The high-frequency trading industry is stepping out of the shadows in Washington.
Closely held companies with undisclosed profits and obscure names like Getco LLC, Hard Eight Futures LLC and Quantlab Financial LLC, are beginning to act more like Wall Street banks, cutting checks to politicians, forming trade groups and hiring lobbyists and ex-regulators. They’re looking to fend off tighter rules and appease lawmakers who say the firms disadvantage small investors and contribute to wild swings in stock prices.
While the companies, which use high-powered computers to execute thousands of trades in milliseconds, aren’t approaching the big banks in Washington spending, they have more than quadrupled their political giving over the last four years, a Bloomberg News analysis shows. The top recipients include Eric Cantor, set to become House majority leader, and several incoming senators who won in last week’s Republican rout.
“They are under attack as an industry and they are fighting back,” said James Angel, a professor at Georgetown University’s business school who is on the board of Direct Edge Holdings LLC, which operates stock exchanges. “There is an old saying in Washington that if you are not at the table, you are on the table.”
In just over a decade, high-frequency trading has evolved from a little-known investment strategy practiced by mathematicians to a force that accounts for the majority of U.S. stock trades. The companies, which prefer to be called automated proprietary trading firms, say they benefit all investors by keeping markets liquid and transaction fees low.
Periods of Stress
The Securities and Exchange Commission is less certain of the benefits. The agency is considering a requirement that high-frequency traders keep buying and selling shares during periods of stress, instead of just abandoning the market. The SEC is also evaluating whether it should slow down computers that submit and cancel thousands of orders in milliseconds by requiring bids to stand for a minimum amount of time.
While regulators may need to address some issues, any rules shouldn’t get in the way of innovation, said David Hirschmann, president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness.
“There are those who really want to turn the clock back to 1980,” said Hirschmann, whose trade group’s members include stock exchanges, financial firms and public companies.
The SEC and members of Congress already were examining the business when the May 6 market plunge temporarily wiped out $862 billion of share value in 20 minutes. Although an investigation by regulators didn’t put direct blame on high-frequency firms, the volatility of stock prices focused more attention in Washington on their operations.
“Those with powerful computers are able to use them to their own financial advantage,” Senator Carl Levin, a Michigan Democrat, said Sept. 28 on the Senate floor. “Those who exploit our markets to the detriment of long-term investors and the real economy will not be able to do so without a battle from the Senate.”
In addition to writing proposed rules, the SEC’s enforcement division is investigating whether computer-driven traders have manipulated prices. “You have to be concerned every time there’s a lack of transparency into a market practice, particularly one like high-frequency trading that is so prevalent,” Robert Khuzami, the SEC’s enforcement chief, said in an interview.
The scrutiny has spurred the industry to seek friends in Washington. Managers and employees of 21 of the largest computerized-trading firms, including Getco, Allston Trading LLC and Infinium Capital Management LLC gave about $490,000 for this year’s congressional elections, compared with just over $100,000 in 2006, according to federal election reports filed through Oct. 15.
In 2000, when some of the firms didn’t yet exist, contributions totaled about $10,000.
Although high-frequency trading wasn’t addressed by Congress in the Dodd-Frank regulatory overhaul, SEC Chairman Mary Schapiro in September 2009 began issuing proposals to curtail market developments that cater to the industry.
After the May 6 stock plunge, she went even further by saying the SEC will examine whether it should restrict a practice by high-frequency firms of canceling most of the orders they submit.
Last January, Representative Cantor of Virginia, the second highest-ranking Republican in the House, sent Schapiro a letter saying her agency’s ideas for regulating fragmented, electronic markets, including a proposal that would prohibit exchanges from giving high-frequency traders and other market participants a split-second peek at stock orders, “appeared ad hoc in nature.”
‘Collect the Facts’
The SEC should “collect all the facts and develop coherent and rational policy objectives before adopting any potentially far-reaching rulemaking proposals,” Cantor wrote in the Jan. 27 note.
Cantor, who helped spearhead his party’s successful campaign to win the House back from Democrats, has been among the largest recipients of contributions from the industry, with he and his political action committee taking in $23,000 since last year, records show.
On Oct. 5, 2009, for example, eight top executives from Chicago-based Getco, including the chief executive officer, general counsel and chief financial officer, gave Cantor more than $10,000, records show.
He collected $1,400 the same day from James Simons, the legendary founder of Renaissance Technologies Corp., a hedge fund that engages in high-frequency trading. Other firms whose employees have contributed money to Cantor include Tradelink LLC and Traditum Group LLC.
