SEC Opens Bear Stearns Stock Manipulation Inquiry, People Say

SEC Opens Bear Stearns Stock Manipulation Inquiry, People Say

March 18 (Bloomberg) -- U.S. regulators are investigating whether traders illegally sought to force Bear Stearns Cos. shares into a tailspin last week by spreading false information about the firm's finances, two people familiar with the inquiry said.

The Securities and Exchange Commission probe is focusing on whether hedge funds or other investors bet on a drop in the company's shares while disseminating rumors that the New York- based company was nearing collapse, said the people, who declined to be identified because the inquiry isn't public. The New York Stock Exchange's regulatory arm is also involved in the investigation, the people said.

Speculation about a cash shortage spurred customers and lenders to pull money from Bear Stearns last week, driving the shares down 57 percent between March 7 and March 14. Two days later, the fourth-largest U.S. securities firm was acquired by JPMorgan Chase & Co. for $2 a share. The company's decline coincided with a surge in investor bets that the stock price would plunge. The SEC's probe is unusual because most of the regulator's stock-manipulation cases focus on penny stocks.

``The commission is in uncharted territory,'' said Peter Henning, a former U.S. Justice Department prosecutor who teaches at Wayne State University Law School in Detroit. ``The problem will be separating out the trading from the noise in the market. There was a lot of speculation about Bear.''

SEC spokesman John Nester and NYSE spokesman Scott Peterson declined to comment. Bear Stearns spokesman Russell Sherman didn't return a phone call seeking comment. The SEC is seeking to question traders who profited from options or short sales, one of the people familiar with the probe said.

Shareholder Losses

The case underscores regulators' concern that malicious rumors have the potential to fuel market panic and exacerbate shareholder losses on financial stocks. Bear Stearns had more than $17 billion in cash and salable assets on March 11 when lenders and customers began removing funds, the SEC said in a March 14 statement.

Bear Stearns Chief Executive Officer Alan Schwartz repeatedly sought to stanch the speculation last week. After clients pulled funds and creditors stopped renewing short-term loans, the Federal Reserve orchestrated a bailout on March 14 by providing funding to the company through JPMorgan.

``We have tried to confront and dispel these rumors and parse fact from fiction,'' Schwartz said in a statement that day. ``Nevertheless, amidst this market chatter, our liquidity position in the last 24 hours had significantly deteriorated.''

Piling On

It may be difficult for the SEC to discern who was trading illegally because investors may have been ``piling on'' as speculation spread, said James Cox, a securities law professor at Duke University in Durham, North Carolina. To prevail in a manipulation case, the SEC would have to show that a trader intentionally spread false information about Bear Stearns while seeking to profit from its potential affect on the shares, he said.

Bear Stearns is the biggest financial blowup since hedge fund Long-Term Capital Management LP's $3.6 billion rescue almost a decade ago. The losses end 85 years of independence for a firm that survived the Great Depression. In all, banks have logged $195 billion of asset writedowns and credit losses linked to subprime home loans since the start of 2007.

BLOOMBERG