SEC to Tighten Rules Regarding Rating Agencies

On Thursday the Securities and Exchange Commission proposed rules intended to stem conflicts of interest and provide more transparency for credit rating companies. In addition to this they proposed banning "flash orders.” Flash orders give some traders a split-second edge in buying or selling stocks. The five members of the SEC, headed by Mary Shapiro, voted at a public meeting to propose these rules. The changes are open to public comment for 60 days.

Regulators say they also hope to spur more competition in the rating industry, with new entrants challenging the dominant firms. In addition, these rules are hoped to make trading practices more transparent.

Flash orders, a headline issue in recent weeks, has raised questions about transparency and fairness on Wall Street. Nasdaq OMX Group Inc., which operates the Nasdaq Stock Market, and the BATS exchange have voluntarily stopped using flash orders, which made up an estimated 3% of stock trading. The New York Stock Exchange has never used them.

The credit rating firms have been criticized for failing to identify risks in securities backed by subprime mortgages. They had to downgrade thousands of the securities last year as home-loan delinquencies soared and the value of those investments plummeted. The downgrades contributed to hundreds of billions in losses and write-downs at big banks and investment firms.

One SEC proposal discussed Thursday is intended to bar companies from "shopping" for favorable ratings of their securities.

In addition, the rating firms would have to publicly disclose every entity that paid for a credit rating. They also would have to provide more information about income earned from companies they rate.

In a rule that was formally adopted Thursday, the companies will have to disclose the history of their ratings actions back to mid-2007.

In California, Atty. Gen. Jerry Brown launched an investigation into the three big credit rating firms, Standard & Poor's, Moody's Investors Service and Fitch Ratings, to determine what role they might have played in the collapse of the financial markets. Brown said he had subpoenaed the three firms to determine whether they violated state law in giving high ratings to relatively unstable assets.

In July, the California Public Employees' Retirement System sued the companies, saying the three ratings firms had lured the fund into bad investments. The nation's largest public pension fund blames them for more than $1 billion in investment losses.

The SEC commissioners took their action during a week when memories of the collapse of Lehman Bros. a year ago were fresh in Washington.