April 30, 2010, 1:31 PM EDT

April 30 (Bloomberg) — E*Trade Financial Corp. founder William a. Porter said he expects more mergers among exchanges in coming years, and that he wouldn’t have a problem if hedge funds were “outlawed.”

the 82-year-old entrepreneur who built E*Trade into a $3.33 billion discount broker with 2.6 million brokerage accounts is receiving the Sullivan Award today in Phoenix for his contributions to the options industry as a co-founder of the New York-based International Securities Exchange. Porter said new exchanges will keep cropping up, and that’s good for investors.

“When more people are competing, that reduces the cost of trading,” Porter said in an interview. “Everyone benefits except market makers who have to trade a lot more to make up for the fact that the spreads shrink.” Market makers buy and sell continuously, usually making money on the difference between bid and offer prices.

CBOE Holdings inc., owner of the Chicago Board Options Exchange, plans to see shares in an initial public offering in June that analysts such as Equity Research Desk LLC’s Diego Perfumo say may be a prelude to a merger. Nymex Holdings inc., CBOT Holdings inc. and International Securities Exchange Holdings inc. were bought within three years of their IPOs, bringing industry takeovers to $61 billion since 2007 after government regulations spurred new markets and squeezed profits, data compiled by Bloomberg show.

four or Five

Competition has driven down commissions and also changed the businesses of exchanges by forcing them to gain volume through mergers. this trend will continue even as new rivals crop up, Porter said.

“In the long haul there will be four or five of these exchange groups,” Porter said. “After we became a live exchange” at ISE, “it was clear to me that we had to join up with someone.” Eurex, owned by Deutsche Boerse AG and SIX Swiss Exchange AG, bought ISE in 2007.

Hedge funds and computer traders provide a “great deal of liquidity that wouldn’t otherwise exist,” benefiting individuals, Porter said. “At same time, the money that hedge funds make generally comes from the little guy or other hedge funds, and I’d just as soon see the whole bunch of them outlawed.”

a hedge fund came to the rescue when the broker Porter founded struggled following the collapse of the subprime- mortgage market.

Citadel’s Rescue

E*Trade, based in New York, hasn’t posted a quarterly profit since 2007, and Kenneth Griffin’s hedge-fund operator Citadel Investment Group LLC injected $2.5 billion of cash into the company in November 2007 to prevent a collapse. E*Trade named Steven Freiberg as chief executive officer in March 2010, after initially failing to find a permanent replacement when Donald Layton retired in December and disclosing that its preferred candidate was no longer available.

Previous winners of the Sullivan Award, which recognizes contributions to the options industry, include CBOE Chief Executive Officer William Brodsky, ISE Co-Founder David Krell, Interactive Brokers Group CEO Thomas Peterffy and Jeffrey Yass, founder of market maker Susquehanna International Group LLP.

In the mid-1990s, Porter began to focus on why E*Trade could charge $9.95 per trade for stocks — “and actually make a lot of profit there,” he said — and had to charge $33 for options trades.

Options Monopoly

the reason was the “cozy monopolistic situation of the exchanges,” which discouraged exchanges from trading one another’s products, keeping investors’ costs high, Porter said. an option on International Business Machines Corp. at the time could change hands only in the trading pit on the Chicago Board Options Exchange. Now IBM options are traded on eight exchanges.

Porter decided to create an electronic market to compete with the four floor-based U.S. exchanges because Europe had begun creating venues that used computers to match orders. He arranged for Stockholm-based OM AB, now part of Nasdaq OMX Group inc., to create the trading platform for his company’s exclusive use in the U.S. Porter co-founded ISE with former NYSE employees David Krell and Gary Katz, who had started a consulting company after the big Board sold its options business to CBOE in 1997, and Marty Averbuch, an E*Trade colleague.

In 2004, ISE briefly became the largest options exchange, surpassing CBOE. In December and March ISE was the third-largest market, behind Nasdaq OMX PHLX, operated by Nasdaq OMX Group inc. in New York. ISE now faces competition from venues that have transformed themselves to battle for share in a largely electronic marketplace. In March, ISE traded 19.4 percent of options volume, its lowest level since June 2002.

Color TV

Porter is also the inventor of an infrared horizon sensor that enables satellites to know which way is “down,” as he put it. He holds 14 patents for inventions in military and commercial technology. these include the first color low-light- level broadcast television camera, the first backpack broadcast color TV camera, which he said weighed 120 pounds, and the first exhaust sensors for automotive pollution control.

Porter got into finance in the mid-1970s after Commercial Electronics inc., a firm he founded in Palo Alto, California, shut down. Porter sold the company in 1975 to New York-based Warner Communications inc. for $15,000, which he began investing. His interest money management pushed him to find a source of online stock quotes. That led in 1978 to his first business plan for Trade*Plus, the predecessor to E*Trade.

“I put the asterisk there because Trade plus is kind of blah, so to give it a little pizzazz,” Porter said. He said he trades about three times a week, either on E*Trade or Fidelity Investments, and his attention to electronics hasn’t waned.

“I buy every new gadget that comes out — I’m a gadgeteer,” he said. “But in the same breath I have to say I don’t know how to run a computer anymore. the world has passed me by.”

–With assistance from Whitney Kisling in New York. Editors: Joanna Ossinger, Nick Baker

To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net.

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net.

E*Trade Founder Sees More Mergers, New Rivals for Exchanges