SEC Subpoenas Wall Street in Expanding Hunt for `Manipulators'

SEC Subpoenas Wall Street in Expanding Hunt for `Manipulators'


July 16 (Bloomberg) -- The U.S. Securities and Exchange Commission subpoenaed Wall Street's biggest firms and hedge-fund advisers in a widening effort to crack down on suspected manipulation of Lehman Brothers Holdings Inc. and Bear Stearns Cos. shares, three people familiar with the situation said.

The SEC's enforcement unit demanded information from banks including Deutsche Bank AG, Goldman Sachs Group Inc. and Merrill Lynch & Co., according to two of the people, who declined to be identified because the inquiries aren't public. The Washington- based regulator is seeking trading records and e-mails, one of them said.

The subpoenas mark a new front in the broadest U.S. investigation of Wall Street trading since state and federal regulators homed in on mutual-fund abuses in 2003. The SEC issued an emergency order yesterday curtailing short selling in financial stocks, including Lehman and mortgage-finance companies Fannie Mae and Freddie Mac. The agency is also examining whether securities firms have adequate internal controls to thwart misconduct.

``The SEC is trying to determine whether there was illegal manipulation of market prices, and that is far easier to do if you have a broad sweep,'' said Tamar Frankel, a law professor at Boston University.

SEC Chairman Christopher Cox, 55, told the Senate Banking Committee yesterday the agency is investigating whether illegal trading contributed to the collapse of Bear Stearns in March and the 80 percent drop in the market value of larger rival Lehman Brothers this year. The probe focuses on traders who seek to profit by intentionally spreading false information about the firms.

SAC, Citadel

SEC spokesman John Nester declined to comment on the subpoenas, as did Deutsche Bank spokesman Ted Meyer, Goldman spokeswoman Andrea Raphael and Merrill spokesman Mark Herr. It is Merrill's policy to cooperate with regulators, Herr said.

More than 50 hedge funds firms including SAC Capital Advisors LLC and Citadel Investment Group LLC have received subpoenas, people with knowledge of the situation said. The Wall Street Journal reported the requests to hedge funds yesterday.

Most of the subpoenas were sent last week, and some recipients are being asked for information relating only to Lehman or Bear Stearns, a person familiar with them said.

The SEC won't limit its focus to individual investors, and will likely sift for ``communications that would suggest traders got together and coordinated efforts for a particular security,'' said Barry Barbash, a partner at Willkie Farr & Gallagher LLP in Washington who previously headed the agency's division of investment management.

Bear's Downfall

The regulator began the probes in March as Bear Stearns's stock plunged on speculation it lacked adequate cash to operate. The drop spurred clients to pull business and forced the firm's sale to JPMorgan Chase & Co. on March 16.

Lehman has struggled since then to quash concerns that have helped push down its stock 78 percent this year. On June 3, the company denied it had borrowed from the Federal Reserve and said cash holdings increased during the quarter. Last week, two of its biggest clients, SAC Capital and bond-fund manager Pacific Investment Management Co., denied they were pulling business.

Cox told officials at the Federal Reserve and U.S. Treasury over the weekend that the agency is stepping up efforts to curb market speculation, a person with knowledge of the talks said.

On July 13, the agency's inspections unit announced plans to cooperate with the Financial Industry Regulatory Authority and the New York Stock Exchange's regulatory arm to check whether firms have controls to prevent the intentional spread of misinformation.

Naked Shorts

Cox yesterday told lawmakers the agency will require traders to obtain shares of brokerages, Freddie Mac and Fannie Mae before betting their shares will fall. The temporary order, to take effect July 21, will bar so-called naked short-selling, in which traders avoid the financial cost of borrowing stocks.

The order requires anyone making a short sale to first ``borrow or arrange to borrow'' the securities and then deliver them by the settlement date. It applies to shares in 19 firms including Citigroup Inc., JPMorgan and UBS AG.

In traditional short selling, traders borrow stock through a broker and hope to profit by selling shares at a higher price and later buying them back at lower prices to repay the loan. Naked short sellers do the same thing, with one difference: They don't borrow any shares, which means they can drive down prices by flooding the market with orders to sell shares they don't have.

Freddie Mac, down as much as 34 percent today before Cox's comments, fell 26 percent to $5.26 in New York Stock Exchange composite trading. Fannie Mae tumbled 27 percent. Lehman rose 82 cents, or 6.6 percent, to $13.22, ending a four-day slide.

`Home to Roost'

``Small public companies have been complaining for years about the abuses of naked and illegal short selling,'' Roel Campos, a former SEC commissioner now at Cooley Godward Kronish in Washington, said in an e-mailed response to questions. ``The new attention by regulators has occurred when those naked-short chickens came home to roost with Bear Stearns and now Lehman.''

The move drew objections from Friedman Billings Ramsey & Co. analyst Paul Miller, who has an underperform rating on both Fannie Mae and Freddie Mac. Miller said the SEC's crackdown on investors shorting their stock ``stinks of favoritism.''

``This whole administration is trying to jawbone the stock market up,'' Miller said. ``Everybody thinks this is short selling and it's not. It's a fundamental shift in how investors look at these companies.''

The SEC has sanctioned only one person so far for alleged stock manipulation stemming from the credit crisis. In April, a former Schottenfeld Group LLC trader settled claims he spread rumors on Nov. 29 that Blackstone Group LP was lowering a takeover bid for Alliance Data Systems Corp. Alliance Data's shares plunged 17 percent in half an hour that day.

``More of these cases have to be brought,'' Cox said in his Congressional testimony.

Historically, ``it has been difficult to parse where rumors start and where they are being spread,'' he said. Now, technology is ``permitting us to trace back through e-mails and instant messages to the very individuals who have manufactured intentionally false information.''

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