No one at Getco has asked Cantor to discuss regulatory policy with the SEC, spokeswoman Sophie Sohn said.
‘Share Our Experience’
Getco supports some rules for high-frequency trading under consideration by the SEC, Sohn said. She said the company already faces obligations to buy and sell stock at the best offer price, because it’s a designated market maker at the New York Stock Exchange.
“As a major participant on many of the world’s leading exchanges, we believe it is important to share our experience with regulators, lawmakers, fellow industry participants and members of the press who are seeking to improve their understanding of market structure,” she said.
Jonathan Gasthalter, a spokesman for Renaissance, declined to comment on Simons’s political contributions.
Cantor also wrote to the SEC after the agency responded to the May crash by urging stock exchanges to implement so-called circuit breakers that halt trading of any stock with a 10 percent price-swing in less than five minutes.
“I am concerned that this was done before conducting a holistic review of the causes of the disruption,” Cantor wrote in his second letter dated May 21. Cantor wasn’t available to comment, said his spokesman John Murray.
Another advocate for electronic trading has been Representative Jeb Hensarling, a Texas Republican who sits on the House Financial Services Committee.
Hensarling and Representative Spencer Bachus, the Alabama Republican in line to become chairman of the financial services panel, advised Schapiro in an Aug. 24 letter to get a better understanding of what caused the crash before “assigning blame to algorithmic or high-frequency trading firms.”
Hensarling received $4,800 last month from Suhas Daftuar and Alexander Morcos, two managing directors of Hudson River Trading LLC, a New York high-frequency trading firm. Hudson River Trading didn’t respond to a request for comment.
In an interview, Hensarling said he’s concerned the SEC is acting “precipitously” in singling out high-frequency trading. “I’m not necessarily saying they are wrong, but the accountability function of Congress is to ensure there is justification for what you’re doing,” he said.
Donations to Democrats
Other politicians who were the biggest recipients of donations from high-frequency traders include Mark Kirk, a Republican who won a U.S. Senate seat in Illinois, Senator Charles Schumer, a New York Democrat, Representative Melissa Bean, an Illinois Democrat, and Robin Carnahan, a Democrat who lost her race for a U.S. Senate seat from Missouri.
In June, about two dozen high-frequency trading firms formed a trade association to respond to legislative and regulatory proposals. Known as the Principal Traders Group, the association said it plans to reach out to the media to improve its understanding of electronic trading.
“They felt their voice was missing in the press,” said James Overdahl, a vice president at NERA Economic Consulting in Washington who advises the group. The firms want to make sure that any proposed rules are “data driven and responding to actual evidence,” he said.
The Principal Traders Group is a part of the Futures Industry Association, which advocates on behalf of financial companies in Washington. The unit doesn’t lobby, said Overdahl, a former chief economist at the SEC and Commodity Futures Trading Commission.
Still, a number of high-frequency firms, including members of the Principal Traders Group, have retained former aides to lawmakers to push their interests in Washington.
Getco in April 2008 hired the Rich Feuer Group, which represents financial titans such as Goldman Sachs Group Inc. and Credit Suisse Group AG. Getco has paid Rich Feuer at least $730,000 in the past two years to lobby Congress and the SEC on rules affecting electronic trading and U.S. market structure, according to federal disclosure records.
RGM Trading LLC, a high-frequency trader based in Austin, Texas, hired Patton Boggs LLP’s Micah Green this year and has paid his firm $180,000. Green, who was head of the Bond Market Association, also lobbies on behalf of Quantlab, a computerized-trading firm based in Houston.
RGM and Quantlab didn’t respond to requests for comment.
Former Dodd Aide
Alex Sternhell, a former aide to Senate Banking Committee Chairman Chris Dodd, has been paid $310,000 since last year to lobby for Hudson River Trading, records show.
Some of the companies have also employed former regulators. Getco hired SEC lawyer Elizabeth King in June, adding to a roster of agency alumni that includes John McCarthy, the company’s general counsel, and former SEC Chairman Arthur Levitt, who’s a consultant. Cameron Smith, Quantlab’s general counsel, worked at the SEC in the 1990s.
Levitt is a board member of Bloomberg LP, the parent company of Bloomberg News.
The high-frequency trading firms’ Washington education is following a well-worn path, traveled by such companies as Microsoft Corp. and Google Inc. that avoided the political process until they grew too big to escape notice.
“Like so many other cutting edge technologies that have run into the media and regulatory whipsaw, high-frequency trading firms would be smart to engage in the Washington public policy discussion,” said Israel Klein, a lobbyist at the Podesta Group who represents financial companies.