Aug. 21 (Bloomberg) -- Incorrect securities pricing found at Credit Suisse Group AG, Morgan Stanley and Lehman Brothers Holdings Inc. is more widespread and will be investigated, the U.K.'s financial regulator said today.

The Financial Services Authority said it will begin the probe next year after finding that securities valuations at a ``large number'' of London banks were ``materially flawed or inadequate,'' the agency said. The problems may worsen if banks fire compliance and risk officers, the FSA said.

``We recommend that you consider carefully any headcount reduction exercises that will affect valuation-control functions at this sensitive time,'' FSA Chief Executive Officer Hector Sants wrote in a letter to CEOs last week and made public today.

Incorrect pricing on London trading desks has contributed to $2.8 billion of writedowns. The FSA letter comes a week after the U.K. operations of Credit Suisse, Switzerland's second- largest bank, was fined 5.6 million pounds ($10.6 million) for failing to properly oversee pricing of asset-backed securities.

Spokeswoman Teresa La Thangue declined to say how many mis- marking incidents the FSA has uncovered or name companies targeted. ``The fact that we've sent a `Dear CEO' letter isn't unprecedented, but it's rare,'' La Thangue said. ``It means that it's an issue we're taking very seriously.''

The FSA will be visiting firms and ``wielding a big stick,'' said Patrick Buckingham, a regulatory lawyer at Herbert Smith and a former Lehman Brothers in-house lawyer. ``The FSA has been chomping at the bit to bring an enforcement case based on a lack of systems and controls.''

`Negative Adjustments'

Credit Suisse joined at least three of its competitors in identifying incorrect pricing this year. The Zurich-based bank had to write down holdings by $2.65 billion when it discovered the mis-pricings.

Morgan Stanley suspended a credit trader and disclosed $120 million of ``negative adjustment'' in June relating to erroneous valuations of his positions. The New York-based firm said it was cooperating with authorities in London and conducting an internal review. The internal review is continuing, London-based spokesman Wesley McDade said today, declining to comment further.

Merrill Lynch & Co., the third- largest U.S. securities firm, said in May it was probing a trading desks in London and suspended a trader after discovering he may have overstated the value of some of the bank's equity derivatives.

Overstated

The trader, who Merrill declined to identify, traded derivatives based on individual stocks for the firm's own account, according to a person with direct knowledge of the matter. Merrill initially determined that he may have overstated the value of some holdings by less than 10 million pounds in April, when his marks were detected, the person said.

In March, Lehman Brothers, the fourth-largest U.S. securities firm, suspended two London-based equity traders after internal controls identified ``issues'' on share valuations. The sums involved were ``not material,'' an official for the company said at the time.

The regulator hasn't yet investigated the banks. The fine levied on Credit Suisse was based the bank's own review.

The marking incidents reflect common traits, including poor oversight of traders and a lack of seniority for product-control staff, the FSA's letter said.

Securities firms in London and New York have slashed more than 100,000 jobs in the past year as investment-banking revenue fell. Job openings in London's financial-services industry declined for the seventh straight month in July, a survey released today by recruitment firm Morgan McKinley showed.

Difficult to Value

The FSA is particularly concerned that fair-value accounting, a process companies use to put a price on difficult- to value assets, doesn't properly reflect the fluctuating value of complex and illiquid products such as collateralized-debt obligations, securities derived from a bundle of debt.

Fair value is the price at which an asset could be bought or sold in the current market. Assets have to be given a fair value on balance sheets, even if companies intend to hold them to maturity. Policy makers globally are grappling with how assets can be given a fair value in illiquid markets.

To contact the reporters on this story: Caroline Binham in London at cbinham@bloomberg.net Joyce Moullakis in London at 7939 or jmoullakis@bloomberg.net.

Last Updated: August 21, 2008 13:17 EDT