or if the effect of the Mergers on KCG’s financial results is not consistent with the expectations of financial or industry analysts.
Regulatory and legal uncertainties could harm KCG’s business
The capital markets industry in the U.S. and the foreign jurisdictions in which KCG conducts its business is subject to extensive oversight under federal, state and applicable foreign laws, rules and regulations, as well as the rules of SROs. Broker dealers, investment advisors and financial services firms are subject to regulations concerning all aspects of their businesses, including trade practices, best execution practices, capital adequacy, record-keeping, anti-money laundering, fair and requisite disclosure, and the conduct of their officers, supervisors and employees. KCG’s operations and profitability may be directly affected by, among other things, additional legislation or regulation, or changes in rules promulgated by domestic or foreign governments or regulators; and changes in the interpretation or enforcement of existing laws, regulations and rules. Failure to comply with these laws, rules or regulations could result in, among other things, administrative or court proceedings, censure, fines, the issuance of cease-and-desist orders or injunctions, loss of membership, or the suspension or disqualification of the market participant or broker dealer, and/or their officers, supervisors or employees. KCG’s ability to comply with applicable laws, regulations and rules is largely dependent on its internal systems to ensure compliance, as well as its ability to attract and retain qualified compliance personnel. Each of KCG’s regulators engages in a series of periodic and special examinations and investigations to monitor compliance with such laws, rules and regulations that may result in disciplinary actions in the future due to alleged noncompliance. KCG is currently the subject of regulatory reviews and investigations that may result in disciplinary actions, including the imposition of fines and penalties, in the future due to alleged non-compliance.
Federal, state and foreign legislators, regulators and SROs are constantly proposing, or enacting, new regulations which may impact KCG’s business. These include rules regarding, among others, a CAT designed to improve the ability of the SEC and others to oversee trading in the U.S. securities markets, private or over-the-counter markets,

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sometimes referred to as dark liquidity pools, increased transaction and other fees, transaction taxes, enhanced requirements regarding market access (including SEC Rule 15c3-5) and for technology testing and implementation, increased obligations for market makers, higher capital requirements, and order routing limitations. A number of new regulations that impact market makers were recently either adopted or implemented. In particular, on August 1, 2012, SEC Rule 613 was published in the Federal Register. This rule requires the securities exchanges and FINRA to act jointly in developing a national market system plan to develop, implement, and maintain a CAT, with respect to the trading of listed equity securities and listed options. Once implemented, the CAT will impose substantial new reporting requirements on broker dealers, such as KCG. In addition, the SEC proposed Regulation SCI in March 2013. If adopted, Regulation SCI will require members of exchanges and broker dealer operators of alternative trading systems with significant volume to meet new requirements regarding testing and systems integrity. Additionally, Section 31 fees, sometimes described as “SEC Fees”, are reviewed regularly. These could increase substantially in the future in order to recover the costs incurred by the government, including the SEC, for supervising and regulating the securities markets.
Further, in January 2010, the SEC issued a Concept Release seeking public comment on certain market structure issues such as high frequency trading, the colocation of servers with exchange matching engines, off-exchange trading, including internalization where brokers match orders with their own inventory, and markets that do not publicly display price quotations including dark liquidity pools. In particular, high frequency trading continues to be a controversial feature of modern markets and regulatory scrutiny by federal, state and foreign regulators and SROs is likely to continue. Although no rules have yet been proposed in the U.S., there are market participants that continue to call upon the U.S. Congress and the SEC to make changes to limit high-frequency trading and these changes could impact KCG’s business negatively.
In addition, the financial services industry in many foreign countries is heavily regulated, much like the U.S. The varying compliance requirements of these different regulatory jurisdictions and other factors may limit KCG’s ability to conduct business or expand internationally. For example, the review of MiFID, which was implemented in November 2007, is nearing completion. Proposed changes to MiFID, which consist of a directive called MiFID 2, and regulations called MiFIR, are expected to be finalized in April 2014.The adoption of MiFID 2/MiFIR will include many changes likely to affect KCG’s business. For example, the changes will require firms like KCG and other market participants to conduct all trading on European markets through authorized investment firms. MiFID 2/MiFIR will also require market makers, including KCG, to post firm quotes at competitive prices and will supplement current requirements with regard to investment firms’ risk controls related to the safe operation of electronic systems. MiFID 2/MiFIR may also impose additional requirements on trading platforms on which KCG trades, such as circuit breakers, synchronization of business clocks, and flagging of algorithms. The implementation of these new requirements is tentatively planned for the second half of 2016 and may impose technological and compliance costs on KCG as a participant in those trading platforms.
In addition, public debate in Europe regarding high-frequency trading is leading policymakers to consider laws and regulations that may impact KCG’s business. For example, France and Italy have adopted FTTs. These taxes have not had a material impact on KCG’s profitability, however, changes to or expansion of these FTTs could impact KCG’s business. In addition, eleven EU Member States are working to agree on FTTs under the EU’s enhanced cooperation procedure, which would apply the FTTs only in those Member States that volunteered to participate in the FTTs. The scope of instruments and transactions that may be covered by these FTTs are still under discussion and it is, therefore, premature to determine the impact of such FTTs on KCG’s business. However, any FTTs may have a material effect on KCG's business, financial condition and operating results. In addition, in Germany, proposed legislation could, among other things, place limits on order-to-execution ratios and require all high-frequency traders on German exchanges to be authorized to trade in Germany.
Any of these laws, rules or regulations, if adopted, as well as any regulatory or legal actions or proceedings, changes in legislation or regulation, and changes in market customs and practices could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG’s business is subject to substantial risk from litigation, regulatory investigations and potential liability under federal, state and international laws, rules and regulations
Many aspects of KCG’s business involve substantial risks of liability. KCG is exposed to potential liability under federal, state and foreign securities laws, other federal, state and foreign laws and court decisions, as well as rules and regulations promulgated by U.S. and foreign regulators. KCG is also subject to the risk of potential litigation. From time to time, KCG and its subsidiaries and certain of their past and present officers, directors and employees, are, and KCG may be in the future, named as parties in legal actions, regulatory investigations and proceedings, arbitrations

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and administrative claims and have been subject to claims alleging the violation of such laws, rules and regulations, some of which have resulted in the payment of fines, awards, judgments and settlements. Moreover, KCG may be required to indemnify past and present officers, directors and employees in regards to these matters. Certain corporate events, such as a reduction in KCG’s workforce, could also result in additional litigation or arbitration. KCG could incur significant legal expenses in defending such litigations or proceedings.
As described further in Part I, Item 3, "Legal Proceedings" of this Form 10-K, in October 2013, KCA, a broker dealer subsidiary of KCG, reached a settlement with the SEC relating to the August 1, 2012 technology issue. Under the terms of the settlement order issued to KCA by the SEC, KCA is required to cease and desist from committing future violations of SEC Rule 15c3-5, the Market Access Rule, and Rules 200(g) and 203(b) of Regulation SHO, the Short Sale Rules. As a result of the settlement order, KCG may be subject to heightened regulatory scrutiny from the SEC and other regulators with respect to violations of the Market Access Rule, the Short Sale Rules and other SEC rules and regulations. In addition, the settlement agreement contains substantive obligations that KCA must comply with. A failure to comply with the terms of the settlement could result in additional actions against KCA.
An adverse resolution of any current or future lawsuits, legal or regulatory proceedings or claims against KCG could have a material adverse effect on its business and reputation, financial condition and operating results.
KCG faces risks related to the events of August 1, 2012
Knight experienced a technology issue at the opening of trading at the NYSE on August 1, 2012. This issue was related to its installation of trading software and resulted in Knight’s broker dealer subsidiary, KCA, sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market. Although this software was subsequently removed from Knight’s systems and the software issue was limited to the routing of certain NYSE-listed stocks, it resulted in Knight realizing a pre-tax loss including related legal and professional fees of approximately $468.1 million. This severely impacted Knight’s capital base and business operations, and Knight experienced reduced order flow, liquidity pressures and harm to customer and counterparty confidence.
As a result of this technology issue and its impact, Knight is currently subject to litigation by former Knight stockholders alleging that they were damaged by this technology issue. In addition, as described further in "Legal Proceedings" in Part I, Item 3 of this Form 10-K, in October 2013, KCA reached a settlement with the SEC, in which KCA, without admitting or denying the findings, consented to the issuance of a settlement order. As a condition of that settlement, KCA was required to retain an independent consultant to conduct a comprehensive review of KCA’s compliance with the SEC’s Market Access Rule, which we refer to as the Independent Compliance Review. Other regulatory or governmental agencies may decide to conduct further investigations into similar issues and related matters. While KCG is unable to predict the outcome of any existing or future litigation or regulatory or governmental investigation, an unfavorable outcome in one or more of these matters could have a material adverse effect on KCG’s financial condition or ongoing operations. In addition, KCG may incur significant expenses in defending against the existing litigation or any other future litigation, or in connection with any regulatory or governmental investigations, and in implementing technical changes and remedial measures which may be required pursuant to the Independent Compliance Review or otherwise necessary or advisable. KCG may also be required to take remedial steps that could be burdensome for its business operations.
Additionally, if existing or potential future clients and/or counterparties do not believe that KCG has addressed the technology issues related to the events of August 1, 2012, or if they have concerns about future technology issues, this could cause existing or future customers of KCG to lose confidence in KCG’s systems and could adversely affect its reputation and its ability to attract or maintain customers and counterparty relationships. In the event that KCG is not able to restore the confidence of former Knight customers or counterparties, KCG may experience reduced business activity in its trading, market making and other businesses, which could adversely impact the results of KCG’s operations.
Substantial competition could reduce KCG’s market share and harm KCG’s financial performance
All aspects of KCG’s business are intensely competitive. KCG faces competition in its businesses primarily from global, national and regional broker dealers, exchanges, and ATSs. ATSs include crossing networks that match orders in private or without a public quote, electronic communication networks that match orders off-exchange based on a displayed public quote or ECNs, and dark liquidity pools which offer a variety of market models enabling investors to trade off-exchange. Equities competition is based on a number of factors, including KCG’s execution standards (e.g., price, liquidity, speed and other client-defined measures), client relationships and service, reputation, payment for order flow, market structure, product and service offerings, and technology. KCG will continue to face intense competition in connection with all of its trading activities, and KCG’s ability to effectively compete will depend on a number of factors

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including its ability to design, build and effectively deploy the necessary technologies and operations to support all of its trading activities. A number of competitors of KCG’s businesses have greater financial, technical, marketing and other resources than KCG. Some of KCG’s competitors offer a wider range of services and financial products than KCG does and have greater name recognition and a more extensive client base. These competitors may be able to respond more quickly than KCG to new or evolving opportunities and technologies, market changes, and client requirements and may be able to undertake more extensive promotional activities and offer more business attractive terms to clients including larger order flow rebate payments. Moreover, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties or may consolidate to enhance their services and products. It is possible that new competitors, or alliances among competitors, may also emerge and they may acquire significant market share. The trend toward increased competition in KCG’s businesses is expected to continue and it is possible that KCG’s competitors may acquire increased market share.
As a result of the above, there can be no assurance that KCG will be able to compete effectively with current or future competitors, which could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG could lose significant sources of revenues if it loses any of its larger clients
At times, a limited number of clients could account for a significant portion of KCG’s order flow, revenues and profitability, and KCG expects a large portion of the future demand for, and profitability from, its trade execution services to remain concentrated within a limited number of clients. The loss of one or more larger clients could have an adverse effect on KCG’s revenues and profitability in the future.
None of KCG’s clients is currently contractually obligated to utilize KCG for trade execution services and, accordingly, these clients may direct their trade execution activities to other execution providers or market centers at any time. Some of these clients have grown organically or acquired market makers and specialist firms to internalize order flow or will have entered into strategic relationships with competitors. There can be no assurance that KCG will be able to retain these major clients or that such clients will maintain or increase their demand for KCG’s trade execution services. Further, the continued integration of Knight and GETCO could result in disruption to KCG’s ongoing businesses and relationships or cause issues with standards, controls, procedures and policies that adversely affect the ability of KCG to maintain relationships with customers, or to solicit new customers. The loss, or a significant reduction, of demand for KCG’s services from any of these clients could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG is highly dependent on key personnel
KCG is highly dependent on a limited number of key personnel. KCG’s success is dependent to a large degree on its ability to retain the services of its existing key executives and to attract and retain additional qualified personnel in the future. Competition for such personnel is intense. The loss of the services of any of KCG’s key executives or the inability to identify, hire and retain necessary highly qualified executive management in the future could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG’s success also depends, in part, on the highly skilled, and often specialized, individuals KCG employs. KCG’s ability to attract and retain management, trading, market making, sales and technology professionals, as well as quantitative analysts and programmers is important to KCG’s business strategy. KCG strives to provide high quality services that allow it to establish and maintain long-term relationships with its clients. KCG’s ability to do so depends, in large part, upon the individual employees who represent KCG in its dealings with such clients. There can be no assurance that KCG will not lose such professionals due to increased competition or other factors in the future, or that such professionals will not leave KCG voluntarily. The loss of sales, trading or technology professionals, particularly senior professionals with broad industry or technical expertise and long-term relationships with clients, could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG has significant leverage
Although KCG has repaid a significant portion of its indebtedness incurred in connection with the Mergers, approximately $440.0 million aggregate principal amount of such indebtedness as well as $117.3 million of Convertible Notes remains outstanding as of the date of this report, which reflects the $100.0 million repayment in January 2014, see Footnote 25 "Subsequent Events" to the Company's Consolidated Financial Statements included in Part II, Item 8 "Financial Statements and Supplementary Data" herein. This leverage may have important negative consequences for KCG and its stockholders, including:

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increasing its vulnerability to general adverse economic and industry conditions;
requiring it to dedicate a portion of its cash flow from operations to payments on its indebtedness, thereby reducing the availability of cash flow to fund working capital, capital expenditures, acquisitions and investments and other general corporate purposes;
making it difficult for it to optimally manage the cash flow for its businesses;
limiting its flexibility in planning for, or reacting to, changes in its businesses and the markets in which it operates;
placing it at a competitive disadvantage compared to its competitors that have less debt;
subjecting it to a number of restrictive covenants that, among other things, limit its ability to pay dividends and distributions, make acquisitions and dispositions, borrow additional funds, and make capital expenditures and other investments, and
exposing it to interest rate risk due to the variable interest rate on borrowings under its credit facility.
KCG’s ability to make payments of the principal on and refinance its indebtedness will depend on its future performance, its ability to generate cash flow and market conditions, each of which is subject to economic, financial, competitive and other factors beyond its control. KCG’s business may not continue to generate cash flow from operations sufficient to service its debt and make necessary capital expenditures. If KCG is unable to generate such cash flow, it may be required to adopt one or more alternatives, such as selling assets, restructuring debt, undertaking additional borrowings or issuing additional debt or obtaining additional equity capital on terms that may be onerous or highly dilutive to current shareholders. KCG’s ability to refinance all or a portion of its indebtedness will depend on KCG's financial condition and its ability to access the capital markets and the credit markets. KCG may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in increased financing costs or a default on its debt obligations.
KCG may be unable to remain in compliance with the financial maintenance and other affirmative and negative covenants contained in its debt instruments and the obligation to comply with such covenants may adversely affect its ability to operate its business
KCG’s current debt instruments contain financial maintenance and other affirmative and negative covenants that impose significant requirements on KCG and limit its ability to engage in certain transactions or activities. In addition, in the future KCG may enter into other debt instruments with covenants different from, and potentially more onerous than, those expected to be included in the KCG debt facilities. These covenants could limit KCG’s flexibility in managing its businesses. Further, there can be no assurance that KCG will be able to generate sufficient earnings to enable KCG to satisfy the financial maintenance and other affirmative and negative covenants included in its debt instruments. In the event that KCG is unable to either comply with these restrictions and other covenants or obtain waivers from its lenders, KCG would be in default under these debt instruments and, among other things, the repayment of KCG’s debt could be accelerated by its lenders. In such case, KCG might not be able to repay its debt or borrow sufficient funds to refinance its debt on commercially reasonable terms, or on terms that are acceptable to KCG, resulting in a default on its debt obligations, which could have an adverse effect on its financial condition.
In connection with the Mergers, KCG entered into a first lien credit facility and assumed the second lien senior secured notes, which contain customary affirmative and negative covenants for facilities of their type and customary exceptions, qualifications and “baskets” which provide KCG exceptions to certain of the negative covenant restrictions on its business up to certain specified amounts. The negative covenants include, among other things, limitations on indebtedness, liens, hedging agreements, investments, loans and advances, asset sales, mergers and acquisitions, dividends, transactions with affiliates, prepayments of other indebtedness, modifications of organizational documents and other material agreements, restrictions on subsidiaries, capital expenditures, issuance and repurchases of capital stock, negative pledges and business activities.
The first lien credit facility also has financial maintenance covenants establishing a maximum consolidated first lien leverage ratio, a minimum consolidated interest coverage ratio and a minimum consolidated tangible net worth.

