UPDATE 1-SEC eyes efficiency, small stocks in trading probe

* Regulator plans paper on high-frequency trading in 2010

* Considering market efficiency, small- and mid-cap stocks

* Official says long-term investors the focus

NEW YORK, Nov 4 (Reuters) - The U.S. Securities and Exchange Commission is considering whether the growth of high-frequency trading has made markets more or less efficient for long-term investors, including those trading small- and mid-cap stocks, an SEC official said on Wednesday.

The market regulator plans to issue a discussion paper early next year on high-frequency trading, where banks, hedge funds and proprietary firms use sophisticated computer algorithms to make markets and profit from tiny spreads and imbalances.

"The most important thing that (the SEC) is focusing on ... is how are long-term investors doing," and whether markets are meeting the needs of both individuals and institutions such as pension and mutual funds, Daniel Gray, senior special counsel in the SEC's division of market regulation, told a conference here.

High-frequency critics, Gray noted, say markets in the last few years have become less efficient for long-term investors as trading went increasingly electronic, despite lower transaction costs. "This is going to be one important issue that's going to be addressed by the commission," he said.

"We're not just going to look at the top 100 stocks and ask how they're trading. We'll look at mid-cap stocks, small-cap stocks as well," Gray said, adding the SEC will also consider whether smaller institutions have the tools needed to trade efficiently.

"In today's markets, can mid-sized institutional investors trade efficiently in mid-cap stocks?" he said at the FPL Americas conference.

High-frequency traders are estimated to account for some 60 percent of all U.S. equity trading volume. Using lightning-fast trading techniques, they have replaced floor specialists and slower trading firms as the new market makers. (Reporting by Jonathan Spicer; Editing by Steve Orlofsky)