SEC Tries to Snuff Out Wall Street Rumors

But the effort to prove malicious intent about Lehman Brothers, Bear Stearns, and other financial firms is as elusive as capturing smoke

Rumors have always been a way of life on Wall Street. But not-so-idle chatter has become a powerful force during the credit crisis, with financial stocks getting pummeled routinely on rumors of bankruptcies, capital shortfalls, and the like. The Securities & Exchange Commission thinks it's gotten out of hand and is launching an investigation into rumor-mongering. It's also cracking down on the short-selling of certain financial stocks.

But the regulatory system draws a huge distinction between wrongheaded blather and bald-faced lies. That's why many think the SEC's probe will bear little fruit. Says securities lawyer Ira Lee Sorkin: "How do you track down smoke?"

The problem isn't the rumors—it's the dismal business environment that has allowed those rumors to resonate. Much of the talk has centered on banks' atrocious balance sheets. Because so many mortgage-related assets are impossible to measure right now, it's easy to jump to the conclusion that any number of banks might be in dire straits. Valuing assets is "nothing more than a guess," says Frank Partnoy, a law professor at the University of San Diego.

It doesn't help that banks keep changing their stories. Last summer, they tried to soothe investors with predictions of a quick end to the credit crunch, only to report massive losses later. After telling some analysts that it would shrink its assets in the first quarter, Lehman Brothers (LEH) reported a rise. For traders, it isn't a huge leap to wonder if there's some fire near that smoke. Or even to wonder aloud.

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