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KCG may be able to incur substantially more debt and take other actions that could diminish its ability to make payments on its indebtedness when due, which could further exacerbate the risks associated with its current level of indebtedness.
Despite KCG’s indebtedness level and the negative covenants contained in the first lien credit facility and second lien senior secured notes, KCG may be able to incur substantially more indebtedness in the future. KCG is not fully restricted under the terms of the credit agreement for the first lien credit facility or the indenture for the second lien senior secured notes from incurring additional debt, securing existing or future debt, recapitalizing KCG’s debt or taking a number of other actions, including certain additional indebtedness incurred in the ordinary course of business by KCG’s broker dealer subsidiaries and certain other regulated subsidiaries, any of which additional indebtedness could diminish KCG’s ability to make payments on its indebtedness when due and further exacerbate the risks associated with KCG’s current level of indebtedness. If new debt is added to KCG’s or any of its existing and future subsidiaries' current debt, the related risks that KCG now faces could intensify.
KCG’s principal stockholders own a substantial percentage of KCG’s Class A Common Stock, which could limit the ability of other stockholders to influence corporate matters or result in actions that the other stockholders do not believe to be in KCG’s interests or their interests
As of February 24, 2014, 2014 KCG’s four largest stockholders beneficially owned an aggregate of approximately 55% of KCG’s outstanding Class A Common Stock (including restricted stock units) (or 60%, assuming exercise of the KCG warrants held by these holders in full) based on the most recent Schedule 13D or 13G filed by the holders. As a result, these large stockholders may be able to exert influence over KCG’s affairs and policies, including the election of directors and the approval of mergers, acquisitions and other extraordinary transactions. In addition, three of the largest stockholders hold four seats on KCG’s board of directors This concentrated control will limit the ability of the remaining stockholders to influence corporate matters, and the interests of the large stockholders may not coincide with KCG’s interests or the interests of the remaining stockholders. The concentration of ownership may also have the effect of delaying, preventing or deterring a change of control of KCG, could deprive KCG’s stockholders of an opportunity to receive a premium for their common stock as part of a sale of KCG and might ultimately affect the market price of KCG’s common stock.
These large stockholders may seek to sell large portions of KCG Class A Common Stock in one or a series of related transactions, including through block trades, 10b5-1 sales plans or underwritten secondary offerings. In connection with the Mergers, certain of these stockholders were granted registration rights, which, subject to certain limitations, require KCG to assist such stockholders in conducting one or more registered offerings of all or a portion of their holdings. Any significant sales of KCG Class A Common Stock or any market perception of future sales of KCG Class A Common Stock may result in a decrease in the trading price of KCG’s Class A Common Stock.
Shares of KCG Class A Common Stock are subject to dilution as a result of exercise of the warrants
The shares of KCG Class A Common Stock are subject to dilution upon exercise of KCG’s warrants. Approximately 24.3 million shares of KCG Class A Common Stock may be issued in connection with exercise of the warrants. These warrants have exercise prices ranging from $12.00 to $15.00 and terms of between four and six years. The warrants may be exercised at any time, even if the current market price of the KCG Class A Common Stock is below the applicable exercise price.
The market price of KCG Class A Common Stock will likely be influenced by the warrants. For example, the market price of KCG Class A Common Stock could become more volatile and could be depressed by investors’ anticipation of the potential resale in the market of a substantial number of additional shares of KCG Class A Common Stock received upon exercise of the warrants.
KCG may not be able to keep up with rapid technological and other changes or adequately protect its intellectual property
The markets in which KCG competes are characterized by rapidly changing technology, evolving industry standards, frequent new product and service announcements, introductions and enhancements and changing client demands. If KCG is not able to keep up with these rapid changes on a timely and cost-effective basis, it may be at a competitive disadvantage. The widespread adoption of new internet, networking or telecommunications technologies or other technological changes could require KCG to incur substantial expenditures to modify or adapt its services or infrastructure. Any failure by KCG to anticipate or respond adequately to technological advancements (including advancements related to telecommunications, data transfer, execution and messaging speeds), client requirements

20


or changing industry standards or to adequately protect its intellectual property, or any delays in the development, introduction or availability of new services, products or enhancements, could have a material adverse effect on KCG’s business, financial condition and operating results.
Additionally, the success of KCG and its subsidiaries has largely been attributable to their sophisticated proprietary technology that has taken many years to develop. KCG has benefited from the fact that the type of proprietary technology it employs has not been widely available to its competitors. If KCG’s technology becomes more widely available to its current or future competitors for any reason, KCG’s operating results may be adversely affected.
KCG uses trademark, trade secret, copyright and other proprietary rights and procedures to protect its intellectual property and technology resources. Despite its efforts, monitoring unauthorized use of KCG’s intellectual property is difficult and costly, and KCG cannot be certain that the steps it takes to prevent unauthorized use of its proprietary rights are sufficient to prevent misappropriation of its technology, particularly in foreign countries where laws or law enforcement practices may not protect proprietary rights as fully as in the United States. In addition, KCG cannot be sure that courts will adequately enforce contractual arrangements KCG has entered into to protect its proprietary technologies. If any of KCG’s proprietary information were misappropriated by or otherwise disclosed to our competitors, its competitive position could be adversely affected. KCG may incur substantial costs to defend ownership of its intellectual property or to replace misappropriated proprietary technology. If a third party were to assert a claim of infringement of KCG’s proprietary rights, obtained through patents or otherwise, against KCG with respect to one or more of its methods of doing business or conducting its operations, KCG could be required to spend significant amounts to defend such claims, develop alternative methods of operations, pay substantial money damages or obtain a license from the third party.
Capacity constraints, systems failures and delays could harm KCG’s business
KCG’s business activities are heavily dependent on the integrity and performance of the computer and communications systems supporting them and the services of certain third parties. KCG’s systems and operations are vulnerable to damage or interruption from human error, technological or operational failures, natural disasters, power loss, computer viruses, intentional acts of vandalism, terrorism and other similar events. The nature of KCG’s businesses involves a high volume of transactions made in rapid fashion which could result in certain errors being repeated or compounded before they are discovered and successfully rectified. Extraordinary trading volumes or other events could cause KCG’s computer systems to operate at an unacceptably slow speed or even fail. KCG’s necessary dependence upon automated systems to record and process transactions and large transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.
While KCG has invested significant amounts of capital to upgrade the capacity, reliability, scalability and speed of its systems, there can be no assurance that its systems will be sufficient to handle current or future trading volumes, and the modifications themselves may result in unanticipated and undesirable consequences. For example, the August 1, 2012 Knight technology issue that led to the aforementioned trading losses related to an update of trading software. Although KCG will continually update and modify its trading software in response to changes in its business, rule changes and for various other reasons, there are no assurances that such updates and modifications to KCG’s trading software will not result in future trading losses. Many of KCG’s systems are, and much of its infrastructure is, designed to accommodate additional growth without material redesign or replacement; however, KCG may need to make significant investments in additional hardware and software to accommodate growth, including to manage the complexities of the larger firm and / or to accommodate any increase in transaction volume resulting from the Mergers. Failure to make necessary expansions and upgrades to its systems and infrastructure, including any inability to develop and upgrade existing technology, transaction-processing systems or network infrastructure to accommodate increased sales volume through KCG’s transaction-processing systems, could lead to unanticipated system disruptions, slower response time, degradation in levels of customer service and impaired quality and speed of order fulfillment. KCG may not successfully evaluate or utilize technology acquired as a result of the Mergers, which may also lead to failures and delays. Such failures or delays could cause substantial losses for KCG and its clients and could subject KCG to claims from its clients for losses, including litigation and arbitration claims, as well as regulatory actions. From time to time, KCG has reimbursed its clients for losses incurred in connection with systems failures and delays. Capacity constraints, systems failures and delays may occur in the future and could cause, among other things, unanticipated problems with KCG’s trading or operating systems, disruptions in its client and non-client market making activities, disruptions in service to its clients, slower system response times resulting in transactions not being processed as quickly as KCG’s clients desire, decreased levels of client service and client satisfaction, and harm to KCG’s reputation.

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If any of these events were to occur, KCG could suffer substantial financial losses, loss of clients or reduction in the growth of its client base, increased operating expenses, litigation or other client claims and regulatory sanctions or additional regulatory burdens.
KCG has business continuity capabilities that could be utilized in the event of a disaster or disruption. Since the timing and impact of disasters and disruptions are unpredictable, KCG has to be flexible in responding to actual events as they occur. Significant business disruptions can vary in their scope. A disruption might only affect KCG, a building that KCG occupies, a business district in which KCG is located, a city in which KCG is located or an entire region. Within each of these areas, the severity of the disruption can also vary from minimal to severe. KCG’s business continuity facilities are designed to allow it to substantially continue operations if KCG is prevented from accessing or utilizing its primary offices for an extended period of time. Although KCG has employed significant effort to develop, implement and maintain reasonable business continuity plans, KCG will not be able to ensure that its systems will properly or fully recover after a significant business disruption in a timely fashion. If KCG is prevented from using any of its current trading operations or any third party services, or if its business continuity operations do not work effectively, KCG may not have complete business continuity. This could have a material adverse effect on KCG’s business, financial condition and operating results.
Failure of third-party systems on which KCG relies could adversely affect its business
KCG relies on certain third-party computer systems or third-party service providers, including clearing systems, exchange systems, Internet service, communications facilities and other facilities. Any interruption in these third-party services, or deterioration in their performance, could be disruptive to KCG’s business. If KCG’s arrangement with any third party is terminated, KCG may not be able to find an alternative source of systems support on a timely basis or on commercially reasonable terms. This could have a material adverse effect on KCG’s business, financial condition and results of operations.
KCG may incur losses as a result of ineffective risk management processes and strategies.
KCG seeks to monitor and control its risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, internal controls, management review processes and other mechanisms. While KCG employs a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Thus, KCG may, in the course of its activities, incur losses.
Exposure to credit risk may adversely affect KCG’s results of operations
KCG will be at risk if issuers whose securities or other instruments KCG holds, customers, trading counterparties, counterparties under derivative contracts or financing agreements, clearing agents, exchanges, clearing houses or other financial intermediaries or guarantors default on their obligations to KCG due to bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud or other reasons. Such defaults could have a material adverse effect on KCG’s results of operations, financial condition and cash flows.
KCG conducts the majority of its trade executions as principal or riskless-principal with broker dealers, financial services firms and institutional counterparties. KCG self-clears a considerable portion of its trade executions, which requires that KCG compare and match trades, record all transaction details, finance inventory and maintain deposits with clearing organizations, rather than rely upon an outside party to provide those services. When KCG self-clears its securities transactions, it is required to hold the securities subject to those transactions until the transactions settle, which typically occurs three trading days following the date of execution of the transaction. During the period of time from the execution to the settlement of a securities transaction, the securities to be transferred in the transaction may incur a significant change in value or the counterparty to the transaction may become insolvent, may default on its obligation to settle the transaction or may otherwise become unable to comply with its securities financing contractual obligations, resulting in potential losses to KCG. KCG is also exposed to credit risk from its counterparties when it self-clears securities transactions and when it clears securities transactions through an unaffiliated clearing broker, the latter of which is the case with a minority of KCG’s trade executions. Counterparty credit risk relates to both the deposits held with clearing organizations and instances where a trade might have failed, or be contested, adjusted or generally deviate from the terms understood at the time of execution. Under the terms of the agreements between KCG and its clearing brokers, the clearing brokers have the right to charge KCG for losses that result from a counterparty’s failure to fulfill its contractual obligations. No assurance can be given that any such counterparty will not default on its

22


obligations, which default could have a material adverse effect on KCG’s business, financial condition and operating results.
Although KCG has procedures for reviewing credit exposures to specific customers and counterparties to address present credit concerns, default risk may arise from events or circumstances that are difficult to detect or foresee, including rapid changes in securities, commodity and foreign exchange price levels. Some of KCG’s risk management methods depend upon the evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by KCG. That information may not, in all cases, be accurate, complete, up-to-date or properly evaluated. In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions, which in turn could adversely affect KCG. KCG may be materially and adversely affected in the event of a significant default by its customers and counterparties.
KCG’s failure to achieve and maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could cause investors to lose confidence in its financial statements and have a material adverse effect on KCG’s business and stock price
KCG devotes considerable resources, including management’s time and other internal resources, to complying with regulatory requirements relating to internal control over financial reporting. Although GETCO and its subsidiaries have not previously been, and in 2013 were not, subject to the requirements of Section 404 of the Sarbanes-Oxley Act, these entities will be subject to such requirements in 2014. If KCG cannot successfully integrate the financial reporting processes of GETCO and Knight with adequate internal controls over financial reporting, management’s assessment may be negative and/or KCG’s independent registered public accounting firm may be unable to issue an unqualified attestation report on the effectiveness of KCG’s internal control over financial reporting. This could lead to a negative reaction in the financial markets due to a loss in investor confidence, and, in turn, the market price of KCG Class A Common Stock could be materially adversely affected.
In addition, internal control over financial reporting, no matter how well designed, has inherent limitations. Therefore, internal control over financial reporting determined to be effective can provide only reasonable assurance with respect to financial statement preparation and may not prevent or detect all misstatements. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. As such, KCG could lose investor confidence in the accuracy and completeness of its financial reports, which may have a material adverse effect on its stock price.
KCG’s reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates
KCG’s accounting policies and assumptions are fundamental to its reported financial condition and results of operations. KCG’s management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report KCG’s financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in us reporting materially different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting KCG’s reported financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. If such estimates or assumptions underlying KCG’s financial statements are incorrect, KCG may experience material losses.
In November 2013, KCG restated certain legacy historical financial statements of GETCO. As a result of these restatements, KCG's management concluded that there were material weaknesses in GETCO's financial statement preparation processes and the related disclosure controls for the period leading up to the Mergers. Any future restatements or corrections of errors may result in a loss of investor confidence in KCG’s financial reporting.
Additionally, from time to time, the Financial Accounting Standards Board and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of KCG’s financial statements. These changes are beyond KCG’s control, can be difficult to predict and could materially impact how KCG reports its financial condition and results of operations. Changes in these standards are continuously

23


occurring, and given the current economic environment, more drastic changes may occur. The implementation of such changes could have a material adverse effect on KCG’s business, financial condition and results of operations.
Self-clearing exposes KCG to significant operational, financial, and liquidity risks
KCG self-clears substantially all of its domestic and international equities transactions using proprietary platforms and intends to expand self-clearing across product offerings and asset classes in the future. Self-clearing requires KCG to finance the majority of its inventory and maintain margin deposits at clearing organizations. Self-clearing exposes KCG’s business to operational risks, including business and technology disruption, operational inefficiencies, liquidity and financing risks and potentially increased expenses and lost revenue opportunities. While KCG’s clearing platform, operational processes, enhanced infrastructure, and current and future financing arrangements, have been carefully designed, KCG may nevertheless encounter difficulties that may lead to operating inefficiencies, including technology issues, dissatisfaction amongst KCG’s client base, disruption in the infrastructure that supports the business, inadequate liquidity (as Knight experienced during the events of August 1, 2012), increased margin requirements with clearing organizations and counterparties who provide financing with respect to inventories, reductions in available borrowing capacity and financial loss. Any such delay, disruption, expense or failure could adversely affect KCG’s ability to effect transactions and manage its exposure to risk. Moreover, any of these events could have a material adverse effect on KCG’s business, financial condition and operating results.
Acquisitions, strategic investments, divestitures and other strategic relationships involve certain risks
KCG is the product of strategic relationships and acquisitions, and it may continue to pursue opportunistic strategic acquisitions of, investments in, or divestitures of businesses and technologies. Acquisitions may entail numerous risks, including difficulties in assessing values for acquired businesses, intangible assets and technologies, difficulties in the assimilation of acquired operations and products, diversion of management’s attention from other business concerns, employee retention issues, assumption of unknown material liabilities of acquired companies, amortization of acquired intangible assets and the potential writedown of goodwill due to impairment, which could reduce future reported earnings, or result in potential loss of clients and/or key employees of acquired companies. KCG may not be able to integrate successfully certain operations, personnel, services or products that it has acquired or may acquire in the future.
As KCG has sought to refocus on its core market making and trading services, it has shutdown, reconstituted or disposed of several non-core businesses, including its reverse mortgage origination and securitization business, which accounted for $39.9 million in revenues in 2013 which are included within discontinued operations. Additional divestitures are possible in the future and may have a material impact on KCG’s balance sheet or results of operations. There is no guarantee that KCG will be able to replace the revenue generated by any divested business. Divestitures generally also entail numerous risks. The divestiture of an existing business could reduce KCG’s future operating cash flows and revenues, make its financial results more volatile, and/or cause a decline in revenues and profits. A divestiture could also cause a decline in the price of KCG Class A Common Stock and increased reliance on other elements of its core business operations. In addition, the agreements to sell any divested businesses may require KCG to indemnify the buyer in certain situations. If KCG does not successfully manage the risks associated with a divestiture, its business, financial condition, and results of operations could be adversely affected. KCG also may not find suitable purchasers for businesses it may wish to divest. In addition, the decision to pursue acquisitions, divestitures or other strategic transactions may jeopardize KCG’s ability to retain the services of its existing key employees and to attract and retain additional qualified personnel in the future.
Strategic investments also entail some of the other risks described above. If these investments are unsuccessful, KCG may need to incur charges against earnings. KCG may build and establish a number of strategic relationships. These relationships and others KCG may enter into in the future may be important to its business and growth prospects. KCG may not be able to maintain these relationships or develop new strategic alliances.
International activities involve certain risks
KCG’s international operations expose it to financial, cultural, regulatory and governmental risks. Approximately 25% of the pro forma combined revenues of Knight and GETCO in the three years ended December 31, 2013, resulted from international operations. The financial services industry in many foreign countries is heavily regulated, much like the U.S., but differences, whether cultural, legal or otherwise, do exist. KCG is exposed to risks and uncertainties, including political, economic and financial instability, changes in requirements, exchange rate fluctuations, staffing challenges and the requisite controls needed to manage such operations. To continue to operate and expand its services globally, KCG will have to comply with the unique legal and regulatory controls of each country in which it

