SEC proposes banning ‘flash trading’

updated 8:01 a.m. ET Sept. 18, 2009

WASHINGTON - Regulators on Thursday proposed banning "flash orders," which give some traders a split-second edge in buying or selling stocks.

They also proposed rules designed to stem conflicts of interest and provide more transparency for credit rating companies.

The changes, which were opened to public comment for 60 days, could eventually be adopted by the agency, possibly with revisions.

The credit rating industry was widely faulted for its role in the subprime mortgage debacle and the financial crisis. The five members of the Securities and Exchange Commission voted at a public meeting to propose rules that could reshape an industry dominated by three firms: Standard & Poor's, Moody's Investors Service and Fitch Ratings. Their practices would be opened wider to public view and subject to some restraints.

Regulators say they also hope to spur more competition in the rating industry, with possibly new entrants — as well as the other seven existing agencies — challenging the dominant firms. One of the SEC's proposals is intended to bar companies from "shopping" for favorable ratings of their securities, by requiring companies to disclose whether they had received preliminary ratings from other agencies.

Meanwhile, flash orders have become a hot-button issue in recent weeks amid questions about transparency and fairness on Wall Street. A flash order refers to certain members of exchanges — often large institutions — buying and selling information about ongoing stock trades milliseconds before that information is made public. Some big banks and financial companies, using high-speed computer programs, can get a quick, sneak peek at how others investors are trading, giving them a fleeting glimpse into the direction of the market.

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 percent of stock trading. The New York Stock Exchange has never used them.

In July, Democratic Sen. Charles Schumer had called on the SEC to ban flash orders, threatening legislation if it failed to act. "This proposal will once and for all get rid of flash trading, which if left untouched, could seriously undermine the fairness and transparency of our markets," Schumer said in a statement Thursday.

The rating agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company's ability to raise or borrow money, and at what cost which securities will be purchased by banks, mutual funds, state pension funds or local governments.

But the rating agencies 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 writedowns at big banks and investment firms.

In a rule that was formally adopted Thursday, the agencies will have to disclose the history of their ratings actions, which normally include reasons for them, back to mid-2007 — when the SEC gained authority to regulate the agencies by law.

Also, agencies that are paid by companies to rate complex securities — such as those underpinned by mortgages or student loans, as opposed to more traditional corporate or municipal bonds — must now notify the other agencies that it is in the process of determining the rating.

MORE FROM U.S. BUSINESS

U.S. business Section Front

AIG, ex-CEO Greenberg settle disputes U.S.-made drywall also being investigated NYT: Medical debt spurs more bankruptcies Washington Post closing several U.S. bureaus Google sorry for offensive pic in Obama search AIG CEO Benmosche to get $7M pay package 'Problem' banks at highest level in 16 years Microsoft's chief financial officer to step down Is Facebook preparing to go public? Sprint asked to drop ‘most dependable’ claim U.S. business Section Front   Add U.S. business headlines to your news reader: