SEC takes on flash trading and seeks rules for raters
By Ronald D. Orol, MarketWatch
WASHINGTON (MarketWatch) -- Under pressure to take steps to restore faith in the markets, the Securities and Exchange Commission on Thursday proposed to ban "flash trading" and impose new regulations on credit-rating agencies.
The SEC proposals would to stop the practice of exchanges "flashing" an order it receives to some of its participants, rather than seeking out a seller in a competing exchange or marketplace, and would tighten up on credit raters that were considered key contributors to the economic crisis because of their excessively glowing outlooks for subprime-backed securities.
Seeking to solve an inequity in the trading systems, commissioners voted unanimously to propose barring exchanges and trading platforms from allowing their high frequency trader clients to see data about stock orders one second or less before the market gets the information. This so called "flash trading," system permits high frequency traders to get information just before it becomes public.
The SEC also voted unanimously to introduce a variety of rating agency rules, including a measure that would require corporations to disclose "pre-ratings" obtained from rating agencies before a rating firm is actually selected to conduct a rating.
The pre-rating measure is intended to eliminate a practice known as "ratings shopping," in which an investment bank hired by a corporation privately solicits preliminary ratings from multiple agencies for a securitized product and then only pays for and discloses the most favorable rating received. The provision seeks to help investors gain a better picture about the corporation's security rating.
Raters would have to disclose who paid for their ratings and whether it or any of its affiliates provided any services to the corporation receiving the debt rating.
The commissioners also agreed to adopt a rule -- supported by the White House -- that will require raters to disclose to its competitors its data and process for determining a particular credit rating. Rival raters receiving the data would need to use it to produce a secondary rating. The agency's goal would be to have multiple ratings for the same product, which would improve the credibility of the ratings.
All three measures were expected after SEC Chairwoman Mary Schapiro indicated in August that the commission was expected to consider the rules.
"The changes being considered today will benefit investors in many ways," Schapiro said. "The rules we are proposing or adopting will help address conflicts of interest, and prevent ratings shopping, which have to do to improve the reliability of the ratings process."
The agency also proposed a series of other credit-rating agency measures, including a provision that would have rating agencies disclose their entire history of ratings within a year for corporate paid ratings. The measure would seek to provide investors with information about whether a cozy relationship exists between the corporation seeking the rating and the rating firm issuing it. It expands on an existing disclosure rule which requires raters to provide a 10% rating sample of its rating history.
Raters sought a one-year lag before its historical information is disclosed because they believed more frequent disclosure would hurt their ability to obtain and retain businesses.
Flash trading
With the existing flash-trading approach, potential sellers use high-speed technology to see the buy order and respond within a fraction of second. If no buy order takes place, the exchange will route the offer to other markets.
Already some exchanges are voluntarily prohibiting flash trading. Nasdaq said in early August that it was eliminating flash orders.
However, Sen. Charles Schumer, D-N.Y., said he was pleased with the proposal, which he said would enshrine the prohibition. Schumer had pressed SEC to ban flash trades early August.
"This ban, as proposed, is pretty much water-tight and should not be weakened by the commission as the rule-making process goes forward," Schumer said. "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." |