24


conducts, or intends to conduct business, the requirements of which may be onerous or may not be clearly defined. The varying compliance requirements of these different regulatory jurisdictions and other factors may limit KCG’s ability to successfully conduct or expand its business internationally. It may increase KCG’s costs of investment. Additionally, operating international locations involves both execution and reputational risk. KCG may not be able to manage these costs or risks effectively.
Rules governing specialists and designated market makers may require KCG to make unprofitable trades or prevent KCG from making profitable trades
Specialists and designated market makers are granted certain rights and have certain obligations to "make a market" in a particular security. They agree to specific obligations to maintain a fair and orderly market. In acting as a specialist or designated market maker, KCG is subjected to a high degree of risk by having to support an orderly market. In this role, KCG may at times be required to make trades that adversely affect its profitability. In addition, KCG may at times be unable to trade for its own account in circumstances in which it may be to its advantage to trade, and KCG may be obligated to act as a principal when buyers or sellers outnumber each other. In those instances, KCG may take a position counter to the market, buying or selling securities to support an orderly market. Additionally, the rules of the markets which govern KCG’s activities as a specialist or designated market maker are subject to change. If these rules are made more stringent, KCG’s trading revenues and profits as specialist or designated market maker could be adversely affected.
KCG is a holding company and depends on its subsidiaries for dividends, distributions and other payments
KCG is a legal entity separate and distinct from its broker dealer and other subsidiaries. KCG’s principal source of cash flow, including cash flow to pay principal and interest on its outstanding debt, will be dividends and distributions from its subsidiaries. There are statutory and regulatory limitations on the payment of dividends or distributions by regulated subsidiaries, such as broker dealers. If KCG’s subsidiaries are unable to make dividend payments or distributions to it and sufficient cash or liquidity is not otherwise available, KCG may not be able to make principal and interest payments on its outstanding debt and could default on its debt obligations. In addition, KCG’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors.
Fluctuations in currency exchange rates could adversely affect KCG’s earnings
A significant portion of KCG’s international business is conducted in currencies other than the U.S. dollar, and changes in foreign exchange rates relative to the U.S. dollar can therefore affect the value of non-U.S. dollar net assets, revenues and expenses. Potential exposures as a result of these fluctuations in currencies are closely monitored, and, where cost-justified, strategies are adopted that are designed to reduce the impact of these fluctuations on KCG’s financial performance. These strategies may include the financing of non-U.S. dollar assets with borrowings in the same currency and the use of various hedging transactions related to net assets, revenues, expenses or cash flows. Any material fluctuations in currencies could have a material effect on our operating results.
The market price of KCG’s common stock could fluctuate significantly
The U.S. securities markets in general have experienced significant price fluctuations in recent years. If the market price of KCG Class A Common Stock fluctuates significantly, KCG may become the subject of securities class action litigation which may result in substantial costs and a diversion of management’s attention and resources. KCG’s future quarterly operating results may not consistently meet the expectations of securities analysts or investors, which could have a material adverse effect on the market price of KCG Class A Common Stock.
KCG may not pay dividends
KCG does not currently expect to pay dividends on its common stock. Any determination to pay dividends in the future will be at the discretion of the KCG board of directors and will depend upon among other factors, KCG’s cash requirements, financial condition, requirements to comply with the covenants under its debt instruments and credit facilities, earnings and legal considerations. If KCG does not pay dividends, then the return on an investment in its common stock will depend entirely upon any future appreciation in its stock price. There is no guarantee that KCG Class A Common Stock will appreciate in value or maintain its value.

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Item 1B.
Unresolved Staff Comments
None.
Item 2.
Properties
Our corporate headquarters are located in Jersey City, New Jersey. We lease approximately 266,000 square feet at 545 Washington Boulevard under a lease that expires in October 2021. We also collectively lease approximately 450,000 square feet for our office locations in the U.S., Europe and Asia.
Item 3.
Legal Proceedings
The information required by this Item is set forth in the “Legal Proceedings” section in Footnote 21 "Commitments and Contingent Liabilities" to the Company's Consolidated Financial Statements included in Part II, Item 8 "Financial Statements and Supplementary Data" herein.
Item 4.
Mine Safety Disclosures
Not applicable.

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PART II
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Class A Common Stock is listed on the NYSE under the ticker symbol “KCG”. Regular-way public trading of our Class A Common Stock commenced on July 5, 2013 on the New York Stock Exchange. The following table sets forth, since July 5, 2013, the high and low quarterly closing sales price per share of the Class A Common Stock as reported by the NYSE during the relevant periods.
 
 
High
 
Low
2013
 
 
 
Third Quarter
$
12.24

 
$
8.16

Fourth Quarter
12.08

 
8.29

The closing sale price of our Class A Common Stock as reported by the NYSE on February 27, 2014, was $11.82 per share. As of that date there were 140 holders of record of our Class A Common Stock based on information provided by our transfer agent. The number of stockholders does not reflect the actual number of individual or institutional stockholders that hold our stock because certain stock is held in the name of nominees. Based on information made available to us by our transfer agent, there are 21,595 beneficial holders of our Class A Common Stock. Holders of restricted stock units are not included in the calculation of holders of record.
We have never declared or paid a cash dividend on our Class A Common Stock. The payment of cash dividends is within the discretion of our Board of Directors and will depend on many factors, including, but not limited to, our results of operations, financial condition, capital and liquidity requirements and restrictions imposed by financing arrangements, as further described in the “Financial Condition, Liquidity and Capital Resources” section included in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operation”, and in Footnote 12, “Debt” to the Company’s Consolidated Financial Statements included in Part II, Item 8 “Financial Statements and Supplementary Data”.


27


Comparative Stock Performance Graph
The graph below compares the total cumulative return of the KCG Class A Common Stock from July 5, 2013 (the day KCG commenced regular-way trading on the NYSE) through December 31, 2013, to the Standard & Poor’s 500 Index and the SNL Broker/Dealer Index. The graph assumes that dividends were reinvested and is based on an investment of $100 on July 1, 2013.
 
 
Period Ending
Index
 
07/05/13

 
07/31/13

 
08/31/13

 
09/30/13

 
10/31/13

 
11/30/13

 
12/31/13

KCG Holdings, Inc.
 
100.00

 
85.77

 
80.74

 
80.65

 
81.30

 
111.16

 
111.26

S&P 500
 
100.00

 
104.51

 
101.48

 
104.67

 
109.48

 
112.81

 
115.67

SNL Broker/Dealer
 
100.00

 
105.90

 
100.65

 
104.41

 
108.90

 
117.54

 
121.95


28


The following table contains information about our purchases of KCG Class A Common Stock during the fourth quarter of 2013 (in thousands, except average price paid per share):
Period
 
Total Number of
Shares Purchased
 
Average
Price Paid
per Share
October 1, 2013 - October 31, 2013
 
 
 
 
Employee transactions (1)
 
84

 
 
Total
 
84

 
$
8.53

November 1, 2013 - November 30, 2013
 
 
 
 
Employee transactions (1)
 
10

 
 
Total
 
10

 
$
11.93

December 1, 2013 - December 31, 2013
 
 
 
 
Employee transactions (1)
 
58

 
 
Total
 
58

 
$
11.81

Total
 
 
 
 
Employee transactions (1)
 
151

 
 
Total
 
151

 
$
10.00

________________________________________
Totals may not add due to rounding.
(1) Represents shares of KCG Class A Common Stock withheld in satisfaction of tax withholding obligations upon vesting of employee restricted equity awards.
Equity Compensation Plan Information
The following table sets forth certain information as of December 31, 2013, regarding the Company’s equity compensation plans for stock-based awards.
Plan Category
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
 
Weighted-average exercise
price of outstanding
options, warrants and rights
 
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
 
(In thousands, except weighted-average exercise price)
 
( a )
 
( b )
 
( c )
Equity compensation plans approved by security holders
4,967

 
$
18.45

 
18,771

Equity compensation plans not approved by security holders

 

 

Total
4,967

 
$
18.45

 
18,771



29


Item 6.
Selected Financial Data
The following should be read in conjunction with the Consolidated Financial Statements and the discussion under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this document. The Consolidated Statements of Operations Data for 2013, 2012 and 2011 and the Consolidated Statements of Financial Condition Data at December 31, 2013 and 2012 have been derived from our audited Consolidated Financial Statements included elsewhere in this document. The Consolidated Statements of Operations Data for 2010 and 2009 and the Consolidated Statements of Financial Condition Data at December 31, 2011, 2010 and 2009 are derived from Consolidated Financial Statements updated to conform with current year presentation and not included in this document. 

30


 
For the year ended December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Consolidated Statements of Operations Data:
(In thousands, except per share amounts)
Revenues
 
 
 
 
 
 
 
 
 
Trading revenue, net
$
628,304

 
$
421,063

 
$
611,845

 
$
335,418

 
$
138,384

Commissions and fees
275,474

 
105,518

 
284,620

 
529,673

 
816,778

Interest, net
(537
)
 
(2,357
)
 
(1,211
)
 
50

 
1,099

Investment income and other, net
116,930

 
27,010

 
20,194

 
1,804

 
537

Total revenues
1,020,171

 
551,234

 
915,448

 
866,945

 
956,798

Expenses
 
 
 
 
 
 
 
 
 
Employee compensation and benefits
349,192

 
157,855

 
241,753

 
220,318

 
247,255

Execution and clearance fees
246,414

 
185,790

 
289,025

 
303,574

 
307,036

Communications and data processing
123,552

 
90,623

 
87,116

 
61,844

 
43,402

Depreciation and amortization
55,570

 
34,938

 
1,299

 
46,612

 
29,483

Interest
44,785

 
2,665

 
45,675

 
740

 
961

Payments for order flow
35,711

 
2,964

 
3,299

 
4,086

 
4,710

Occupancy and equipment rentals
24,812

 
12,804

 
17,142

 
7,054

 
6,509

Professional fees
46,662

 
14,072

 
9,903

 
11,621

 
8,193

Business development
4,609

 
23

 
108

 
143

 

Writedown of capitalized debt costs
13,209

 

 

 

 

Writedown of assets and lease loss accrual
14,748

 

 

 

 

Other
43,094

 
23,073

 
26,587

 
21,263

 
17,177

Total expenses
1,002,358

 
524,807

 
721,907

 
677,255

 
664,726

Income from continuing operations before income taxes
17,813

 
26,427

 
193,541

 
189,690

 
292,072

Income tax (benefit) expense
(102,195
)
 
10,276

 
30,841

 
27,834

 
28,972

Income from continuing operations, net of taxes
120,008

 
16,151

 
162,700

 
161,856

 
263,100

Income from discontinued operations, net of taxes
80

 

 

 

 

Net income
$
120,088

 
$
16,151

 
$
162,700

 
$
161,856

 
$
263,100

Basic earnings per share from continuing operations
$
1.50

 
$
0.33

 
$
3.21

 
$
3.24

 
$
5.39

Diluted earnings per share from continuing operations
$
1.48

 
$
0.33

 
$
3.21

 
$
3.24

 
$
5.39

Basic earnings per share from discontinued operations
$

 
$

 
$

 
$

 
$

Diluted earnings per share from discontinued operations
$

 
$

 
$

 
$

 
$

Basic earnings per share
$
1.50

 
$
0.33

 
$
3.21

 
$
3.24

 
$
5.39

Diluted earnings per share
$
1.48

 
$
0.33

 
$
3.21

 
$
3.24

 
$
5.39

Shares used in computation of basic earnings per share
80,143

 
48,970

 
50,688

 
49,977

 
48,773

Shares used in computation of diluted earnings per share
81,015

 
48,970

 
50,688

 
49,977

 
48,773


31


 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
 
(In thousands)
Consolidated Statements of Financial Condition Data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
674,281

 
$
427,631

 
$
607,689

 
$
614,025

 
$
638,326

Financial instruments owned, at fair value
2,721,839

 
654,875

 
240,338

 
99,418

 
66,869

Total assets
6,991,215

 
1,687,536

 
1,302,023

 
1,184,382

 
967,426

Financial instruments sold, not yet purchased, at fair value
2,165,500

 
512,553

 
140,530

 
191,446

 
24,068

Debt
657,259

 
15,000

 
15,000

 
21,654

 
20,000

Redeemable preferred member's equity

 
311,139

 
314,440

 
338,158

 
350,000

Equity
1,507,252

 
654,672

 
622,996

 
532,411

 
439,858


32


Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Explanatory Note
On July 1, 2013, Knight Capital Group, Inc. (“Knight”) merged with and into Knight Acquisition Corp., a wholly-owned subsidiary of KCG Holdings, Inc. (“KCG” or the "Company"), with Knight surviving the merger, GETCO Holding Company, LLC (“GETCO”) merged with and into GETCO Acquisition, LLC, a wholly-owned subsidiary of KCG, with GETCO surviving the merger and GA-GTCO, LLC, a unitholder of GETCO, merged with and into GA-GTCO Acquisition, LLC, a wholly-owned subsidiary of KCG, with GA-GTCO Acquisition, LLC surviving the merger (collectively, the “Mergers”), in each case, pursuant to the Amended and Restated Agreement and Plan of Merger, dated as of December 19, 2012 and amended and restated as of April 15, 2013 (the "Merger Agreement"). Following the Mergers, each of Knight and GETCO became wholly-owned subsidiaries of KCG.
All references herein to the "Company", "we", "our" or "KCG" relate solely to KCG and not Knight. All references to "GETCO" relate solely to GETCO and not KCG.
The Mergers were treated as a purchase of Knight by GETCO for accounting and financial reporting purposes. As a result, the financial results for the year ended December 31, 2013 are comprised of the results of GETCO only for the six months ended June 30, 2013 and the results of KCG (the combined Knight and GETCO) for the six months ended December 31, 2013. All periods prior to 2013 reflect solely the results and financial condition of GETCO.
All GETCO earnings per share and unit share outstanding amounts in this Annual Report on Form 10-K have been calculated as if the conversion of GETCO units to KCG Class A Common Stock took place on January 1, 2011, at the exchange ratio, as defined in the Merger Agreement.
For additional information relating to the Mergers and KCG see the Registration Statement on Form S-4 (Registration No. 333-186624) filed by KCG with respect to the Mergers, the Current Report on Form 8-K filed by KCG on July 1, 2013 with the U.S. Securities and Exchange Commission ("SEC") and the Current Report on Form 8-K filed by KCG on August 9, 2013, the Current Report on Form 8-K filed by KCG on November 12, 2013 related to the restatement of GETCO historical results and in other reports or documents KCG files with, or furnishes to, the SEC from time to time.
Cautionary Statement Regarding Forward-Looking Information
Certain statements contained in this Annual Report on Form 10-K, including without limitation, those under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein (“MD&A”), “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A, and “Legal Proceedings” section in Footnote 21 "Commitments and Contingent Liabilities" to the Company's Consolidated Financial Statements included in Part II, Item 8 "Financial Statements and Supplementary Data", the documents incorporated by reference herein and statements containing the words “believes,” “intends,” “expects,” “anticipates,” and words of similar meaning, may constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts and are based on current expectations, estimates and projections about the Company's industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company's control. Accordingly, readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict including, without limitation, risks associated with: (i) the Mergers including, among other things, (a) difficulties and delays in integrating the Knight and GETCO businesses or fully realizing cost savings and other benefits, (b) the inability to sustain revenue and earnings growth, and (c) customer and client reactions to the Mergers; (ii) the August 1, 2012 technology issue that resulted in Knight’s broker dealer subsidiary sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market and the impact to Knight’s capital structure and business as well as actions taken in response thereto and consequences thereof; (iii) the costs and risks associated with the sale of Knight's institutional fixed income sales and trading business, the sale of KCG's reverse mortgage origination and securitization business and the departure of the managers of KCG's listed derivatives group; (iv) changes in market structure, legislative, regulatory or financial reporting rules; (v) past or future changes to KCG's organizational structure and management; (vi) KCG's ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by KCG's customers and potential customers; (vii) KCG's ability to keep up with technological changes; (viii) KCG's ability to effectively identify and manage market risk, operational and technology risk, legal risk, liquidity risk, reputational risk, counterparty and credit risk, international risk, regulatory risk, and compliance risk; (ix) the cost and other effects of material contingencies, including litigation

33


contingencies, and any adverse judicial, administrative or arbitral rulings or proceedings; and (x) the effects of increased competition and KCG's ability to maintain and expand market share. The above list is not exhaustive. Because forward-looking statements involve risks and uncertainties, the actual results and performance of the Company may materially differ from the results expressed or implied by such statements. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Unless otherwise required by law, the Company also disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made herein. Readers should carefully review the risks and uncertainties disclosed in the Company’s reports with the SEC, including those detailed under “Certain Factors Affecting Results of Operations” in MD&A and in “Risk Factors” in Part I, Item 1A herein, and in other reports or documents the Company files with, or furnishes to, the SEC from time to time. This information should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto contained in this Form 10-K, and in other reports or documents the Company files with, or furnishes to, the SEC from time to time.
Executive Overview
We are a leading independent securities firm offering clients a range of services designed to address trading needs across asset classes, product types and time zones. The Company combines advanced technology with specialized client service across market making, agency execution and trading venues and also engages in principal trading via exchange-based market making. KCG has multiple access points to trade global equities, options, fixed income, foreign currencies and commodities via voice or automated execution.
On December 19, 2012, Knight, GETCO and GA-GTCO, LLC, an affiliate of GETCO entered into the Merger Agreement. The Mergers were approved by the respective stockholders and unitholders of both companies at special meetings held on June 25, 2013, and the Mergers were completed on July 1, 2013. As a result of the Mergers, Knight and GETCO became wholly-owned subsidiaries of KCG.
Pursuant to the Merger Agreement, upon completion of the Mergers subject to proration and certain specified exceptions, each outstanding share of Knight Class A common stock, par value $0.01 per share ("Knight Common Stock") was converted into the right to elect to receive either $3.75 per share in cash or one third of a share of KCG Class A Common Stock. Pursuant to the proration procedures provided in the Merger Agreement and taking into account the waiver by Jefferies LLC, Knight's largest stockholder before the Mergers, of its right to receive cash consideration with respect to certain of its shares, former Knight stockholders eligible for election received a cash payment, in aggregate, of $720.0 million and 41.9 million shares of KCG Class A Common Stock.
Upon completion of the Mergers, GETCO unitholders received, in aggregate, 75.9 million shares of KCG Class A Common Stock and 24.3 million warrants to acquire shares of KCG Class A Common Stock. The warrants comprise 8.1 million Class A warrants, having a $12.00 exercise price and exercisable for a four-year term; 8.1 million Class B warrants, having a $13.50 exercise price and exercisable for a five-year term; and 8.1 million Class C warrants, having a $15.00 exercise price and exercisable for a six-year term (collectively the “KCG Warrants”).
After taking into account the election results and the shares of KCG Class A Common Stock issued to former unitholders of GETCO and stockholders of Knight, 116.8 million shares (including unvested restricted stock units ("RSUs")) of KCG Class A Common Stock were outstanding as of July 1, 2013.
The Mergers are accounted for as a purchase of Knight by GETCO under accounting principles generally accepted in the United States of America ("GAAP"). Under the purchase method of accounting, the assets and liabilities of Knight were recorded, as of completion of the Mergers, at their respective fair values and added to the carrying value of GETCO's existing assets and liabilities. The reported financial condition and results of operations of KCG following completion of the Mergers reflect Knight's and GETCO's balances and reflect the impact of purchase accounting adjustments, including revised amortization and depreciation expense for acquired assets. As GETCO is the accounting acquirer under GAAP, all historical financial information is that of GETCO.
Results of Operations
As of December 31, 2013, our operating segments comprised the following:
Market Making— Our Market Making segment principally consists of market making in the cash, futures and options markets across global equities, options, fixed income, foreign currencies and commodities. As a market maker, we commit capital on a principal basis by offering to buy securities from, or sell securities to, broker dealers, institutions and banks. Principal trading in the Market Making segment primarily consists of direct-to-client and non-client exchange-based electronic market making, including trade executions

34


conducted as an equities Designated Market Maker (“DMM”) on the New York Stock Exchange ("NYSE") and NYSE Amex Equities ("NYSE Amex"). We are an active participant on all major global equity and futures exchanges and also trade on substantially all domestic electronic options exchanges. As a complement to electronic market making, our cash trading business handles specialized orders and also transacts on the OTC Bulletin Board, marketplaces operated by the OTC Markets Group Inc. and the Alternative Investment Market (“AIM”) of the London Stock Exchange.
Global Execution Services— Our Global Execution Services segment comprises agency execution services and trading venues, offering trading in global equities, options, foreign exchange, fixed income and futures to institutions, banks and broker dealers. We generally earn commissions as an agent between principals to transactions that are executed within this segment, however, we will commit capital on behalf of clients as needed. Agency-based, execution-only trading in the segment primarily consists of self-directed trading in global equities through a suite of algorithms or via our execution management system; institutional high touch sales traders executing program, block and riskless principal trades in global equities and exchange traded funds ("ETFs"); an institutional spot foreign exchange electronic communication network ("ECN"); a fixed income ECN that also offers trading applications; an alternative trading system ("ATS") for global equities; and futures execution and clearing through a futures commission merchant ("FCM").         
Corporate and Other— Our Corporate and Other segment invests principally in strategic financial services-oriented opportunities, allocates, deploys and monitors all capital, and maintains corporate overhead expenses and all other income and expenses that are not attributable to the other segments. Our Corporate and Other segment also contains functions that support our other segments such as self-clearing services, including stock lending activities.
Management from time to time conducts a strategic review of our businesses and evaluates their potential value in the marketplace relative to their current and expected returns.  To the extent management and our Board of Directors determine a business may return a higher value to stockholders through a divestiture, or is no longer core to our strategy, management may pursue a sale process. 
The following table sets forth: (i) Revenues, (ii) Expenses and (iii) Pre-tax earnings (loss) from continuing operations of our segments and on a consolidated basis (in thousands): 
 
 
For the year ended December 31,
 
 
2013
 
2012
 
2011
Market Making
 
 
 
 
 
 
Revenues
 
$
688,197

 
$
495,427

 
$
862,759

Expenses
 
584,639

 
460,540

 
658,873

Pre-tax earnings
 
103,559

 
34,887

 
203,886

Global Execution Services
 
 
 
 
 
 
Revenues
 
197,766

 
36,211

 
27,599

Expenses
 
223,506

 
43,541

 
43,006

Pre-tax loss
 
(25,739
)
 
(7,330
)
 
(15,406
)
Corporate and Other
 
 
 
 
 
 
Revenues
 
134,208

 
19,596

 
25,089

Expenses
 
194,215

 
20,726

 
20,028

Pre-tax (loss) earnings
 
(60,007
)
 
(1,130
)
 
5,061

Consolidated
 
 
 
 
 
 
Revenues
 
1,020,171

 
551,234

 
915,448

Expenses
 
1,002,360

 
524,807

 
721,907

Pre-tax earnings
 
$
17,813

 
$
26,427

 
$
193,541

Totals may not add due to rounding.



35


Reconciliation of GAAP Pre-Tax to Non-GAAP Pre-Tax Earnings
We believe that certain non-GAAP financial presentations, when taken into consideration with the corresponding GAAP financial presentations, are important in understanding our operating results. The non-GAAP adjustments incorporate the effects of professional fees related to the Mergers and fees related to Knight's August 1, 2012 technology issue; the acceleration of compensation expense related to certain unit-based awards that vested upon the Mergers; compensation expense related to a reduction in workforce and the departure of the ETF management team; writedowns of assets and lease loss accrual primarily related to office consolidations; writedown of capitalized debt costs related to early repayment of debt; gains and losses from strategic assets including a gain from GETCO's strategic investment in Knight.
We believe the presentation of results excluding these adjustments provides meaningful information to stockholders and investors as they provide a useful summary of our results of operations for the years ended ended December 31, 2013, 2012 and 2011.
The following tables provide a full reconciliation of GAAP to non-GAAP pre- tax results ("adjusted pre-tax earnings") for the years ended December 31, 2013, 2012 and 2011 (in thousands): 
Year ended December 31, 2013
 
Market Making
 
Global
Execution
Services
 
Corporate and
Other
 
Consolidated
Reconciliation of GAAP Pre-Tax to Non-GAAP Pre-Tax:
 
 
 
 
 
 
 
 
GAAP Income (loss) from continuing operations before income taxes
 
$
103,559

 
$
(25,739
)
 
$
(60,007
)
 
$
17,813

Gain on investment in Knight Capital Group, Inc.
 

 

 
(127,972
)
 
(127,972
)
Writedown of capitalized debt costs
 

 

 
13,209

 
13,209

Professional and other fees related to Mergers and August 1st technology issue
 

 

 
47,183

 
47,183

Compensation and other expenses related to reduction in workforce
 
11,518

 
21,444

 
708

 
33,670

Unit based compensation acceleration due to Mergers
 

 

 
22,031

 
22,031

Strategic asset impairment
 

 

 
7,825

 
7,825

Writedown of assets and lease loss accrual
 
108

 
1,681

 
13,344

 
15,133

Adjusted pre-tax earnings
 
$
115,185

 
$
(2,614
)
 
$
(83,679
)
 
$
28,892

Totals may not add due to rounding
Year ended December 31, 2012
 
Market Making
 
Global
Execution
Services
 
Corporate and
Other
 
Consolidated
Reconciliation of GAAP Pre-Tax to Non-GAAP Pre-Tax:
 
 
 
 
 
 
 
 
GAAP Income (loss) from continuing operations before income taxes
 
$
34,887

 
$
(7,330
)
 
$
(1,130
)
 
$
26,427

Investment gain
 
(9,133
)
 

 
(14,599
)
 
(23,732
)
Professional and other fees related to Mergers
 

 

 
4,318

 
4,318

Adjusted pre-tax earnings
 
$
25,754

 
$
(7,330
)
 
$
(11,411
)
 
$
7,013

Totals may not add due to rounding
Year ended December 31, 2011
 
Market Making
 
Global
Execution
Services
 
Corporate and
Other
 
Consolidated
Reconciliation of GAAP Pre-Tax to Non-GAAP Pre-Tax:
 
 
 
 
 
 
 
 
GAAP Income (loss) from continuing operations before income taxes
 
$
203,886

 
$
(15,406
)
 
$
5,061

 
$
193,541

Gain on strategic investment
 

 

 
(27,750
)
 
(27,750
)
Strategic asset impairment
 

 

 
5,000

 
5,000

Adjusted pre-tax earnings
 
$
203,886

 
$
(15,406
)
 
$
(17,689
)
 
$
170,791

Totals may not add due to rounding


36


A summary of the changes in our financial results and balances follows. Please note that the primary reason for the variance between 2013 and 2012 results is the Mergers which occurred on July 1, 2013. Financial results for periods prior to the Mergers reflect solely the results of GETCO while periods following the Mergers reflect the results of KCG which includes both GETCO and Knight.
Consolidated revenues for 2013 increased $468.9 million from 2012, while consolidated expenses increased $477.6 million. Consolidated pre-tax earnings from continuing operations for the year ended December 31, 2013 was $17.8 million as compared to consolidated pre-tax earnings of $26.4 million for the year ended December 31, 2012.
Adjusted pre-tax earnings increased from $7.0 million for the year ended December 31, 2012 to $28.9 million in the year ended December 31, 2013.
Consolidated adjusted pre-tax earnings for 2013 and 2012 exclude net non-GAAP adjustments totaling $11.1 million and $19.4 million, respectively, comprising a gain on GETCO's investment in Knight common stock offset, in part by merger related expenses for compensation and professional fees, August 1st related professional fees, strategic asset impairment as well as writedowns of assets and capitalized debt costs. Detailed breakdown of these items can be found in the Reconciliation of GAAP pre-tax to Non-GAAP pre-tax earnings tables above.
The changes in our adjusted pre-tax earnings by segment from the year ended ended December 31, 2012 to the year ended December 31, 2013 are summarized as follows:
Market Making— Our adjusted pre-tax earnings from Market Making for 2013 was $115.2 million, compared to adjusted pre-tax earnings of $25.8 million for 2012. Results for the current year were aided by the acquisition of Knight. This business provided strong revenue capture, improvements in trading strategies and order routing efficiencies specifically in the direct to client equity trading activity offset, in part, by lower market volumes and volatility.
Global Execution Services— Our adjusted pre-tax earnings from Global Execution Services for 2013 was a loss of $2.6 million, compared to adjusted pre-tax loss of $7.3 million in 2012. In the second half of 2013, the Global Executions Services segment included solid results from KCG Hotspot and KCG Bondpoint as well as KCG EMS, which includes Knight Direct and GETAlpha. Additionally, there were improvements in the high touch business in the latter part of the year. Global Execution Services results in 2013 were adversely affected by severance costs associated with the reorganization of the ETF team.
Corporate and Other—Our adjusted pre-tax earnings from our Corporate and Other segment was a loss of $83.7 million for 2013 compared to a loss of $11.4 million in 2012. Additional interest expense as a result of the debt raised in conjunction with the Mergers, a larger infrastructure, including additional corporate employees and other required costs associated with being a public company all contributed to the additional expense within this segment.
Certain Factors Affecting Results of Operations
We may experience significant variation in our future results of operations. Fluctuations in our future performance may result from numerous factors, including, among other things, global financial market conditions and the resulting competitive, credit and counterparty risks; cyclicality, seasonality and other economic conditions; the value of our securities positions and other financial instruments and our ability to manage the risks attendant thereto; the volume, notional dollar value traded and volatility levels within the core markets where our market making and trade execution businesses operate; the composition, profile and scope of our relationships with institutional and broker dealer clients; the performance, size and volatility of our client market making portfolios; the performance, size and volatility of our exchange-based trading activities; the overall size of our balance sheet and capital usage; impairment of goodwill and/or intangible assets; the performance of our global operations, trading technology and technology infrastructure; the effectiveness of our self-clearing and futures platforms and our ability to manage risks related thereto; the availability of credit and liquidity in the marketplace; our ability to prevent erroneous trade orders from being submitted due to technology or other issues (such as the events that affected Knight on August 1, 2012) and avoiding the consequences thereof; the performance, operation and connectivity to various market centers; our ability to manage personnel, compensation, overhead and other expenses, including our occupancy expenses under our office leases and expenses and charges relating to legal and regulatory proceedings; the strength of our client relationships; changes in payments for order flow; changes to execution quality and changes in clearing, execution and regulatory transaction costs; interest rate movements; the addition or loss of executive management, sales, trading and technology professionals; geopolitical, legislative, legal, regulatory and financial reporting changes specific to financial services and global trading;

