For years they have operated in the shadows, often far from Wall Street, trading stocks at warp speed and reaping billions while criticism rose that they were damaging markets and hurting ordinary investors.
Now high-frequency trading firms, normally secretive, are stepping into the light to buff their image with regulators, the public and other investors.
After quietly growing to account for about 60 percent of the seven billion shares that change hands daily on United States stock markets, the firms are trying to stave off the regulators who are proposing to curb their activities.
To make their case, the firms have formed their first industry trade group, hired former Securities and Exchange Commission staff members and spent nearly $2 million in the last few years on Washington lobbying and contributions to lawmakers. Some even want to be called “automated trading professionals” rather than high-frequency traders.
“Once the spotlight was placed on them they looked at each other, and said, ‘Us, evil? Are you kidding?’ ” said James J. Angel, a finance professor at Georgetown University. “They are reacting in the same way as any threatened industry. They are stepping out of the shadows. They are trying to get their side of the story out.”
At stake is billions in profits for the high-frequency traders and investor confidence in the financial system.
Critics say traders with access to the fastest machines win at the expense of ordinary investors by seizing on the best deals and turning fast profits before other traders. They also say the lightning-fast trading strategies may be making financial markets less stable because the speed and volume of trades distort prices.
The traders say they have brought greater competition to the markets and have substantially cut trading fees for even the smallest investors.
“Central to our view is that our role and other firms’ role in the market is very constructive and very beneficial to investors,” said Richard Gorelick, chief executive of RGM Advisors, a high-frequency trading firm based in Austin, Tex., and one of the companies assuming a higher public profile.
Many firms remain hesitant to speak on the record. But one of the conditions for membership in the new industry group, called the Principal Traders Group, is that firms identify themselves publicly on its Web site.
The group comprises 31 firms. According to data calculated in June, its biggest members spent $690,000 on lobbying last year, more than double what they spent in 2009. They gave more than $547,000 to lawmakers’ political campaigns in 2010, on top of the $456,000 they handed out in the last political cycle in 2008.
High-frequency techniques are used by Wall Street banks and hedge funds, but it is the new independent firms that account for the bulk of this new kind of activity. Most of them were founded in the last 10 to 12 years. Many are still relatively small, employing a dozen to a hundred people, though some have as many as 250.
Trading mostly with their owners’ money, they scoop up hundreds or thousands of shares in one transaction, only to offload them less than a second later before buying more. They can move millions of shares around in minutes, earning a tenth of a penny off each share.
As a group, they earned $12.9 billion in profit in the last two years, according to the Tabb Group, a specialist on the markets. Tabb expects their earnings to slow this year as Wall Street’s big brokerage firms fight back with their own faster computerized trading.
The S.E.C. started to think these firms needed tighter controls in early 2009 when analysts for the first time began to point to the sector’s billions in profit, and critics wondered whether their technological firepower gave them an unfair advantage.
The scrutiny intensified after the May 6, 2010, flash crash, one of the most abrupt market moves in recent history, when stocks plunged some 700 points in minutes before recovering.
Regulators did not blame high-frequency traders for causing the sell-off. But some firms may have exacerbated the decline by switching off their machines and withdrawing from the market. As the number of buyers dropped drastically, so too did the stock prices.
“High-frequency traders turned what was a very down day for many investors into a very profitable one for themselves,” said Mary Schapiro, the S.E.C. chairwoman, in a speech on the anniversary of the flash crash in May. “Their activity that day should cause us to thoroughly examine their current role.”
The S.E.C. has already put in place new stock circuit breakers to stop another flash crash. It has also proposed a rule forcing traders to report large trades.
The S.E.C. and the Commodity Futures Trading Commission are seeking public comments on other proposals to curb high-frequency trading. Final rules may not be introduced until 2012 or later.
Many restrictions are being considered, including limits on the number of orders firms can make each second, and a minimum time for orders to stand. Regulators also want to tighten rules on algorithms used to make trades.
Bart Chilton, commissioner of the Commodity Futures Trading Commission, calls the high frequency traders “cheetahs” who are always first to the kill in the markets and may be gaming the system.
“If markets are going to be efficient and effective and less volatile, we need to cage the cheetahs,” he said in an e-mail. “Prices for everything from milk to mortgages are set in these markets. Markets need to operate without the influence of traders merely trying to prey upon infinitesimal market movements.”
The firms say many of the new proposals are not needed. They portray their business as being in the vanguard of stock-exchange modernization that has brought a greater variety of investors and competition to markets.
For decades, the exchanges were dominated by a privileged, and slow, group of insiders who charged hefty fees. Electronic trading firms now trade on several competing exchanges and execute orders immediately to capture the best price available and drive down commissions, they say. The spread—the difference between buying and selling prices—typically used to be 25 cents or higher per share, but is now down to pennies.
“Our presence reflects the democratization of the market; it is now a level playing field,” said Cameron Smith, counsel for Quantlab, another of the high-frequency firms taking a higher profile. He added: “You don’t want to turn the clock back.”
As the firms fight back, some have hired former S.E.C. staff members to make their arguments to regulators, and have sought prominent public relations firms to put their case to the media. Mr. Smith worked for a while as senior counsel in the S.E.C.’s division of market regulation.
Getco, one of the biggest electronic trading firms, hired John McCarthy, a former associate director in the S.E.C.’s office of compliance inspections and examinations, in 2006. Then last year it hired to its legal team Elizabeth K. King, a former associate director of the commission’s division of market regulation.
Arthur Levitt, a former S.E.C. chairman, and Richard R. Lindsey, a former S.E.C. director of market regulation and chief economist, have been advisers to Getco.
Getco officials say they support “reasoned market reform” and favor changes like obliging traders to stay in markets even when prices grow volatile. The company declined to make its executives available for interviews.
Charles E. Grassley of Iowa, a senior member of the Senate finance committee, has raised concerns about former S.E.C. officials joining firms like Getco.
“It seems like the revolving door from the S.E.C. is constantly spinning,” he said in an interview. “I am worried. It raises a lot of questions about whether they are doing the work when they are at the S.E.C.”