April 26 (Bloomberg) -- Barclays Plc, Europe's biggest underwriter of corporate bonds, used confidential information from serving on creditors' committees to trade securities of bankrupt companies, two people with knowledge of a government investigation said.

The U.S. Securities and Exchange Commission has evidence that Barclays profited from advance knowledge of market-moving developments its analysts and traders received from the bankruptcy panels, said the people, who declined to be identified because the three-year probe isn't public. London- based Barclays is in talks to settle SEC allegations that it broke insider-trading rules, they said.

The investigation highlights the potential for conflicts of interest as banks lend money to foundering clients while also trading their securities. Barclays, the U.K.'s third-largest bank, more than doubled trading revenue from credit products, including bonds and loans, in the past two years.

``As we come to the end of the business cycle and are likely to see more troubled companies in workout situations, this is a timely marker for the SEC to put down against a practice that really can't be tolerated,'' said Mark Radke, a former SEC official now at LeBoeuf, Lamb, Greene & MacRae LLP in Washington. ``Commercial banks have increasingly built up their proprietary trading operations, so the issue is more and more acute.''

Declined Comment

Barclays spokesman Peter Truell and SEC spokesman John Nester declined to comment.

In a March 26 filing with the SEC, Barclays said it ``independently addressed the practices, policies and procedures at issue'' before the regulator's probe began.

``Barclays has cooperated with the SEC staff during its investigation and is in ongoing negotiations with the staff to resolve the matter,'' the bank said in the filing. ``Barclays does not expect that the amount of any settlement would have a significant adverse effect on Barclays financial position.''

Some of the trading under investigation by the SEC dates back to 2002, and those involved are no longer at the bank, the people familiar with the probe said. Since then, default rates on high-risk bonds have declined to the lowest in a decade, according to data compiled by Moody's Investors Service.

Securities firms, hedge funds, private-equity managers and law practices are hiring traders, bankers, investors and attorneys specializing in bankruptcies and so-called distressed debt, anticipating an increase in defaults as the economy slows.

Record Revenue

Bear Stearns Cos., the fifth-largest U.S. securities firm, said last month that distressed debt helped fuel record first- quarter revenue in its credit-products department.

Barclays may reach a settlement agreement with the SEC in the next few weeks and probably will pay a fine, the people said. The bank's net trading income increased 56 percent last year to 3.6 billion pounds ($7.2 billion), helping boost net income by 33 percent to almost 4.6 billion pounds.

Insider trading is illegal when it involves exploiting confidential, market-moving information unknown to other investors. The practice ``undermines investor confidence in the fairness and integrity of the markets,'' according to the SEC.

U.S. bankruptcy committees are made up of lenders, bondholders, suppliers, and in some cases, labor unions, and are usually selected by federal government officials. Barclays faced allegations of similar misconduct in 2003 after it served on a creditors' committee that supervised the debt restructuring of Galey & Lord Inc., a New York-based textile maker.

Secret Buys

Merrill Lynch & Co., the biggest U.S. brokerage firm, and other members of the Galey & Lord bankruptcy panel sued Barclays, claiming it ``callously placed its own pecuniary interests over the interests of the committee and its unsecured creditor constituency.'' They said Barclays secretly bought Galey & Lord bank debt after getting inside information about the company, according to the 2003 complaint.

Barclays paid $2 million in 2004 to settle the case without admitting or denying wrongdoing.

Lachlan Edwards, the head of Goldman Sachs Group Inc.'s restructuring group in Europe, said this month that lenders shouldn't also be traders.

Selling ``ever more complex'' financial services to struggling companies while betting on distressed debt ``has the potential to result in the wrong product or a conflict of interest,'' Edwards wrote in the April issue of International Financial Law Review. ``The former is bad for the company (and often for the creditors) and the latter bad for the investment bank.''

New York-based Goldman is the world's biggest debt trader by revenue.

False Claims

The SEC has cracked down on abuses on bankruptcy committees before. The agency sued Van Greenfield, manager of New York- based hedge fund Blue River LLC, for gaining a spot on WorldCom Inc.'s creditors' panel in 2002 by falsely claiming to own $400 million of the company's bonds. Greenfield settled in 2005.

A lawsuit filed last month against Barclays by a former analyst on its distressed-debt trading desk in New York shows how the bank may have broken securities rules.

Michael Econn said his supervisor ``directed'' employees to join bankruptcy committees, ``thereby potentially gaining nonpublic information.'' Analysts on the desk served on panels for companies including Galey & Lord and UAL Corp., the parent of United Airlines that filed for bankruptcy in 2002.

The supervisor, Steven Landzberg, then traded the companies' bank loans and bonds, saying he was allowed to, so long as counterparties signed ``Big Boy letters,'' acknowledging that Barclays ``might have nonpublic information,'' according to the complaint, filed March 26 in Federal District Court in Manhattan. Econn said only six of the letters have been found ``out of thousands of trades.''

Legal Fees

Econn, who worked at Barclays from 2000 to 2004, claims in his suit that the bank forced him out and then stopped paying his legal fees after he cooperated with the SEC's insider- trading probe. Econn's attorney, Anne Vladeck in New York, declined to comment.

``Mr. Landzberg cannot comment on the details of the allegations in Mr. Econn's complaint because of a pending SEC investigation,'' Landzberg's lawyer, David Spears of Spears & Imes LLP in New York, said in an e-mail. ``Econn's complaint contains numerous misstatements and inaccuracies regarding Mr. Landzberg, and it should be viewed as the product of a disgruntled former employee who is seeking money.''

To contact the reporter on this story: Otis Bilodeau in Washington at obilodeau@bloomberg.net

Last Updated: April 26, 2007 19:18 EDT