37


legal or regulatory matters and proceedings; the Mergers and the costs and integration associated therewith; the amount, timing and cost of business divestitures/acquisitions or capital expenditures; the integration, performance and operation of acquired businesses; the incurrence of costs associated with acquisitions and dispositions; investor sentiment; and technological changes and events.
Such factors may also have an impact on our ability to achieve our strategic objectives, including, without limitation, increases in market share, growth and profitability in the businesses in which we operate. If demand for our services declines or our performance deteriorates significantly due to any of the above factors, and we are unable to adjust our cost structure on a timely basis, our operating results could be materially and adversely affected. As a result of the foregoing factors, period-to-period comparisons of our revenues and operating results are not necessarily meaningful and such comparisons cannot be relied upon as indicators of future performance. There also can be no assurance that we will be able to continue to achieve the level of revenues that we have experienced in the past or that we will be able to improve our operating results.
Trends
Global Economic Trends
Our businesses are affected by many factors in the global financial markets and worldwide economic conditions. These factors include the growth level of gross domestic product in the U.S., Europe and Asia, and the existence of transparent, efficient and liquid equity and debt markets and the level of trading volumes and volatility in such markets.
During the year ended December 31, 2013, trade volume and volatility levels across equity markets decreased as compared to the previous year. Secondary trading volumes in the equity markets were also down from prior years. Overall, there are still concerns about global stability and growth, inflation and declining asset values.
Trends Affecting Our Company
We believe that our businesses are affected by the aforementioned global economic trends as well as more specific trends. Some of the specific trends that impact our operations, financial condition and results of operations are:
Clients continue to focus on statistics measuring the quality of equity executions (including speed of execution and price improvement). In an effort to improve the quality of their executions as well as increase efficiencies, market makers continue to increase the level of sophistication and automation within their operations and the extent of price improvement. The continued focus on execution quality has resulted in greater competition in the marketplace, which, along with market structure changes and market conditions, has negatively impacted the revenue capture and margin metrics of the Company and other market making firms.
Market Making and Global Execution Services transaction volumes executed by clients have fluctuated over the past few years due to retail and institutional investor sentiment, market conditions and a variety of other factors. Market Making and Global Execution Services transaction volumes may not be sustainable and are not predictable.
Over the past several years exchanges have become far more competitive, and market participants have created ATS, ECNs and other execution venues which compete with the OTC and listed trading venues. Initiatives by these and other market participants could draw market share away from the Company, and thus negatively impact our business. In addition, there are many new entrants into the market, including ATS, Multilateral Trading Facilities, systematic internalizers, dark liquidity pools, high frequency trading firms, and market making firms competing for retail and institutional order flow. Further, many broker dealers offer their own internal crossing networks. These factors continue to create further fragmentation and competition in the marketplace.
Market structure changes, competition, market conditions and a steady increase in electronic trading have resulted in a reduction in institutional commission rates and volumes which may continue in the future. Additionally, many institutional clients allocate commissions to broker dealers based not only on the quality of executions, but also in exchange for research, or participation in soft dollar and commission recapture programs.
There continues to be growth in electronic trading, including direct market access platforms, algorithmic and program trading, high frequency trading ECNs and dark liquidity pools. In addition, electronic trading continues to expand to other asset classes, including options, currencies and fixed income. The expansion

38


of electronic trading may result in the growth of innovative electronic products and competition for order flow and may further reduce demand for traditional institutional voice services.
Market structure changes, competition and technology advancements have led to an industry focus on increasing execution speeds and a dramatic increase in electronic message traffic. Increases in execution speeds and message traffic require additional expenditures for technology infrastructure and place heavy strains on the technology resources, bandwidth and capacities of market participants. Additionally, the expansion by market participants into trading of non-equities products offers similar challenges.
There has been continued scrutiny of the capital markets industry by the regulatory and legislative authorities, both in the U.S. and abroad, which could result in increased regulatory costs in the future. New legislation or new or modified regulations and rules could occur in the future. Members of the U.S. Congress continue to ask the SEC and other regulators to closely review the financial markets regulatory structure and make the changes necessary to insure the rule framework governing the U.S. financial markets is comprehensive and complete. The SEC and other regulators, both in the U.S. and abroad, have adopted and will continue to propose and adopt rules where necessary, on a variety of marketplace issues – including, but not limited to: high frequency trading, transaction taxes, indications of interest, off-exchange trading, dark liquidity pools, internalization, post-trade attribution, colocation, market access, short sales, consolidated audit trails, policies and procedures relating to technology controls and systems, and market volatility rules (including, Regulation Systems Compliance and Integrity -- or, Regulation SCI).
We expect increases, possibly substantial, in Section 31 fees and fees imposed by other regulators. In addition, the Depository Trust & Clearing Corporation (DTCC) and NSCC are considering proposals which could require substantial increases in clearing margin, liquidity and collateral requirements.
The Dodd-Frank Act affects nearly all financial institutions that operate in the U.S. While the weight of the Dodd-Frank Act falls more heavily on large, complex financial institutions, smaller institutions will continue to face a more complicated and expensive regulatory framework.
Income Statement Items
The following section briefly describes the key components of, and drivers to, our significant revenues and expenses.
Revenues
Our revenues consist principally of Trading revenues, net and Commissions and fees from all of our business segments.
Trading profits and losses on principal transactions primarily relate to our global market making activities and are included within Trading revenues, net. These revenues are primarily affected by changes in the amount and mix of equity trade and share volumes; our revenue capture, dollar value of equities traded, fixed income, options, futures and FX trading volume and strategies; our ability to derive trading gains by taking proprietary positions; changes in our execution standards; development of, and enhancement to, our market making models; performance of our client and non-client trading models; volatility in the marketplace; our mix of broker dealer and institutional clients; client service and relationships and regulatory changes and evolving industry customs and practices.
Revenues on transactions for which we charge explicit commissions or commission equivalents, which include the majority of our institutional client orders and commissions on futures transactions are included within Commissions and fees. Commissions and fees are primarily affected by changes in our equity, fixed income, futures and foreign exchange transaction volumes with institutional clients; client relationships; changes in commission rates; client experience on the various platforms; level of volume based fees from providing liquidity to other trading venues; and the level of our soft dollar and commission recapture activity.
Interest, net is earned from our cash held at banks, cash held in trading accounts at third party clearing brokers and from collateralized financing arrangements, such as securities borrowing. The Company’s third party clearing agreements call for payment or receipt of interest income, net of transaction-related interest charged by clearing brokers for facilitating the settlement and financing of securities transactions. Net interest is primarily affected by interest rates; the level of cash balances held at banks and third party clearing brokers including those held for customers; the level of our securities borrowing activity; our level of securities positions in which we are long compared to our securities positions in which we are short; and the extent of our collateralized financing arrangements.

39


Investment income and other, net primarily represents returns on our strategic and deferred compensation investments, including the gain recognized on Knight common stock. Such income or loss is primarily affected by the performance and activity of our strategic investments.
Expenses
Employee compensation and benefits expense primarily consists of salaries and wages paid to all employees; performance-based compensation, which includes compensation paid to sales personnel and incentive compensation paid to all other employees based on our profitability; employee benefits; and stock and unit-based compensation. Employee compensation and benefits expense fluctuates, for the most part, based on changes in our revenues and business mix, profitability and the number of employees. Compensation for employees engaged in sales activities is determined primarily based on a percentage of their gross revenues net of certain transaction-based expenses.
Execution and clearance fees primarily represent fees paid to third party clearing brokers for clearing equities, options and fixed income transactions; transaction fees paid to Nasdaq and other exchanges, clearing organizations and regulatory bodies; and execution fees paid to third parties, primarily for executing trades on the NYSE, other exchanges and ECNs. Execution and clearance fees primarily fluctuate based on changes in trade and share volume, execution strategies, rate of clearance fees charged by clearing brokers and rate of fees paid to ECNs, exchanges and certain regulatory bodies.
Communications and data processing expense primarily consists of costs for obtaining market data, connectivity, telecommunications services, co-location and systems maintenance.
Depreciation and amortization expense results from the depreciation of fixed assets, which consist of computer hardware, furniture and fixtures, and the amortization of purchased software, capitalized software development costs, acquired intangible assets and leasehold improvements. We depreciate our fixed assets and amortize our intangible assets on a straight-line basis over their expected useful lives. We amortize leasehold improvements on a straight-line basis over the lesser of the life of the improvement or the remaining term of the lease.
Interest expense consists primarily of costs associated with our debt and for collateralized financing arrangements such as securities lending and sale of financial instruments under our agreements to repurchase.
Payments for order flow primarily represent payments to broker dealer clients, in the normal course of business, for directing to us their order flow in U.S. equities and options. Payments for order flow will fluctuate as we modify our rates and as our percentage of clients whose policy is not to accept payments for order flow varies. Payments for order flow also fluctuate based on U.S. equity share and option volumes, our profitability and the mix of market orders, limit orders, and customer mix.
Occupancy and equipment rentals consist primarily of rent and utilities related to leased premises and office equipment.
Professional fees consist primarily of legal, accounting, consulting, and other professional fees.
Business development consists primarily of costs related to sales and marketing, advertising, conferences and relationship management.
Writedown of assets and lease loss accrual consist primarily of costs associated with the writedown of assets which management has determined to be impaired and lease losses related to excess office space.
Writedown of capitalized debt costs represents charges recorded as the result of the prepayment of our debt.
Other expenses include regulatory fees, corporate insurance, employment fees, and general office expense.

40


Results of Operations
The following table sets forth the consolidated statements of operations data as a percentage of total revenues:
 
 
For the year ended December 31,
 
 
2013
 
2012
 
2011
Revenues
 
 
 
 
 
 
Trading revenues, net
 
61.6
 %
 
76.4
 %
 
66.8
 %
Commissions and fees
 
27.0
 %
 
19.1
 %
 
31.1
 %
Interest, net
 
-0.1
 %
 
-0.4
 %
 
-0.1
 %
Investment income and other, net
 
11.5
 %
 
4.9
 %
 
2.2
 %
Total revenues
 
100.0
 %
 
100.0
 %
 
100.0
 %
Expenses
 
 
 
 
 
 
Employee compensation and benefits
 
34.2
 %
 
28.6
 %
 
26.4
 %
Execution and clearance fees
 
24.2
 %
 
33.7
 %
 
31.6
 %
Communications and data processing
 
12.1
 %
 
16.4
 %
 
9.5
 %
Interest
 
4.4
 %
 
0.5
 %
 
0.1
 %
Depreciation and amortization
 
5.4
 %
 
6.3
 %
 
5.0
 %
Payments for order flow
 
3.5
 %
 
0.5
 %
 
0.4
 %
Professional fees
 
4.6
 %
 
2.6
 %
 
1.9
 %
Occupancy and equipment rentals
 
2.4
 %
 
2.3
 %
 
1.1
 %
Business development
 
0.5
 %
 
0.0
 %
 
0.0
 %
Writedown of capitalized debt costs
 
1.3
 %
 
0.0
 %
 
0.0
 %
Writedown of assets and lease loss accrual
 
1.4
 %
 
0.0
 %
 
0.0
 %
Other
 
4.2
 %
 
4.2
 %
 
2.9
 %
Total expenses
 
98.3
 %
 
95.2
 %
 
78.9
 %
Income from continuing operations before income taxes
 
1.7
 %
 
4.8
 %
 
21.1
 %
Income tax (benefit) expense
 
-10.0
 %
 
1.9
 %
 
3.4
 %
Income from continuing operations, net of tax
 
11.8
 %
 
2.9
 %
 
17.8
 %
Loss from discontinued operations, net of tax
 
0.0
 %
 
0.0
 %
 
0.0
 %
Net income
 
11.8
 %
 
2.9
 %
 
17.8
 %
_______________________________
Percentages may not add due to rounding.
Year Ended December 31, 2013 and 2012
Revenues
Market Making
 
For the year
 ended December 31,
 
 
 
 
 
2013
 
2012
 
Change
 
% of Change
Trading revenues, net (thousands)
$
614,232

 
$
421,063

 
$
193,168

 
45.9
%
Commissions and fees (thousands)
86,260

 
69,307

 
16,953

 
24.5
%
Interest, net and other (thousands)
(12,294
)
 
5,057

 
(17,352
)
 
N/M

Total Revenues from Market Making (thousands)
$
688,197

 
$
495,427

 
192,770

 
38.9
%
Totals may not add due to rounding.
N/M - Not meaningful
Total revenues from the Market Making segment, which primarily comprises Trading revenues, net and Commissions and fees from our domestic businesses, were $688.2 million for 2013 and $495.4 million in 2012. Revenues for 2013 were driven by solid U.S. equity revenue capture. Specifically, both direct-to-client trading strategies as well as non-client exchange-based market making in fixed income and options performed well in 2013, although, revenues across all asset classes were negatively impacted due to lower market volumes and volatility.

41


Global Execution Services 
 
For the year
 ended December 31,
 
 
 
 
 
2013
 
2012
 
Change
 
% of Change
Commissions and fees (thousands)
$
189,215

 
$
36,211

 
$
153,004

 
422.5
%
Trading revenues, net (thousands)
11,823

 
(1
)
 
11,823

 
N/M

Interest, net and other (thousands)
(3,273
)
 
1

 
(3,273
)
 
N/M

Total Revenues from Global Execution Services (thousands)
$
197,766

 
$
36,211

 
161,555

 
446.1
%
Totals may not add due to rounding.
N/M - Not meaningful
Total revenues from the Global Execution Services segment, which primarily comprises Commissions and fees and, to a lesser extent, Trading revenues, net from agency execution activity and activity on our venues were $197.8 million for 2013. Revenues principally reflect the performance of our high and low touch equity businesses, including KCG EMS, which includes Knight Direct and GETAlpha, as well as trading venues such as KCG Hotspot and KCG Bondpoint.
Corporate and Other 
 
For the year
 ended December 31,
 
 
 
 
 
2013
 
2012
 
Change
 
% of Change
Total Revenues from Corporate and Other (thousands)
$
134,208

 
$
19,596

 
$
114,612

 
584.9
%
Total revenues from the Corporate and Other segment, which represent interest income from our stock borrow activity and gains or losses on strategic investments were $134.2 million for 2013 and $19.6 million in 2012. Revenues in 2013 include a $128.0 million non-cash gain on GETCO's investment in Knight common stock.
Expenses
Employee compensation and benefits expense fluctuates, for the most part, based on changes in our business mix, revenues, profitability and the number of employees. Employee compensation and benefits expense was $349.2 million for 2013 and $157.9 million in 2012. The increase on a dollar basis was primarily due to an increase in the number of employees following the Mergers and higher severance costs associated with reductions in our workforce and the reorganization of our ETF team following the Mergers. Excluding the compensation expenses related to reductions in our workforce and the reorganization of our ETF team of $33.7 million, and costs related to unit based compensation acceleration due to the Mergers of $22.0 million, Employee compensation and benefits was $293.5 million or 32.6% of total revenues for 2013, excluding the revenue items excluded from adjusted pre-tax earnings ("adjusted revenues"), and $157.9 million or 28.6% for 2012.
The number of full time employees increased to 1,229 at December 31, 2013 as compared to 409 at December 31, 2012. As of the Merger date of July 1, 2013, the number of full time employees was 1,397 (excluding employees of Urban).
Execution and clearance fees were $246.4 million for 2013 and $185.8 million in 2012. Execution and clearance fees fluctuate based on changes in transaction volumes, shift in business mix, regulatory fees and operational efficiencies and scale. Execution and clearance fees were 27.4% of adjusted revenues for 2013 and 33.7% for 2012.
Payments for order flow fluctuate as a percentage of revenue due to changes in volume, client and product mix, profitability, and competition. Payments for order flow were $35.7 million for 2013 and $3.0 million in 2012. The variance is due to the addition of the direct-to-client market making business that was added as part of the Mergers. As a percentage of adjusted revenues, Payments for order flow were 4.0% in 2013 and 0.5% for 2012.
Interest expense was $44.8 million for 2013 and $2.7 million in 2012. Interest expense increased primarily due to interest on the debt financing for the Mergers as well as stock loan interest expense as it relates to the funding of our securities positions.
Professional fees were $46.7 million for 2013 and $14.1 million in 2012. Professional fees include legal costs incurred after the Mergers related to Knight's August 1, 2012 trading loss and legal, consulting and investment banking fees related to the Mergers. Excluding the $34.2 million in professional fees related to the Mergers and August 1, 2012

42


trading loss, Professional fees were $12.4 million for 2013 compared to $9.8 million in 2012, excluding $4.3 million in professional fees related to the Mergers.
Writedown of assets of $14.7 million for the year ended December 31, 2013 primarily relates to a writedown of excess real estate as we consolidated several offices located in the same city following the Mergers. There were no writedown of assets for the year ended December 31, 2012. Writedown of capitalized debt costs of $13.2 million for 2013 relates to the writedown of debt issuance costs as a result of the repayment of $300.0 million of the First Lien Credit Facility.
All other expenses were $251.6 million for the year ended December 31, 2013 and $161.5 million for the comparable period in 2012. These cost increases primarily relate to an increase in the size of KCG following the Mergers. Communications and data processing expense primarily relates to market data, co-location and connectivity expenses. Depreciation and amortization expense results from the depreciation of fixed assets and the amortization of purchased software, capitalized software development costs, acquired intangible assets and leasehold improvements. Occupancy and equipment rentals expense include additional real estate related costs in 2013 following the Mergers. Business development expense primarily includes client-related events and higher advertising costs.
Our effective tax rate for the year ended December 31, 2013 from continuing operations of -574% differed from the federal statutory rate of 35% primarily due to the recognition of $103.5 million of deferred tax benefits as a result of GETCO becoming subject to U.S. corporate income taxes following the Mergers, the nontaxable gain from GETCO's investment in Knight common stock, foreign taxes, nondeductible expenses including certain compensation and meals and entertainment and GETCO being structured as a pass through entity that was not largely subject to U.S. corporate income taxes prior to the Mergers. Our effective tax rate for the year ended December 31, 2012 from continuing operations of 38.9% differed from the federal statutory rate of 35% primarily due to GETCO being structured as a pass through entity that was not largely subject to U.S. corporate income taxes prior to the Mergers as well as state, local and non-U.S. income taxes.
Year Ended December 31, 2012 and 2011
Revenues
Market Making
 
For the year
 ended December 31,
 
 
 
 
 
2012
 
2011
 
Change
 
% of Change
Trading revenues, net (thousands)
$
421,063

 
$
611,845

 
$
(190,782
)
 
(31.2
)%
Commissions and fees (thousands)
69,307

 
257,021

 
(187,714
)
 
(73.0
)%
Interest, net and other (thousands)
5,057

 
(6,106
)
 
11,164

 
N/M

Total Revenues from Market Making (thousands)
$
495,427

 
$
862,759

 
(367,332
)
 
(42.6
)%
Totals may not add due to rounding.
N/M - Not meaningful
Total revenues from the Market Making segment, which primarily comprises Trading revenues, net and Commissions and fees from our domestic businesses, were $495.4 million for 2012 and $862.8 million in 2011. Revenues for 2012 were affected by lower market volumes and volatility as well as lower market share. Revenues were also affected by lower liquidity rebates due to lower volumes.

