SEC proposes new rules for credit rating agencies

WASHINGTON — Federal regulators on Thursday proposed new rules designed to stem conflicts of interest and provide more transparency for Wall Street's credit rating industry, which 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 new entrants challenging the dominant firms. The proposed rules, which were opened to public comment, could eventually be adopted by the agency, possibly with revisions. The SEC commissioners also proposed a ban on "flash orders" — a practice that gives some traders a split-second advantage in buying or selling stocks.

It has become a hot-button issue in recent weeks amid 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 percent of stock trading. The New York Stock Exchange has never used them.

The credit rating agencies have been widely 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.

One SEC proposal discussed Thursday is intended to bar companies from "shopping" for favorable ratings of their securities. "These proposals are needed because investors often consider ratings when evaluating whether to purchase or sell a particular security," SEC Chairman Mary Schapiro said before the vote. "That reliance did not serve them well over the last several years, and it is incumbent upon us to do all that we can to improve the reliability and integrity of the ratings process."

The SEC commissioners took their action during a week when memories of the collapse of Lehman Brothers a year ago were fresh in Washington. "There is general consensus that the rating agencies contributed significantly to the damage and the widespread loss of confidence," said Commissioner Luis Aguilar. In July, Sen. Charles Schumer, D-N.Y., 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. In California, Attorney General Jerry Brown launched an investigation into the three big agencies 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 "recklessly giving stellar ratings to shaky assets." Word of the probe came after the California Public Employees' Retirement System sued the agencies, blaming them for more than $1 billion in investment losses.

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