SEC Set to Target Credit Rating Agencies, Flash Trades

The Securities and Exchange Commission will discuss later today rules to improve oversight of the credit rating industry, long dominated by Moody's Moody's Investors Service, McGraw-Hill's Standard & Poor's, and Fimalac's Fitch Ratings.


At the same hearing, the SEC is expected to propose a ban on flash trades—or buy and sell orders that exchanges send to a specific group of participants before revealing them publicly.

Global policymakers are trying to make credit agencies more accountable after the firms assigned top ratings to products linked to shoddy mortgages that later lost much of their value, costing investors trillions of dollars.

The SEC may force banks to share data used to rate bonds with all credit rating agencies, reducing the risk that investors will buy securities with inflated ratings, people familiar with the situation said.

Data would not be disclosed publicly, but would be shared in an attempt to generate unsolicited ratings for their products, one source said.They requested anonymity because the discussions are private.

The SEC may also require all credit agencies to reveal more information about past ratings so investors could compare their relative performance, with perhaps a one- or two-year time lag, the people said. This requirement would apply regardless whether agencies are paid by issuers or by investors, they said.

The proposals remain in flex as the five SEC commissioners debate the scope of any changes.

The regulator is expected to issue a general discussion paper that questions whether credit agencies should be regulated as 'experts' under securities law, and thus subject to tougher standards of liability. Rating agencies are exempt from such regulation.

In contrast, auditors are considered experts, and are more easily sued over their findings.

The SEC is also expected to consider removing references to credit ratings in some of its rules—a move that would force Wall Street to do more due diligence. This measure is supported by the Obama administration.

The SEC has already proposed removing references to the ratings in most of its rules.

However, the powerful mutual fund industry has trampled over that plan because it would scrap a requirement that money market funds hold investment-grade securities. The agency will not consider removing that particular reference for money market funds at its Thursday meeting.

SEC spokesman John Nester said: 'The commission will consider measures to strengthen oversight of credit rating agencies and improve the quality of ratings through greater transparency and accountability.'

Meanwhile, a regulatory ban on so-called flash trading, which gives some big brokerage firms a split-second advantage in buying and selling stocks, will take time to implement, SEC Chairman Mary Schapiro told CNBC in an interview last month.

"I have talked to the major market participants, investors and the senator, so we are going to look at all the inequities that occur, but it will take some time to make this happen," Schapiro said. "There's a very good argument that it's brought liquidity to the markets. We have the balance the good and the bad. But I believe we are headed [a ban] in that direction."

Flash trading gives certain members of exchanges—including Nasdaq, Direct Edge and BATS— the ability to buy and sell order information milliseconds before that information is made public. High-speed computer software can take advantage of that brief period to allow those members to get better prices and profits. (Click here to read more about the practice)

"We have concern about whether we developing a two tier market where some people have access to more information than others do," said Schapiro. "We are looking into whether they [practices] should be permitted and we'll go through a process as we have to, at the SEC to deal with that."

"My real concern is what kind of transparency should there be post trades,' Schaprio added. "Our guide posts in all of this will be investor protection."

Schapiro said the SEC is also looking at so-called dark pools, a method through which large Wall Street brokerages make deals away from the markets, Schapiro said there's no decision yet on whether to ban them.

"I think the jury's out right now on them on whether they are appropriate," said Schapiro. "I think there is a need for anonymity in some cases."

As for reinstating the uptick rule, which requires that every short sale transaction be entered at a price that is higher than the price of the previous trade, Schapiro again said there's no decision yet. "We are still hearing from investors on the uptick rule and circuit breakers," Schapiro said. "But I would like to resolve the short shelling issues by the year's end."

Asked to comment about the reported tirade of Treasury Secretary Timothy Geithnerto her and others at a meeting last week about not supporting the Obama administration's plan for regulation reform, Schaprio said that eventually everyone would be on board together and the differences were minor.

—Reuters contributed to this report.