43


Global Execution Services 
 
For the year
 ended December 31,
 
 
 
 
 
2012
 
2011
 
Change
 
% of Change
Commissions and fees (thousands)
$
36,211

 
$
27,599

 
$
8,612

 
31.2
%
Trading revenues, net (thousands)
(1
)
 

 
(1
)
 
N/M

Interest, net and other (thousands)
1

 

 
1

 
N/M

Total Revenues from Global Execution Services (thousands)
$
36,211

 
$
27,599

 
8,612

 
31.2
%
Totals may not add due to rounding.
Total revenues from the Global Execution Services segment, which primarily comprises Commissions and fees from agency execution activity and activity on our venues were $36.2 million for 2012 and $27.6 million in 2011. The increase in revenues principally reflects the higher routing volumes and revenues for GETAlpha.
Corporate and Other 
 
For the year
 ended December 31,
 
 
 
 
 
2012
 
2011
 
Change
 
% of Change
Total Revenues from Corporate and Other (thousands)
$
19,596

 
$
25,089

 
$
(5,493
)
 
(21.9
)%
Total revenues from the Corporate and Other segment, which includes gains or losses on strategic investments were $19.6 million for 2012 and $25.1 million in 2011. Revenues for 2012 includes a $16.0 million dividend from our strategic investment in Chi-X. Revenues for 2011 includes $27.8 million in unrealized gains on our strategic investment in BATS.
Expenses
Employee compensation and benefits expense was $157.9 million for 2012 and $241.8 million in 2011. The decrease on a dollar basis was primarily due to lower discretionary compensation resulting from a decrease in overall results offset, in part, by higher salary and wages due to increased headcount.
Execution and clearance fees were $185.8 million for 2012 and $289.0 million in 2011. Execution and clearance fees fluctuate based on changes in transaction volumes, shift in business mix, regulatory fees and operational efficiencies and scale. As a percentage of total revenue, Execution and clearance fees were 33.7% for 2012 and 31.6% for the comparable period in 2011. Execution and clearance fees in 2012 were lower due to lower trading volumes.
Payments for order flow fluctuate as a percentage of revenue due to changes in volume, client and product mix, profitability, and competition. Payments for order flow were $3.0 million for 2012 and $3.3 million for 2011. The decrease in Payments for order flow was due to lower trading volumes. As a percentage of total revenue, Payments for order flow were 0.5% for 2012 and 0.4% in 2011.
Professional fees were $14.1 million for 2012 and $17.1 million in 2011. Professional fees in 2012 include legal costs related to the legal, consulting and investment banking fees related to the Mergers. Excluding the $4.3 million of professional fees related to the Mergers, Professional fees were $9.8 million for 2012. Professional fees decreased in 2012 due to lower corporate legal, tax consulting, and other consulting fees.
Interest expense was $2.7 million for 2012 and $1.3 million in 2011. Interest expense increased primarily due to interest on a new secured credit facility as well as a draw down on the $50.0 million unsecured revolver to fund the Company's August 2012 investment in Knight.
All other expenses were $161.5 million for 2012 and $169.4 million in 2011. Communications and data processing expense relates to market data, co-location and connectivity expenses. Occupancy and equipment rentals expense includes additional real estate related costs as well as new office leases. Other expenses decreased due to lower travel costs and lower costs associated with firmwide events.
Our effective tax rate of 38.9% and 15.9% for the year ended December 31, 2012 and 2011, respectively, from continuing operations differed from the federal statutory rate of 35% primarily due to GETCO being structured as a pass through entity that was not largely subject to U.S. corporate income taxes prior to the Mergers as well as state, local and non-U.S. income taxes.

44


Financial Condition, Liquidity and Capital Resources
Financial Condition
We have historically maintained a highly liquid balance sheet, with a substantial portion of our total assets consisting of cash, highly liquid marketable securities and short term receivables. As of December 31, 2013 and December 31, 2012, we had total assets of $6.99 billion and $1.69 billion, respectively, a significant portion of which consisted of cash or assets readily convertible into cash as follows (in thousands): 
 
December 31,
2013
 
December 31, 2012
Cash and cash equivalents
$
674,281

 
$
427,631

Financial instruments owned, at fair value:
 
 
 
Equities
2,298,785

 
378,933

Listed options
339,798

 
92,305

Debt securities
83,256

 
183,637

Collateralized agreements:
 
 
 
Securities borrowed
1,357,387

 
52,261

Receivables from brokers, dealers and clearing organizations (1)
952,957

 
142,969

Total cash and assets readily convertible to cash
$
5,706,464

 
$
1,277,736

* Totals may not add due to rounding.
(1) Excludes $304.3 million of assets segregated or held in separate accounts under federal or other regulations.
Substantially all of the non-cash amounts disclosed in the table above can be liquidated into cash within five business days under normal market conditions, however, the liquidated values may be subjected to haircuts during distressed market conditions as Knight saw following its August 1, 2012 trading loss.
Financial instruments owned principally consist of equities and listed options that trade on the NYSE, NYSE Amex and NYSE Arca markets, Nasdaq and on the OTC Bulletin Board as well as U.S. government and non-U.S. government obligations and corporate debt securities, which include short-term bond funds. These financial instruments are used to generate revenues in our Market Making and Global Execution Services segments.
Securities borrowed represent the value of cash or other collateral deposited with securities lenders to facilitate our trade settlement process.
Receivables from brokers, dealers and clearing organizations include interest bearing cash balances held with third party clearing brokers, including, or net of, amounts related to securities transactions that have not yet reached their contracted settlement date, which is generally within three business days of the trade date.
As of December 31, 2013, $1.23 billion of equities have been pledged as collateral to third-parties under financing arrangements. As of December 31, 2012, $50.7 million of equities were pledged as collateral to third-parties under financing arrangements.
Other assets primarily comprises collateral accounts, as well as deposits, prepaids and other miscellaneous receivables.
The growth in the balances of financial instruments owned, receivable from brokers, dealers and clearing organizations and securities borrowed are all consistent with and related to the Mergers. Our securities inventory fluctuates based on trading volumes, market conditions, trading strategies utilized and our pre-determined risk limits.
Total liabilities were $5.48 billion at December 31, 2013 and $721.7 million at December 31, 2012. Similar to the asset side, the growth in Financial instruments sold, not yet purchased, Collateralized financings and Payable to brokers, dealers and clearing organizations is related to the addition of the market making and global execution services businesses in conjunction with the Mergers. As noted throughout the document, substantially all of our debt was issued in order to complete the Mergers. The “Liquidity and Capital Resources” section of this document includes a detailed description of the debt.

45


Equity, including redeemable preferred member's equity, increased by $541.4 million, from $965.8 million at December 31, 2012 to $1.51 billion at December 31, 2013. The increase in equity, including redeemable preferred member's equity, from December 31, 2012 was primarily a result of the Mergers, which resulted in $461.0 million of equity being issued to former Knight stockholders, as well as 2013 net income.
Liquidity and Capital Resources
We have financed our business primarily through cash generated by operations, a series of debt transactions and the issuance of equity.
At December 31, 2013, we had net current assets, which consist of net assets readily convertible into cash less current liabilities, of approximately $1.37 billion.
Net income from continuing operations was $120.0 million during 2013 and $16.2 million during 2012. Included in these amounts were certain non-cash income and expenses such as gain on investment, stock and unit-based compensation, depreciation, amortization and certain non-cash writedowns. We recorded a non-cash gain of $128.0 million on the investment in Knight common stock in 2013. Stock and unit-based compensation was $64.3 million and $12.3 million during 2013 and 2012, respectively. Depreciation and amortization expense was $55.6 million and $34.9 million during 2013 and 2012, respectively. We had non-cash charges of $14.7 million for the writedown of excess real estate and fixed assets at these locations during 2013 and $13.2 million for the writedown of capitalized debt costs in conjunction with our $300.0 million in debt repayment. There were no non-cash writedowns during 2012. Net income from continuing operations during 2013 also included a $103.5 million non-cash deferred income tax benefit due to the Company becoming subject to U.S. corporate income taxes as a result of the Mergers.
Capital expenditures related to our continuing operations were $27.7 million and $31.4 million during 2013 and 2012, respectively. Purchases of investments were $0.2 million and $87.3 million during 2013 and 2012, respectively. Purchases of investments in 2012 was primarily related to the acquisition of Knight preferred shares in the third quarter of 2012. Proceeds and distributions received from investments were $3.3 million and $72.2 million during 2013 and 2012, respectively. Payments to former Knight stockholders during 2013 were $720.0 million in conjunction with the Mergers.
Cash Convertible Senior Subordinated Notes
In March 2010, Knight issued $375.0 million of Cash Convertible Senior Subordinated Notes (the “Convertible Notes”) due on March 15, 2015 in a private offering exempt from registration under the Securities Act of 1933, as amended.
The Convertible Notes bear interest at a rate of 3.50% per year, payable semi-annually in arrears, on March 15 and September 15 of each year, commencing on September 15, 2010 and will mature on March 15, 2015, subject to earlier repurchase or conversion. The Convertible Notes are reported as Debt in the Company’s Consolidated Statements of Financial Condition.
On July 1, 2013, $375.0 million, which was the amount needed to repurchase the aggregate amount of Knight's Convertible Notes in full at maturity, was deposited in a cash collateral account under the sole dominion and control of the collateral agent under the First Lien Credit Facility (the "Collateral Account").
Following the Mergers, a total of $257.7 million in principal amount of the Convertible Notes were repurchased using funds deposited in the Collateral Account. The repurchase included accrued and unpaid interest of $3.6 million. $117.3 million in principal of the Convertible Notes were outstanding at December 31, 2013. In October 2013, the funds remaining in the Collateral Account were used to repay a portion of the First Lien Credit Facility. As of December 31, 2013, there were no funds remaining in the Collateral Account.
Senior Secured Notes Indenture
On June 5, 2013 GETCO Financing Escrow LLC (“Finance LLC”), a wholly-owned subsidiary of GETCO, issued 8.250% senior secured notes due in 2018 in the aggregate principal amount of $305.0 million (the “Senior Secured Notes”) pursuant to an indenture, dated June 5, 2013 (as amended, the "Senior Secured Notes Indenture"). On July 1, 2013, KCG entered into a first supplemental indenture (the “First Supplemental Indenture”) pursuant to which KCG assumed all of the obligations of Finance LLC which comprised the Senior Secured Notes plus certain escrow agent fees and expenses of $3.0 million.

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On July 1, 2013, KCG and certain subsidiary guarantors (the "Guarantors") under the First Lien Credit Facility, as defined below, entered into a Second Supplemental Indenture, whereby the Senior Secured Notes and the obligations under the related Senior Secured Notes Indenture will be fully and unconditionally guaranteed on a joint and several basis by the Guarantors and are secured by second-priority pledges and second-priority security interests in, and mortgages on, the collateral securing the First Lien Credit Facility, subject to certain exceptions.
The Senior Secured Notes mature on June 15, 2018 and bear interest at a rate of 8.250% per year, payable on June 15 and December 15 of each year, beginning on December 15, 2013.
The Senior Secured Notes Indenture contains customary affirmative and negative covenants, including limitations on indebtedness, liens, hedging agreements, investments, loans and advances, asset sales, mergers and acquisitions, dividends, transactions with affiliates, prepayments of other indebtedness, restrictions on subsidiaries and issuance of capital stock. As of December 31, 2013, we were in compliance with the covenants.
On July 1, 2013, KCG and the Guarantors entered into a joinder to the registration rights agreement dated June 5, 2013, (the "Senior Secured Notes Registration Rights Agreement") between Finance LLC and Jefferies LLC as representative of the initial purchasers of the Senior Secured Notes. Pursuant to the registration rights agreement, KCG shall use commercially reasonable efforts to (i) file an exchange offer registration statement with the SEC with respect to a registered offer to exchange the Senior Secured Notes, (ii) issue exchange securities within 365 days after June 5, 2013, and, (iii) in certain circumstances, file a shelf registration statement with respect to resales of the Senior Secured Notes. If KCG and the Guarantors fail to comply with certain obligations under the Senior Secured Notes Registration Rights Agreement, additional interest of up to 1.00% per annum will accrue on the Senior Secured Notes.
In October 2013, the Company received consents ("Consent") from 99.7% of its registered holders ("Holders") of the Senior Secured Notes to amend, among other things, the terms of the Senior Secured Notes among the Company, The Bank of New York Mellon, as trustee and collateral agent (the “Trustee”), and the guarantors. As a result, the Company entered into a Third Supplemental Indenture with the Trustee to amend the Senior Secured Notes Indenture to permit the purchase, redemption or repayment of the Convertible Notes at any price, including at a premium or at a discount from the face value thereof, with any available cash.
First Lien Credit Facility
On July 1, 2013, KCG, as borrower, entered into a first lien senior secured credit agreement (the “Credit Agreement”) with Jefferies Finance LLC and Goldman Sachs Bank USA. The Credit Agreement was in the amount of $535.0 million (the “First Lien Credit Facility”), all of which was drawn on July 1, 2013
The First Lien Credit Facility also provides for a future uncommitted incremental first lien senior secured revolving credit facility of up to $50.0 million, including letter of credit and swingline sub-facilities, on certain terms and conditions contained in the Credit Agreement. For the six months ended December 31, 2013, there were no borrowings made against the $50.0 million first lien senior secured revolving credit facility.
The First Lien Credit Facility bears interest, at KCG's option, at a rate based on the prime rate (“First Lien Prime Rate Loans”) or based on LIBOR (“First Lien Eurodollar Loans”). First Lien Prime Rate Loans bear interest at a rate per annum equal to the greatest of prime rate, 2.25%, the federal funds rate plus 0.50%, and an adjusted one-month LIBOR rate plus 1.00%, in each case plus an applicable margin of 3.50%. First Lien Eurodollar Loans bear interest at a rate per annum equal to the adjusted LIBOR rate (subject to a 1.25% LIBOR floor) corresponding to the interest period plus an applicable margin of 4.50% per annum. As of December 31, 2013, the interest rate was 5.75% per annum.
The First Lien Credit Facility matures on December 5, 2017. The First Lien Credit Facility requires an amortization payment of $235.0 million on July 1, 2014, followed by quarterly amortization payments of $7.5 million on each September 30, December 31, March 31 and June 30, with the balance due on maturity.
Optional prepayments of borrowings under the First Lien Credit Facility are permitted at any time, without premium or penalty, subject, however, to a 1% prepayment premium for optional prepayments of the First Lien Credit Facility made prior to July 1, 2014 with a new or replacement term loan facility with an “effective” interest rate less than that applicable to the First Lien Credit Facility.
The First Lien Credit Facility is fully and unconditionally guaranteed on a joint and several basis by all of KCG's existing and future direct and indirect 100% owned domestic subsidiaries, other than certain subsidiaries including

