SEC scrutiny of short selling zeroes in on rumors

— -- A Securities and Exchange Commission investigation into whether traders spread misinformation in a bid to drive down shares of financial firms focuses in part on a series of midsummer Wall Street rumors, according to an SEC subpoena.

The SEC also extended the temporary ban on short sales of stock of more than 900 financial firms. The ban would have expired Thursday night.

Served on numerous hedge funds, the subpoena identifies two former investment banks — Bear Stearns and Lehman Bros. — that the SEC believes may have been subject to short-selling manipulation aimed at generating trading profits as share prices in the two firms dropped.

The subpoena, reviewed by USA TODAY, seeks internal trading data, personnel information and e-mail and other communications relating to June and July market rumors that:

•Lehman would get access to the Federal Reserve Bank's discount window.

•British bank Barclays would buy Lehman for $15 a share (its market price was near $20).

•Major investment firms SAC Capital and Pimco had stopped trading with Lehman.

Other SEC subpoenas issued in the investigation cite similar rumors involving Bear Stearns, according to a person with direct knowledge of the investigation who declined to be identified because the case is ongoing.

The SEC subpoenaed the information to investigate if traders originated or spread the rumors to profit from short selling Bear and Lehman shares.

Lehman filed for bankruptcy protection earlier this month and subsequently sold its core trading operation to Barclays. JPMorgan Chase jpm acquired Bear in March.

The SEC this month broadened the investigation by ordering dozens of hedge funds to provide similar trading data and communications about trading in the stocks of insurance giant AIG, Goldman Sachs and other firms, according to the person with direct knowledge of the case.

The SEC declined to comment.

It is legal to sell short by borrowing shares and selling them in the hope of profiting by replacing the shares with equivalents bought later at a lower price. But it is illegal to spread false rumors to try to drive down the share price while short selling.

Several financial executives have complained that their companies' share prices were driven down by short sellers spreading rumors seeking to profit from this year's financial crisis.

Along with communications related to market rumors, the SEC subpoena seeks all trading positions for Bear and Lehman from June 1 through early July. It also seeks names of officials responsible for approving trades, details of all client relationships with Lehman and Bear, plus information about any changes in those relationships.

Separately, the FBI launched preliminary investigations of possible fraud involving Lehman, AIG and mortgage giants Fannie Mae fnm and Freddie Mac, fre the Associated Press reported last week.