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regulated broker dealers and other regulated subsidiaries that, in each case, are not permitted to provide such guarantees under applicable law.
The First Lien Credit Facility contains customary affirmative and negative covenants, including limitations on indebtedness, liens, hedging agreements, investments, loans and advances, asset sales, mergers and acquisitions, dividends, transactions with affiliates, prepayments of other indebtedness, restrictions on subsidiaries, capital expenditures and issuance of capital stock. It also contains financial maintenance covenants establishing a maximum consolidated first lien leverage ratio, a minimum consolidated interest coverage ratio and a minimum consolidated tangible net worth.
In connection with the Consent and the Third Supplemental Indenture, the Company entered into an amendment to its Credit Agreement (the “Credit Agreement Amendment”) with the consent of the requisite percentage of lenders under its First Lien Credit Facility. The Credit Agreement Amendment permits the Company to prepay a portion of the principal amount of borrowings under the First Lien Credit Facility from time to time for a period of 60 days following the effective date of the Credit Agreement Amendment out of the cash set aside in the Collateral Account, after which period the remaining cash in the Collateral Account will be required to be used to prepay a portion of the principal amount of borrowings under the First Lien Credit Facility. As permitted by the Credit Agreement Amendment, the Company applied 100% of the $117.3 million cash set aside in the Collateral Account to prepay a portion of the principal amount of borrowings under the First Lien Credit Facility on October 23, 2013. The Credit Agreement Amendment also permits the purchase, redemption or repayment of the Convertible Notes at any price, including at a premium or at a discount from the face value thereof, with any available cash. See “Principal repayment under Credit Agreement” for a discussion of the repayment.
The Company incurred issuance costs of $37.4 million in connection with the issuance of Senior Secured Notes, Credit Agreement and Consent. The issuance costs were capitalized and recorded within Other assets on the Consolidated Statements of Financial Condition and are being amortized over the respective terms of the Senior Secured Notes and the Credit Agreement. Including issuance costs, the Senior Secured Notes and Credit Agreements have effective yields of 9.0% and 8.3%, respectively, as of December 31. 2013. During the fourth quarter of 2013, the Company made $300.0 million principal repayments under the Credit Agreement resulting in $235.0 million principal outstanding under the First Lien Credit Facility at December 31, 2013. The payments resulted in a writedown of debt issuance costs of $13.2 million in 2013. The Company made an additional $100.0 million principal repayment in January 2014, which resulted in a further writedown of debt issuance costs at such time. See "Subsequent Events" below for further discussion.
Revolving Credit Agreement
On July 1, 2013, OCTEG, LLC (“OCTEG”) and KCA, each of which are wholly-owned broker dealer subsidiaries of KCG effective July 1, 2013, as borrowers, and KCG, as guarantor, entered into a credit agreement (the “OCTEG-KCA Facility Agreement”) with a consortium of banks and financial institutions. The OCTEG-KCA Facility Agreement replaces an existing credit agreement, dated as of June 6, 2012, among OCTEG and three banks.
The OCTEG-KCA Facility Agreement comprises two classes of revolving loans in a total committed amount of $450.0 million, together with a swingline facility with a $50.0 million sub-limit, subject to two borrowing bases (collectively, the “OCTEG-KCA Revolving Facility”): Borrowing Base A and Borrowing Base B. The OCTEG-KCA Revolving Facility also provides for a future increase of the revolving credit facility of up to $300.0 million to a total of $750.0 million on certain terms and conditions.
Borrowings under the OCTEG-KCA Facility shall bear interest, at the applicable borrower's option, at a rate based on the federal funds rate (“Base Rate Loans”) or based on LIBOR (“Eurodollar Loans”), in each case plus an applicable margin. For each Base Rate Loan, the interest rate per annum is equal to the greater of the federal funds rate or an adjusted one-month LIBOR rate plus (a) for each Borrowing Base A loan, a margin of 1.75% per annum and (b) for each Borrowing Base B loan, a margin of 2.25% per annum. For each Eurodollar Loan, the interest rate per annum is equal to an adjusted LIBOR rate corresponding to the interest period plus (a) for each Borrowing Base A loan, a margin of 1.75% per annum and (b) for each Borrowing Base B loan, a margin of 2.25% per annum. As of December 31, 2013, there were no outstanding borrowings under the OCTEG-KCA Facility Agreement.
The proceeds of the Borrowing Base A loans are available to both OCTEG and KCA and may be used solely to finance the purchase and settlement of securities. The proceeds of Borrowing Base B loans are available solely to KCA and may be used solely to fund clearing deposits with the National Securities Clearing Corporation.

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The borrowers will be charged a commitment fee at a rate of 0.35% per annum on the average daily amount of the unused portion of the OCTEG-KCA Facility Agreement.
The loans under the OCTEG-KCA Facility Agreement will mature on June 6, 2015. The OCTEG-KCA Revolving Facility is fully and unconditionally guaranteed on an unsecured basis by KCG and, to the extent elected by OCTEG or KCA, any of their respective subsidiaries. It is secured by first-priority pledges of and liens on certain eligible securities, subject to applicable concentration limits, in the case of Borrowing Base A loans, and by first-priority pledges of and liens on the right to the return of certain eligible NSCC margin deposits, in the case of Borrowing Base B loans.
The OCTEG-KCA Revolving Facility includes customary affirmative and negative covenants, including limitations on indebtedness, liens, hedging agreements, investments, loans and advances, asset sales, mergers and acquisitions, dividends, transactions with affiliates, restrictions on subsidiaries, issuance of capital stock, negative pledges and business activities. It contains financial maintenance covenants establishing a minimum total regulatory capital for each of OCTEG and KCA, a maximum total asset to total regulatory capital ratio for each of OCTEG and KCA, a minimum excess net capital limit for each of OCTEG and KCA, a minimum liquidity ratio for KCA, and a minimum tangible net worth threshold for KCG. As of December 31, 2013, we were in compliance with the covenants.
In connection with the OCTEG-KCA Revolving Facility, The Company incurred issuance costs of $1.2 million which has been capitalized and recorded within Other assets on the Consolidated Statements of Financial Condition and is being amortized over the term of the OCTEG-KCA Revolving Facility.
OCTEG and KCA shall each be obligated only with respect to the principal and interest of their own borrowings, and not the interest and principal of the other borrower's borrowings.
See Footnote 12 “Debt” included in Part II, Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.
The OCTEG-KCA Revolving Facility was amended on October 24, 2013 to permit OCTEG to be removed as a borrower under the OCTEG-KCA Revolving Facility. As of January 1, 2014, OCTEG was merged into KCA as a result of consolidating our domestic broker dealers. KCA was renamed KCG Americas LLC.
Stock issuance
On July 1, 2013, prior to the closing of the Mergers, GETCO issued $55.0 million of units to an affiliate of General Atlantic, which were converted to shares of KCG Class A Common Stock and warrants upon the closing of the Mergers.
Stock repurchase
We do not have an authorized stock repurchase program as of December 31, 2013. Certain treasury stock repurchases represent shares of KCG Class A Common Stock repurchased in satisfaction of tax withholding obligations upon vesting of employee restricted equity awards. We had 122.2 million shares of KCG Class A Common Stock outstanding as of December 31, 2013, including RSUs.
Regulatory requirements
Our U.S. registered broker dealers are subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker dealers and FCMs and require the maintenance of minimum levels of net capital, as defined in SEC Rule 15c3-1 as well as other capital requirements from several commodity organizations including the Commodities Futures Trading Commission (“CFTC”) and the National Futures Association (“NFA”). These regulations also prohibit a broker dealer from repaying subordinated borrowings, paying cash dividends, making loans to its parent, affiliates or employees, or otherwise entering into transactions which would result in a reduction of its total net capital to less than 120% of its required minimum capital. Moreover, broker dealers are required to notify the SEC, CFTC and other regulators prior to repaying subordinated borrowings, paying dividends and making loans to its parent, affiliates or employees, or otherwise entering into transactions, which, if executed, would result in a reduction of 30% or more of its excess net capital (net capital less minimum requirement). The SEC and the CFTC have the ability to prohibit or restrict such transactions if the result is detrimental to the financial integrity of the broker dealer. As of December 31, 2013, our broker dealers were in compliance with the applicable regulatory net capital rules.
The following table sets forth the net capital level and requirements for our regulated U.S. broker dealer subsidiaries at December 31, 2013, as reported in its respective regulatory filing (in thousands):

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Entity
 
Net Capital
 
Net Capital
Requirement
 
Excess Net
Capital
KCA
 
$
396,655

 
$
22,300

 
$
374,355

OCTEG
 
98,737

 
1,000

 
97,737

GETCO Execution Services, LLC
 
11,433

 
250

 
11,183

As of January 1, 2014, OCTEG was merged into KCA as a result of consolidating our domestic broker dealers and KCA was subsequently renamed KCG Americas LLC.
Our U.K. registered broker dealers are subject to certain financial resource requirements of the FCA while our Singapore and Australian broker dealers are subject to certain financial resource requirements of the Securities and Futures Commission (“SFC”) and the Australian Securities and Investment Commission, respectively. The following table sets forth the financial resource requirement for the following significant foreign regulated broker dealers at December 31, 2013 (in thousands):
Entity
 
Financial
Resources
 
Resource
Requirement
 
Excess
Financial
Resources
GETCO Europe Limited
 
$
157,254

 
$
80,900

 
$
76,354

KCG Europe Limited
 
97,892

 
65,967

 
31,927

Contractual Obligations
In connection with our operating activities, we enter into certain contractual obligations. Our future cash payments associated with our contractual obligations pursuant to operating leases, net of sublease obligations as of December 31, 2013 are summarized below (in thousands):
 
Payments due in:
 
2014
 
2015-
2016
 
2017-
2018
 
2019-
2027
 
Total
Senior Secured Notes (1)
$

 
$

 
$
305,000

 
$

 
$
305,000

Credit Agreement (1)
11,750

 
47,000

 
176,250

 

 
235,000

Convertible Notes (1)

 
117,259

 

 

 
117,259

Operating lease obligations (2)
25,374

 
45,721

 
46,381

 
63,031

 
180,507

Capital lease (2)
8,222

 
2,072

 

 

 
10,294

Total
$
45,346

 
$
212,052

 
$
527,631

 
$
63,031

 
$
848,060

________________________________________
1 -
See Footnote 12, “Debt” to the Consolidated Financial Statements
2 -
See Footnote 21, “Commitments and Contingent Liabilities” to the Consolidated Financial Statements
Totals may not add due to rounding.
KCG also has provided, and may in the future provide, in the ordinary course of business, unsecured guarantees to guarantee the payment obligations of certain of its subsidiaries under trading, repurchase, financing and stock loan arrangements, as well as under certain leases.
Off-Balance Sheet Arrangements
As of December 31, 2013, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Effects of Inflation
The majority of our assets are liquid in nature and therefore are not significantly affected by inflation. However, the rate of inflation may affect our expenses, such as employee compensation, office leasing costs and communications expenses, which may not be readily recoverable in the prices of the services offered by us. To the extent inflation results in rising interest rates and has other adverse effects on the securities markets, it may adversely affect our financial position and results of operations.

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Discontinued Operations
In July 2013, we entered into an agreement to sell to an investor group our reverse mortgage origination securitization business, Urban, that was previously owned by Knight. The transaction completed in the fourth quarter of 2013. The results of operations have been included in Income from discontinued operations, net of tax within the Consolidated Statements of Operations for the year ended December 31, 2013.
Subsequent Events
Principal repayment under Credit Agreement
On January 22, 2014, the Company made a $100.0 million principal repayment under the Credit Agreement and will record an additional writedown of its capitalized debt issuance cost of $4.2 million in the first quarter of 2014. Including this payment, the Company has completed $400.0 million in principal repayments since entering into the Credit Agreement on July 1, 2013, fully satisfying the amortization payment of $235.0 million due on July 1, 2014 leaving a remaining outstanding balance of $135.0 million.
Merger of BATS and Direct Edge
In January 2014, BATS Global Markets Inc. and Direct Edge Holdings LLC announced plans to pay certain dividends to shareholders contingent on the completion of their pending merger. As a shareholder in both BATS and Direct Edge, KCG received approximately $41.7 million from the aggregate dividends paid at the close of the merger, which occurred on January 31, 2014.
Critical Accounting Policies
Our Consolidated Financial Statements are based on the application of GAAP which requires us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates and any such differences may be material to our Consolidated Financial Statements. We believe that the estimates set forth below may involve a higher degree of judgment and complexity in their application than our other accounting estimates and represent the critical accounting estimates used in the preparation of our consolidated financial statements. We believe our judgments related to these accounting estimates are appropriate. However, if different assumptions or conditions were to prevail, the results could be materially different from the amounts recorded.
Financial Instruments and Fair Value—We value our financial instruments using a hierarchy of fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.
The fair value hierarchy can be summarized as follows:
 
Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that we have the ability to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
Level 2—Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
Changes in fair value are recognized in earnings each period for financial instruments that are carried at fair value.
Our financial instruments owned and financial instruments sold, not yet purchased will generally be classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices or broker or dealer quotations with reasonable levels of price transparency.
The types of instruments that trade in markets that are not considered to be active, but are valued based on observable inputs such as quoted market prices or alternative pricing sources with reasonable levels of price transparency are generally classified within Level 2 of the fair value hierarchy.
Our foreign currency forward contracts, investment in the Deephaven Funds and deferred compensation investments are also classified within Level 2.

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We have no financial instruments classified within Level 3 of the fair value hierarchy.
There were no transfers of financial instruments between levels of the fair value hierarchy for any periods presented.
Goodwill and Intangible Assets—As a result of our various acquisitions, we have acquired goodwill and identifiable intangible assets. We determine the values and useful lives of intangible assets upon acquisition. Goodwill is the cost of acquired companies in excess of the fair value of net assets, including identifiable intangible assets, at the acquisition date. We test goodwill and intangible assets with an indefinite useful life for impairment at least annually or when an event occurs or circumstances change that signifies the existence of impairment.
Goodwill
Goodwill of $16.3 million at December 31, 2013 primarily a result of the Mergers and primarily relates to our Market Making segment. We test the goodwill in each of our reporting units for impairment at least annually by comparing the estimated fair value of each reporting unit with its estimated net book value. We will derive the fair value of each of our reporting units based on valuation techniques we believe market participants would use for each segment (observable market multiples and discounted cash flow analyses) and we will derive the net book value of our reporting units by estimating the amount of stockholders’ equity required to support the activities of each reporting unit. As part of our test for impairment, we will also consider the profitability of the applicable reporting unit as well as our overall market value, compared to our book value. No events occurred during the year ended December 31, 2013 that would indicate that our goodwill may not be recoverable.
Intangible Assets
Intangible assets, less accumulated amortization, of $191.5 million at December 31, 2013 are primarily a result of the Mergers and are primarily attributable to our Market Making and Global Execution Services segments. We amortize intangible assets with definite lives on a straight-line basis over their useful lives, the majority of which have been determined to range from three to 12 years. We will test amortizable intangibles for recoverability whenever events indicate that the carrying amounts may not be recoverable. No events occurred during the year ended December 31, 2013 that would indicate that the carrying amounts of our intangible assets may not be recoverable.
Investments—Investments primarily comprise strategic investments and deferred compensation investments. Strategic investments include noncontrolling equity ownership interests and debt instruments held by us within our non-broker dealer subsidiaries, primarily in financial services-related businesses. Strategic investments are accounted for under the equity method, at cost or at fair value. We use the equity method of accounting when we have significant influence, generally considered to be between 20% and 50% equity ownership or greater than 3% to 5% of a partnership interest. We hold strategic investments at cost, less impairment if any, when we are not considered to exert significant influence on operating and financial policies of the investee. We account for our deferred compensation investments, which primarily consist of mutual funds, at fair value.
We review investments on an ongoing basis to ensure that the carrying values of the investments have not been impaired. If we assess that an impairment loss on a strategic investment has occurred due to a decline in fair value or other market conditions, we write the investment down to its estimated impaired value.
We maintain a deferred compensation plan related to certain employees and directors. This plan provides a return to the participants based upon the performance of various investments. In order to hedge our liability under this plan, we generally acquire the underlying investments and hold such investments until the deferred compensation liabilities are satisfied. We record changes in value of such investments in Investment income and other, net, with a corresponding charge or credit to Employee compensation and benefits on the Consolidated Statements of Operations.
Market Making, Sales, Trading and Execution Activities—Financial instruments owned and Financial instruments sold, not yet purchased, which relate to market making and trading activities, include listed and other equity securities, listed equity options and fixed income securities which are recorded on a trade date basis and carried at fair value. Trading revenue, net (trading gains, net of trading losses) and commissions (which includes commission equivalents earned on institutional client orders and futures transactions) and related expenses are also recorded on a trade date basis. Our third party clearing agreements call for payment or receipt of interest income, net of transaction-related interest charged by clearing brokers for facilitating the settlement and financing of securities transactions.

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Dividend income relating to securities owned and dividend expense relating to securities sold, not yet purchased, derived from our market making activities are included as a component of Trading revenues, net on our Consolidated Statements of Operations.
Lease Loss Accrual—It is our policy to identify excess real estate capacity and where applicable, accrue for related future costs, net of estimated sublease income. In the event we are able to sublease the excess real estate after recording a lease loss, such accrual is adjusted to the extent the actual terms of sub-leased property differ from the assumptions used in the calculation of the accrual. In the event that we conclude that previously determined excess real estate is needed for our use, such lease loss accrual is adjusted accordingly. Any such adjustments to previous lease loss accruals are recorded in Writedown of assets and lease loss accrual on the Consolidated Statements of Operations
Income taxes—Prior to the Mergers, GETCO and the majority of its subsidiaries were treated as partnerships or disregarded entities for U.S. income tax purposes and, accordingly, were not subject to federal income taxes. Instead, the former GETCO members were liable for federal income taxes on their proportionate share of taxable income. Upon completion of the Mergers, the Company became a corporation subject to U.S. corporate income taxes and, following the Mergers, the Company records deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and measures them using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. The Company evaluates the recoverability of future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of temporary differences and forecasted operating earnings.
Other Estimates—The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions. In addition to the estimates that we make in connection with accounting for the items noted above, the use of estimates is also important in determining provisions for potential losses that may arise from discontinued operations, litigation, regulatory proceedings and tax audits.
When determining stock-based employee compensation expense, we make certain estimates and assumptions relating to volatility and forfeiture rates. We estimate volatility based on several factors including implied volatility of market-traded options on our common stock on the grant date and the historical volatility of our common stock. We estimate forfeiture rates based on historical rates of forfeiture of employee stock awards.
We accrue for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be estimated. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total liability accrued with respect to litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses based on, among other factors, the progress of each case, our experience and industry experience with similar cases and the opinions and views of internal and external legal counsel. Given the inherent difficulty of predicting the outcome of our litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, or where cases or proceedings are in the early stages, we cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred. For more information on our legal and regulatory matters, see “Legal Proceedings” in Part I, Item 3 of this Annual Report on this Form 10-K and other reports or documents the Company files with, or furnishes, to the SEC from time to time.
Accounting Standards Updates
Recently adopted accounting guidance
In December 2011, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standard Update (“ASU”) that requires additional disclosures about financial assets and liabilities that are subject to netting arrangements. Under the ASU, financial assets and liabilities must be disclosed at their respective gross asset and liability amounts, the amounts offset on the balance sheet and a description of the respective netting agreements. The new disclosures were required for reporting periods beginning on or after January 1, 2013, and are to be applied retrospectively. Other than requiring additional disclosures, the adoption of this ASU did not have an impact on our Consolidated Financial Statements.
In February 2013, the FASB issued an ASU that requires additional disclosure requirements for items reclassified out of accumulated other comprehensive income. This new guidance requires entities to present either on the face of the income statement or in the notes to the financial statements the effects on the specific line items of the income statement for amounts reclassified out of accumulated other comprehensive income. This ASU was effective for

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reporting periods beginning after December 15, 2012. Other than additional disclosure requirements, the adoption of this ASU did not have an impact on our Consolidated Financial Statements.
Recent accounting guidance to be adopted in future periods
In March 2013, the FASB issued an ASU concerning the parent's accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. This ASU provides for the release of the cumulative translation adjustment into net income when a parent sells a part or all of its investment within a foreign entity, no longer holds a controlling interest in an investment in a foreign entity or obtains control of an investment in a foreign entity that was previously recognized as an equity method investment. This ASU is effective for reporting periods beginning after December 15, 2013, however early adoption is permitted. The adoption of this ASU will not have an impact on the Company's Consolidated Financial Statements.
In July 2013, the FASB issued an ASU to clarify the financial statement presentation of an unrecognized tax benefit when a net operating loss (“NOL”) carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU requires entities to present an unrecognized tax benefit as a reduction of a deferred tax asset for a NOL carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. The ASU is required for reporting periods beginning after December 15, 2013. Upon adoption, entities are required to apply the provisions of the ASU prospectively for all unrecognized tax benefits that exist at the adoption date, however, the ASU also indicates that retrospective application is permitted. We are currently evaluating the impact that such adoption will have on its Consolidated Financial Statements.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to numerous risks in the ordinary course of our business and activities; therefore, effective risk management is critical to our financial soundness and profitability. We have a comprehensive risk management structure and processes to monitor and evaluate the principal risks we assume in conducting our business. Our risk management policies, procedures and methodologies are subject to ongoing review and modification. The principal risks we face are as follows:
Market Risk
Our market making and trading activities expose our capital to significant risks. These risks include, but are not limited to, absolute and relative price movements, price volatility, interest rates, credit spreads and changes in liquidity. Price risks result from exposure to changes in prices of individual financial instruments, baskets and indices. Further risks may result from changes in the factors determining options prices. Interest rate risks result primarily from exposure and changes in the yield curve, the volatility of interest rates and credit spreads.
For working capital purposes, we invest in money market funds and government securities or maintain interest bearing balances at banks and in our trading accounts with clearing brokers, which are classified as Cash and cash equivalents and Receivable from brokers, dealers and clearing organizations, respectively, on the Consolidated Statements of Financial Condition. These financial instruments do not have maturity dates; the balances are short term, which helps to mitigate our market risks. Our cash and cash equivalents held in foreign currencies are subject to the exposure of foreign currency fluctuations. These balances are monitored daily and are hedged or reduced when appropriate and therefore not material to our overall cash position.
We employ proprietary position management and trading systems that provide real-time, on-line position management and inventory control. We monitor our risks by reviewing trading positions and their appropriate risk measures. We have established a system whereby transactions are monitored by senior management and an independent risk control function on a real-time basis as are individual and aggregate dollar and inventory position totals, capital allocations, and real-time profits and losses. Our management of trading positions is enhanced by our review of mark-to-market valuations and position summaries on a daily basis.
In the normal course of business, we maintain inventories of exchange-listed and other equity securities, and to a lesser extent, listed equity options and fixed income securities. The fair value of these financial instruments at December 31, 2013 and 2012 was $2.72 billion and $654.9 million, respectively, in long positions and $2.17 billion and $512.6 million, respectively, in short positions. We also enter into futures contracts, which are recorded on our

54


Statements of Financial Condition within Receivables from brokers, dealers and clearing organizations or Payables to brokers, dealers and clearing organizations as applicable.

We calculate every day the potential losses that might arise from a series of different stress events. These include both single factor and multi factor shocks to asset prices based off both historical events and hypothetical scenarios. The stress calculations include a full recalculation of any option positions, non-linear positions and leverage. Senior management and the independent risk function carefully monitor the highest stress scenarios to ensure that the Company is not unduly exposed to any extreme events.
The potential change in fair value is estimated to be a loss of $10.2 million using a hypothetical 10% increase in equity prices as of December 31, 2013, and an estimated loss of $14.2 million using a hypothetical 10% decrease in equity prices at December 31, 2012. These estimates take into account the offsetting effect of such hypothetical price movements on the fair value of short positions against long positions, and the effect on the fair value of options, futures, nonlinear positions and leverage. The Company has employed a third party tool to assist in the calculation of the Company’s stress risk under the various scenarios that we model.
The following table illustrates, for the period indicated, our average, highest and lowest month-end inventory at fair value (based on both the aggregate and the net of the long and short positions of financial instruments (in thousands):
 
2013
 
2012
 
2011
 
Aggregate of
Long and Short
Positions
 
Net of Long
and Short
Positions
 
Aggregate of
Long and Short
Positions
 
Net of Long
and Short
Positions
 
Aggregate of
Long and Short
Positions
 
Net of Long
and Short
Positions
Average month-end
$
3,137,170

 
$
175,171

 
$
1,074,546

 
$
50,331

 
$
615,648

 
$
85,197

Highest month-end
5,268,422

 
561,353

 
1,417,482

 
440,775

 
1,069,005

 
557,391

Lowest month-end
1,198,112

 
(224,760
)
 
539,224

 
(405,583
)
 
241,481

 
(253,855
)
Operational Risk
Operational risk can arise from many factors ranging from routine processing errors to potentially costly incidents arising, for example, from major systems failures or human errors. For example, on August 1, 2012, at the open of trading at the NYSE, Knight experienced a technology issue related to the installation of trading software which resulted in its broker dealer subsidiary, KCA, sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market. As a result of this technology issue, Knight incurred a pre-tax loss of $461.1 million which principally relates to trading losses.
Following the events of August 1, 2012, Knight carefully reviewed the matter internally and subsequently took numerous remedial measures designed to enhance its processes and controls. Subsequent to the Mergers, KCG has continued to refine and enhance its risk governance and control infrastructure. The changes that have been implemented since August 1, 2012 include: appointing a Chief Risk Officer; establishing a formal Risk Committee of the Board; establishing a formal Operational Risk Management function and hiring a Global Head of Operational Risk Management; implementing change management controls which require at different stages an additional layer of review and supervisory approval for significant software installations; adding market access controls designed to more closely monitor outbound routers and enable the rapid automatic shut-down of the routers; deploying various kill switches for specific applications and market access; establishing an Emergency Response Center ("ERC") that provides 24-hour coverage during global trading days, creates transparency and awareness around operational risks and changes, and is organized and tasked with responding to operational incidents or natural disasters in real-time; and establishing an Emergency Management Plan that sets forth procedures to be followed when responding to an emergency event that goes beyond individual emergency solving capabilities and has become significant enough to warrant involvement beyond individual groups or the ERC to ensure sound decision making and to minimize impact to the Company. We will continue to carefully monitor, enhance and strengthen our controls as needed.
Our businesses are highly dependent on our ability and our market centers' ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in several currencies and products. We incur operational risk across all of our business activities, including revenue generating activities as well as support functions. Legal and compliance risk is included in the scope of operational risk and is discussed below under “Legal Risk.”
Primary responsibility for the management of operational risk lies with our operating segments and supporting functions, and secondary responsibility lies with the Operational Risk Management function. Our operating segments

55


maintain controls designed to manage and mitigate operational risk for existing activities. As new products and business activities are developed, we endeavor to identify operational risks and design controls to seek to mitigate the identified risks.
Disaster recovery plans are in place for critical facilities related to our primary operations and resources, and redundancies are built into the systems as deemed reasonably appropriate. We have also established policies, procedures and technologies designed to seek to protect our systems and other assets from unauthorized access. There is no assurance that such plans, policies, procedures and technologies will prevent a significant disruption to our business.
Liquidity Risk
Liquidity risk is the risk that we would be unable to meet our financial obligations as they arise in both normal and strained funding environments. To that end, we have established a comprehensive and conservative set of policies and procedures that govern the management of liquidity risk for the Company at the corporate level and at the subsidiary entity level.
We maintain a liquidity pool consisting of primarily cash and other highly liquid instruments at the holding company level to satisfy intraday and day-to-day funding needs, as well as potential cash needs in a strained funding environment.
Secured funding for the majority of the firm’s inventory is done through the firm’s regulated U.S. broker dealer subsidiary, KCA. As such, a significant portion of the firm’s liquidity risk lies within KCA. We consider cash and other highly liquid instruments held within KCA, up to $150.0 million, a part of the firm’s liquidity pool to support financial obligations in normal and strained funding environments. Together with the cash and highly liquid instruments held at the holding company level and KCA, we target having $425.0 million in the firm’s liquidity pool.
Cash and other highly liquid investments held by all other subsidiary entities are available to support financial obligations within those entities.
Our liquidity pool comprises the following (in thousands): 
 
December 31,
2013
 
December 31, 2012
Liquidity Pool Composition
 
 
 
  Holding companies
 
 
 
Cash held at banks
$
225,597

 
$
3,678

Money market and other highly liquid investments
27,420

 
110,833

  KCA
 
 
 
Cash held at banks
19,605

 

Money market and other highly liquid investments
130,395

 

Total Liquidity Pool
$
403,017

 
$
114,511

Cash and other highly liquid investments held by other subsidiary entities
$
271,264

 
$
313,120

In addition, we maintain committed and uncommitted credit facilities with a number of unaffiliated financial institutions. In connection with the uncommitted credit facilities, the lenders are at no time under any obligation to make any advances under the credit facilities, and any outstanding loans must be repaid on demand.
We regularly perform liquidity risk stress testing based on a scenario that considers both market-wide stresses and a company-specific stress over a one-month period. Given the nature of the Company’s business activity and balance sheet composition, survival over the first one to three days of a severe stress environment is most critical, after which management actions could be effectively implemented to navigate through prolonged periods of financial stress. The modeled cash inflows and outflows from the stress test serve as a quantitative input to assist us in establishing the Company’s liquidity risk appetite and amount of liquid assets to be held at the corporate level. The liquidity stress test considers cash flow risks arising from, but not limited to, a dislocation of the secured funding market, additional unexpected margin requirements, and operational events.
We maintain a contingency funding plan (“CFP”) which clearly delineates the roles, responsibilities and actions that will be utilized as the Company encounters various levels of liquidity stress with the goal of fulfilling all financial

56


obligations as they arise while maintaining business activity. We periodically update and test the operational functionality of various aspects of the CFP to ensure it remains current with changing business activity.
Capital Risk
Government regulators, both in the U.S. and globally, as well as self-regulated organizations, have supervisory responsibility over our regulated activities and require us to maintain specified minimum levels of regulatory capital in our broker dealer subsidiaries. If not properly monitored, our regulatory capital levels could fall below the required minimum amounts set by our regulators, which could expose us to various sanctions ranging from fines and censure to imposing partial or complete restrictions on our ability to conduct business.
To mitigate this risk, we continuously evaluate the levels of regulatory capital at each of our regulated subsidiaries and adjust the amounts of regulatory capital as necessary to ensure compliance with regulatory capital requirements. We also maintain excess regulatory capital to accommodate periods of unusual or unforeseen market volatility. In addition, we monitor regulatory developments regarding capital requirements and prepare for changes in the required minimum levels of regulatory capital that may occur in the future.
Legal Risk
Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements and standards. Legal risk also includes contractual and commercial risk such as the risk that counterparty’s performance obligations will be unenforceable. We are generally subject to extensive regulation in the different jurisdictions in which we conduct our business. We have established procedures based on legal and regulatory requirements that are designed to foster compliance with applicable statutory and regulatory requirements. We have also established procedures that are designed to require that our policies relating to conduct, ethics and business practices are followed.
As a result of its technology issue on August 1, 2012, Knight is subject to litigations by former Knight stockholders. We are also subject to several lawsuits challenging the Mergers. See “Legal Proceedings” in Part I, Item 3 herein.
Credit Risk
Credit risk represents the loss that we would incur if a counterparty fails to perform its contractual obligations in a timely manner. We manage credit risk with a global, independent credit risk management function that is responsible for measuring, monitoring and controlling the counterparty credit risks inherent in our business activities. 
Our credit risk function’s process for managing credit risk includes a qualitative and quantitative risk assessment of significant counterparties prior to engaging in business activity, as well as, on an ongoing basis. The review includes formal financial analysis and due diligence when appropriate.
Our credit risk function is responsible for approving counterparties and establishing credit limits to manage credit risk exposure by counterparty and business line. The assigned limits reflect the various elements of assessed credit risk and are subsequently revised to correspond with changes in the counterparties’ credit profiles. Our credit risk function communicates counterparty limits to the business areas as well as senior management, and monitors compliance with the established limits.
Where appropriate, counterparty exposure is monitored on a daily basis and the collateral, if required, is marked to market daily to accurately reflect the current exposure.
Foreign Currency Risk
Our exposure to foreign currency transaction gains and losses is the result of our foreign subsidiaries having a functional currency other than the U.S. dollar and transacting business in currencies other than the U.S. dollar, primarily the British pound and the Euro. A portion of these risks are hedged, but fluctuations in currency exchange rates could impact our results of operations, financial position and cash flows.

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Consolidated Quarterly Results
The following table sets forth certain unaudited consolidated quarterly statement of operations data for 2013 and 2012. In the opinion of management, this unaudited information has been prepared on substantially the same basis as the Consolidated Financial Statements appearing elsewhere in this document and includes all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the unaudited consolidated quarterly data. The unaudited consolidated quarterly data should be read in conjunction with the audited Consolidated Financial Statements and notes thereto appearing elsewhere in this document. The results of any quarter are not necessarily indicative of results for any future period.
 
Quarter Ended*
 
Dec. 31,
2013
 
Sept. 30,
2013
 
Jun. 30,
2013
 
Mar. 31,
2013
 
Dec. 31,
2012
 
Sept. 30,
2012
 
Jun. 30,
2012
 
Mar. 31,
2012
 
(in thousands, except per share amounts)
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading revenues, net
$
212,809

 
$
230,471

 
$
98,260

 
$
86,765

 
$
87,326

 
$
92,556

 
$
115,704

 
$
125,476

Commissions and fees
111,083

 
109,079

 
29,813

 
25,499

 
26,031

 
25,542

 
26,059

 
27,886

Interest, net
433

 
(177
)
 
(672
)
 
(121
)
 
(359
)
 
(781
)
 
(892
)
 
(324
)
Investment (loss) income and other, net
(2,277
)
 
128,446

 
(9,642
)
 
402

 
12,995

 
13,285

 
211

 
519

Total revenues
322,048

 
467,819

 
117,759

 
112,545

 
125,993

 
130,602

 
141,082

 
153,557

Expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Employee compensation and benefits
112,209

 
129,631

 
75,143

 
32,209

 
46,460